Indian economy to benefit from slump in international oil prices

The Indian economy will likely see significant benefits in the form of lower current account deficit, reduced inflation and higher GDP following a slump in international crude oil prices, Kotak Institutional Equities Research said on Wednesday.

The collapse in cooperation between Saudi Arabia and Russia has triggered a plunge in oil prices that shows no signs of abating. Saudi Arabia has been cooperating with Russia to limit supply to the oil market and prop up prices.

Market participants had expected OPEC+ (OPEC nations plus 10 non-OPEC oil-producing countries including Russia) to extend production cuts set to expire in March. But faced with the news that Russia would not participate, Saudi Arabia has decided not to go for it alone. The kingdom has signalled it will boost production above 10 million barrels per day.

With coronavirus already savaging demand for travel and transportation, "the world is now drowning in a glut of crude oil that appears likely to persist for months," said Chris Lafakis, Energy Economist at Moody's Analytics.

For India, this may be a boon to pull out the economy from an 11-year low growth rate and rising inflation.

"Lower oil prices provide significant tailwinds to the Indian economy in the form of lower current account (50 basis points of GDP or USD 15 billion for every USD 10 a barrel decline in crude prices), lower inflation (30 bps for every USD 10/bbl fall) and improved government finances/household savings," Kotak said in a note.

The government's tax revenues saw a spike in FY2016 when crude prices fell sharply. States will, however, lose meaningfully from lower product prices given the ad valorem nature of state VAT on petroleum products; they may also raise VAT on automobile fuels though.

Lower crude prices will benefit automobiles (lower cost of ownership), aviation (lower fuel bill), cement (lower pet-coke prices), consumer companies (lower packaging costs), city gas companies (lower gas prices), oil marketing companies (higher marketing margins on automobile fuels) and paints, it said.

"The Indian economy will likely see significant benefits from lower crude oil prices -- lower current account deficit, lower inflation, lower fiscal deficit and higher GDP growth (one-time impact of lower imports)."

However, upstream oil and gas companies such as Oil India and ONGC may make losses if net realized price is below USD 35 per barrel, it said.

Lafakis said to restore oil prices, global fears about coronavirus must ease, oil exploration and production must fall significantly and the geopolitical rift between Saudi Arabia and Russia must be healed.

"Their cooperation has put a floor under oil prices in recent years. But without that alliance, the oil market becomes a Wild West where only the producers with the strongest means of production can profit," Lafakis said.

Even if the coronavirus scare fades, excess supply from Saudi Arabia and Russia will persist.

In a separate note, Moody's Investors Service said current oil price fall are lower in severity than the commodity price drop of 2015-16 and did not view these as a structural shift at this stage.

"We expect that oil and gas companies will actively manage their liquidity in 2020, reducing capital spending and potentially reducing or suspending distributions to shareholders amid lower operating cash flow and limited access to capital markets," it said.

Heightened price volatility and depressed oil and natural gas prices most directly affect the exploration and production (E&P) and oilfield services (OFS) companies, particularly those facing refinancing needs over the next 6-12 months.

By contrast, the midstream sector benefits from its low commodity-price exposure and protective contracts for gathering, transporting and storing hydrocarbons, it said adding the refining sector is balancing the benefit of a sharp decline in feedstock prices with the reduced demand for fuel products in 2020.

The nearly 20 per cent decline in oil prices to less than USD 35 per barrel (bbl) strains all global oil production and leaves insufficient margin for sustainable replacement of the product, it said.

On March 9, the West Texas Intermediate (WTI) US reference crude price fell to USD 31/bbl and the Brent international reference crude price fell to USD 33/bbl. The disruption of liquefied natural gas imports by China related to coronavirus further pressures weak natural gas prices in an oversupplied market.

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"On top of higher volatility in oil and gas prices for 2020, we now expect that the average WTI price will fall outside our medium-term USD 50-70/bbl price range in 2020," Moody's said.

"While a modest price recovery is likely later in 2020, assuming the coronavirus is contained and economic activities start to normalize, overall 2020 price realizations will still be significantly lower than the 2019 average WTI benchmark price of USD 57/bbl."