Oil price crash could help India's economy but will hurt country's OMCs

Before estimating the possible bonanza for the Indian economy from the massive drop in oil prices, check this out. In late February, the Economist Intelligence Unit (EIU) issued a report about the top five global risks for 2020. The first of those was a possible escalation in global oil prices to about $90 dollars a barrel: “The Economist Intelligence Unit estimates that there is a 25 per cent chance that the US and Iran will be dragged into a direct, conventional war, which would have devastating consequences for the global economy... a prolonged disruption to oil supplies could cause oil prices to rise to as much as US$90/barrel, fuelling a rise in global inflation and dampening consumer and business sentiment”.
 
By March 9, oil prices have crashed to $31 a barrel, down nearly 30 per cent. The drop was already coming. It was aggravated, as a Business Standard report notes, since the world’s biggest crude oil producers failed to agree on production cuts, kicking off a price war. A Bloomberg Quint report notes that Brent Crude fell the most since the 1991 Gulf War “dropping 31 per cent in a matter of seconds, after Friday’s OPEC+ meeting broke up in disarray”. A war, whether between the US and Iran or among the oil producers will certainly correct the prices, bringing them up from the free fall.
 
Meanwhile, using the ballpark figure of Rs 2,900 crore savings in import bill for each dollar drop in oil prices will translate into an annual savings of Rs 2.1 trillion for the Indian economy (assuming a $20 drop in the price of Brent Crude). These are big savings for the economy, which faces a huge headwind to growth from the coronavirus-led global growth slowdown. There are other positives. Spot prices of LNG have more than halved year-on-year to a decadal low to less than $3 per million metric British thermal units (mmBtu) because of oversupply and the coronavirus outbreak. This is happy news for those companies planning to invest in city gas investments for homes and setting up CNG pumps. The viability of their planned Rs 50,000 crore capital expenditure has improved, which “augurs well for both volumes and operating margins of distributors, and consequently, project returns”, notes a Crisil report.

What is the flip side? The upending of forecasts by the current free fall also make it clear that the global oil economy is in serious trouble. This has implications for the gas economy’s viability too. One of those could be the impact on our own oil and gas exploration companies. If the prices of oil threaten to remain at such low levels, both government-run ONGC and Oil India as well as private sector RIL-BP or Vedanta could find it extremely unprofitable to dig more fields, even for gas. It will mean the banks that have financed some of the debts are into fresh trouble. There are no comparable figures for India’s investment-grade energy debt as in the global markets but with those overseas being pulled down so low will not make the banks or anyone else financing the projects happy.
 
That is only one of the issues. The other is the massive investment plans the state-led companies from West Asian countries have for India. All those investments are meant to shore up capacity for the use of oil or gas in India. Last year Aramco, Adnoc and many others had come calling to bid for properties. If fuel prices remain so low, there is little incentive for them to make those outlays. It is partly for this reason that the Indian markets crashed practically out of sight this morning. The Yes Bank shore-up by SBI and RBI did not help at all to correct the ruin.
 
Of course, in the OPEC world it is extremely difficult to make predictions. Last week some analysts had begun to put out reports that the long bear phase in the energy market was about to get over as Saudi Arabia and Russia reach a deal on deep oil production cuts. Instead we have the free fall on Monday.
 
The road from here becomes choppy. All the oil-producing economies have huge sovereign debt. Except the USA, all of them depend on oil revenues to balance their books. The rule of thumb is that oil is profitable to pump out at $40 a barrel. The three giants, the USA, Russia and Saudi Arabia, are all pumping out at less than that. Long ago, Saudi Arabia with its long-depreciated oil wells was the least cost producer of oil. It is not any more. Paradoxically, the slump in the debt market could give the same governments a chance to borrow easily to finance their debt, but this is a risky street for the latter two. For smaller economies, this is of course deep trouble. In any case any loans they can raise depends on how far the markets feel a turnaround will happen. State-run companies will survive the longest with privately-run companies going for the towel sooner. Once one of them does so, it can be a domino effect from there.
 
It could bring up short production from the oil fields and that could potentially begin a turnaround for the oil sector. But it will require a fresh set of investors and even management to begin work on those fields. These in turn have massive costs.
 
India has already begun to get the upside of lower oil prices. Lower investments by the West Asia funds is the downside. This could reverse if the growth rate in the Indian economy turns up. There is a strong relationship between GDP growth rates and growth in oil consumption, especially in India and China (see chart). In two decades since 2001, oil consumption in non-OECD countries declined only three times each coinciding with sharp rise in the price of the fuel. If China, as expected stays in the doldrums, how the global oil prices will behave depends mostly where Indian growth goes from here. This could be the sixth risk in the EIU list.