FALLING OIL PRICES - INDEED A HAPPY NEW YEAR!

By Ruma Dubey

Back from a week-long celebration of Diwali, it was wonderful to see the good cheer continuing with a moderately rising equity market and falling crude prices. The latter is especially much good news.

The news agency, Reuters today reported that Brent Drude has slipped below $86/barrel and this fall, it directly attributed to the report put out by Goldman Sachs, which cut the price forecast for crude, expecting it to hover at $85/barrel in Q1 of 2015 and $80/barrel by Q2, where it expects a situation of pronounced oversupply. Many other analysts, following this estimation from Goldman, cut their price forecast to around $75/barrel. The only lone voice which says that crude could be around $105/barrel is those of Standard Chartered Bank's oil analyst Paul Horsnell. Nigerai, which is a big oil producer is assuming an oil price of $78 per barrel for its 2015 budget.

What about Saudi Arabia? How is it reacting to all these reports? In fact with great nonchalance. Earlier, if prices had fallen to this extent, Saudi Arabia, would have agreed with OPEC to cut production and stall price fall. But this time around, it has opposed production cut and it looks as though, it is waiting to see how far down the prices go. In Sept, despite news of Chinese economy slowing down, it went ahead and increased production by half a percent. And then on 1st Oct, even while prices were falling, Saudi gave discounts to its major Asian customers.

At this juncture, Saudi is not worried as its oil wells are at a stage where cost of oil extraction is lowest; it has recovered all its investments and whatever it makes now is profit. Also all its infrastructure build is based on price of $80/barrel so it really does not have too much to worry at this juncture. It also knows that for USA, to extract shale gas when crude slips below $80/barrel will become unviable. And that is its entire game plan – to bring to a halt USA’s shale gas production. Saudi needs an annual average price of at least $86/barrel to balance its national budget and the current average annual price is around $106. So as one can see, it can wait and watch, to see who blinks first for indeed a long time. Many other the other hand say that Saudi will not hurt its strongest ally, USA and it is not reacting to price fall mainly because, it does not think it needs a higher price and it feels, lower prices could spurt world economy. Well, frankly, we have never really known Saudi to be so altruistic when it came to oil prices.

Venezuela, another big oil producer is worried and has urged OPEC to call for an emergency meeting for a price hike. But Saudi and Kuwait have literally said, “No way!” and have said categorically that they do not plan to change their plans till 2th Nov, the scheduled OPEC meeting.  

For us Indians, naturally this is good news as we import two third of our oil needs, comprising 37$ of import bill. One dollar fall in oil means a direct saving of Rs.40 billion. This means shrinkage in trade deficit and current account deficit too. The benefit which we get directly is that it reduces the subsidy burden on oil marketing companies, which in turn could mean lower fuel prices for us. With petrol and diesel prices now decontrolled, if crude continues to fall, we will have lower prices. And lower fuel prices would mean lower inflation, only to some extent.

Companies which will benefit directly from falling crude prices are mainly upstream oil companies like ONGC, Oil India and less OMCs. These are the obvious gainers. Other big gainer would be paint companies like Asian Paints, Kansai, Berger and Shalimar as 25% of their raw material cost is from a crude derivative and when that price reduces, margins will improve. Analysts say that a 10% fall in crude oil price will boost margins by at least 200 bps. Another gainer will be tyre companies which also uses crude derivatives in its raw material -  in fact it has the double advantage of falling rubber prices too. Sintex is also listed as a big beneficiary as cost of its crude oil polymer, to make plastics will come down. Packaging costs will come down as it also uses petroleum derivative and that means better margins for Essel Propack and even FMCG companies. Airline stocks will also do well as falling crude will help better their balance sheets – a 10% fall in crude will lead to a 300 bps rise in EBITDA margins.

We do not know how long this good time will last. But let’s enjoy the moment as long as it lasts; good moments always pass in a jiffy while the bad ones last a life time.