Not all is lost as oil prices plummet
By: Tavaga Research
Global headlines spelled doom a week ago when the WTI benchmark crude oil fell into negative territory touching negative $40 per barrel for the May delivery contract owing to a global plunge in demand and scarcity of storage capacity for the commodity . Even the Brent Crude benchmark , although subject to floating storage ,fell below $20 a barrel for the first time in two decades.
When the novel Coronavirus travelled to shores beyond China, it sent the entire world into a lockdown. With nowhere to go for most people, and air traffic practically crashing to the ground, the demand for crude oil, the most-used fossil fuel, plummeted.
The last week of April has seen a mild recovery in oil prices with the WTI benchmark trading around the $10 a barrel mark with the Brent Crude counterpart around the $20 a barrel mark. On one hand, the demand has hit rock-bottom but on the other, supply continues to be abundant.
After repeated attempts, the world’s crude oil producers finally seem to agree to the urgent need to curtail supply, as seen in the April 9 Opec (Organisation of the Petroleum-Exporting Countries) meeting. From May 1 till June 30, crude oil production would be cut by 10 million barrel a day
From July 1 to December 31, the cut agreed to 8 million barrel a day, followed by a 6 million barrel a day from January 1, 2021 to April 30, 2022.
All Opec members except for Mexico accepted the resolutions.
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Impact on India
Low crude oil prices is not bad news for India on the whole.
India’s dependence on oil is well documented. It imports 84 percent of our crude oil requirements. So low crude oil prices mean a slashed energy import bill for the country. It also gives a chance for restoring the fiscal balance to a degree.
When the economy is already hit with recessionary pressures, compounded by Covid-19 prevention lockdowns, it could mean energy savings the central government could then spend elsewhere and boost the flagging economy.
The variant of oil purchased by India is dictated by a basket which is a weighted average cost of Oman,Dubai and Brent Crude .
For India , this may be a boon to pull out the economy from the current slump and waive away fears of inflationary pressures in coming months. Although ,the Indian basket hasn’t seen a sharp decline recently ,there’s bound to be a fall. But ,this won’t translate to a commensurate dip in retails prices of petrol and Diesel.The government is desperate for tax revenues right now and the only way to make an extra buck would be through increasing taxes on oil.
The rupee also gets a moment to breathe. Falling dramatically against the dollar, a lower crude oil bill would mean petroleum companies importing crude oil would be shelling out less dollars. In turn, it lowers the demand for dollars and hence, helps restore some value to the rupee.
While our fiscal deficit is high, with a target of being lowered 30 bps to 3.5 percent in 2020-21, the low prices of oil will let some pressure off.
Why are petrol prices rising when crude is down?
There are more components in the retail price of our fuels than global crude oil prices. The other components include excise duty, Vat (Value added tax), BS-IV premium, marketing cost, and margins and dealers commissions.
Crude oil once cleaned by the processing companies is then sold to dealers, who in turn distribute the final fuel to retail fuel pumps. Taxes on fuel cost are charged by both the central government and the state government. While the central government charges excise duty, the state government charges Vat, with petroleum products accounting for roughly 30 percent of state governments’ revenues.
The central excise which is charged on a litre of petrol is Rs 19.98, while for diesel, it is Rs 15.83 a litre. The central government also charges custom duty on the import of crude oil, which is 2.5 percent of the import price.
Vat may range from 6 percent on petrol in Andaman and Nicobar to as high as 33 percent on petrol in Madhya Pradesh. Lakshadweep is the only Indian state which does not charge Vat on petrol and diesel.
As it is, both central and the state governments stand to lose a large swathe of revenue due to the lockdown, grounding all flights and banning vehicular traffic.
What is making matters worse is the rupee continues to be battered. While falling crude prices can restore value to an extent, other factors are rendering rupee cheaper by the day against the dollar. It is resulting in steeper oil bills.
With the falling crude oil prices several sectors in India may stand to benefit. Companies in sectors like paints, tyre, cement, chemicals, pipings, aviation will be the biggest beneficiary because most of them use crude oil as their raw material.
Meanwhile, the lack of storage space at Cushing that triggered WTI’s sub-zero dive doesn’t look likely to improve by the time the June contract expires, although the realization that prices can actually turn negative may help avoid a repeat in mid-May.
Oil price fluctuation
Oil price fluctuations are inevitable. When it fluctuates, producers, investors, and analysts are affected. The key factors which dictate oil prices include demand-supply dynamics, geo-political events, and Opec policy interventions.
The US shale oil and gas industry picked up steam a decade ago and has led to rapid growth in the US’ oil production. As a result, Saudi Arabia and other oil-producing West Asian countries have seen their market share gradually decline.
The damage to oil-producing countries
These low crude prices will send shockwaves across the globe, and will most probably wipe out small players who cannot sustain these price levels. Saudis have the capacity to produce more oil and can break even at lower output prices.
Oil and gas income for many small players who are members of Opec is set to decline to 50-85 percent in 2020 according to the Wall Street Journal.
Oil companies in the US are highly leveraged and cannot sustain oil prices at $25-30.
Venezuela and Iran, hit by US sanctions, and members of Opec have sought $5 billion each in emergency funds from the IMF.
It has to be seen how well the world takes to Opec’s supply adjustments once it starts picking up the pieces.