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Volatility in energy prices likely

As supply adjusts to demand, even share prices across the petroleum value-chain would also swing a lot

Devangshu Datta 

The 2015-16 budgetary estimates (BE) assumed the Indian crude oil basket would cost an average of $70 a barrel in the financial year. The basket (a weighted average of several grades of oil, including Dubai, Oman, North Sea Brent) has averaged around $56 a barrel between April and October.

That has meant a much lower import bill than estimated. Between April and September, it has led to savings of about Rs 45,000 crore on crude imports. If these prices last, it could mean savings of Rs 90,000 crore over the financial year. Also, about Rs 4,000 crore has been shaved off the subsidy bill.

ICRA estimates that at current dollar-rupee rates, every $1 a barrel decrease in crude oil prices leads to a reduction of the import bill by Rs 6,500 crore, and also eases under-recoveries by the oil marketing companies (OMC) by Rs 900 crore. Also, a drop of $1per barrel means the petro-subsidy bill dips by Rs 600 crore. If the basket stays below $60, the government will not force upstream producers like Oil and Natural Gas Corporation (ONGC) and Oil India Limited (OIL) to contribute to the subsidy.

It is harder to calculate the impact of soft gas prices. But, there have been substantial savings, both in terms of cheaper LNG spot-cargo imports and also cheaper domestic prices. The latter are revised every six months. The latest reset saw an 18 per cent cut from the previous price.

Lower prices have allowed price "decontrol" in commonly-used fuels. OMCs are now allowed to set and revise pump prices of diesel, aviation turbine fuel and petrol, every fortnight. However, the OMCs are owned by the central government and hikes are sometimes delayed due to political considerations. This is one reason why privately-controlled refiners such as Essar and Reliance are hesitant about the retail business.

The Indian basket fell to a low of $46-47 in January and hit a recent low of $48-49 in August. Last month, however, there has been bottoming out. The basket was again pushed above $51 per barrel. If the Northern winter is cold, there will be high demand for fuel oil for central heating. The US Energy Information Administration (US-EIA) also projects that global oil demand will grow strongly in calendar 2016. This is not necessarily true.

America's technological prowess created a revolution in shale mining which brought huge new supplies to market. The US found ways to mine gas and oil stuck inside shale and rock formations, by "frakking", or fracturing the rock by drilling multiple holes and pumping liquids in at high pressure to force the gas/oil out. This is environmentally damaging and expensive but it meant new deposits could be tapped.

Organization of the Petroleum Exporting Countries (Opec), led by Saudi Arabia and Russia, has fought back by maintaining production, despite low demand and increased shale supplies. This has led to a glut of cheap oil, which has forced some shale operators out of business. As of now, the number of rigs deployed in shale operations is less than half the number 12 months ago. Iran is also returning to the global market, which will mean more supply and, possibly, lower prices. So, more shale producers could go bankrupt and shale ops cannot be quickly rebooted. Put another way, Opec can cut production quicker than shale operators can increase it.

In 2016, if global demand rises, and the shale industry has reduced production, the supply-demand equation could swing in the other direction. We could see a sudden spike in crude prices. That would be an acid test of the commitment to decontrol. It is much easier politically to pass on price cuts than to allow rising prices to play out unchecked.

As said above, the US-EIA predictions might well be wrong. Global growth will not rise much next year and demand is linked to that. But, crude prices might have bottomed out. If OPEC and other conventional producers regain control of the market, they can manipulate supply to force prices up. And, at some stage, prices will surely recover. Whatever the timeframe, high crude and gas prices will have an unpleasant impact on India's economy.

Next year is likely to see volatility in energy prices, with sudden spikes and falls as supply adjusts to demand. Uncertain directional trends will translate into substantial volatility in energy industry share prices. The last year has seen OMCs register a turnaround, while producers have lost a little ground. If crude prices start bouncing around unpredictably, share prices across the petroleum value-chain would also swing a lot. Be prepared for that.

First Published: Sun, October 18 2015. 22:09 IST