The impact of lower oil prices
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Brent crude prices dropped to a three-month low on 14 March to $51 a barrel (see chart). That’s despite Opec’s (Organization of the Petroleum Exporting Countries) efforts to cut production and stabilize the market. Increasing rig counts and high oil inventories in the US are weighing on crude oil prices.
What’s more, as Sugandha Sachdeva, assistant vice-president and in-charge (metals, energy and currency research) at Religare Securities Ltd, points out, sentiments have further soured as Opec in its recent monthly report increased its 2017 forecast for oil production outside the group, which indicates the oil markets may take long to move close to balance.
In its latest monthly oil market report, Opec said for 2017, non-Opec oil supply is now projected to grow by 400,000 barrels per day (bpd) to average 57.74 million bpd, up by 160,000 bpd from the February report. This is driven by higher expectations for Canada, the US and Russia. “It seems that the oil supply recovery is gathering momentum in the world oil market, stimulated by gradually rising prices as well as improvements in drilling efficiency and well productivity in North America,” said Opec.
Sachdeva says: “In fact, it won’t be surprising if Brent crude drops to $47 a barrel in the near term, as it has shifted gears to downside after the prolonged consolidation phase.”
Lower oil prices are good news for India, considering we import a huge portion of our oil requirements. It will lower inflation.
In general, the drop in crude oil prices should lead to a decline in global petroleum product prices as well. Locally, apart from global petroleum product prices, the rupee-dollar exchange rate also plays an important role in determining prices.
Lower prices tend to have a positive effect on demand for products. But, according to data from Petroleum Planning and Analysis Cell, domestic petroleum products consumption growth in the country has slowed down in the last three months. As of now, analysts think this is temporary and hence, there is nothing to worry about yet as far as oil marketing companies (OMCs) —Bharat Petroleum Corp. Ltd, Hindustan Petroleum Corp. Ltd and Indian Oil Corp. Ltd—are concerned.
Further, lower oil prices reduce cost of fuel and loss wastage (cost incurred for running the refinery and the fuel lost in the system) for OMCs. Also, sharp crude oil price movements in a short period of time determine inventory gains and losses for these companies. Shares of OMCs have outperformed the benchmark Sensex by a good margin in the last one year, capping near-term upsides.
For upstream oil companies— Oil and Natural Gas Corp. Ltd and Oil India Ltd, lower oil prices don’t augur well, as they translate into lower net price realization. These stocks have outperformed the benchmark Sensex in the past one year too. However, lower crude oil prices pose a risk to any potential expansion in valuations in the near future.
Finally, what’s the outlook on crude oil prices? The chart provides an answer. Note how prices have fallen almost to the level they were at last November. According to Sachdeva of Religare Securities, though sporadic pullback rallies are quite likely after the steep decline, broadly the outlook on crude oil prices is bearish what with the US Federal Reserve expected to hike interest rates and the expected strength in the dollar, which will be negative for oil prices.