Mumbai: Finance minister Pranab Mukherjee on Tuesday said declining oil prices will help the government manage inflation and reduce its subsidy burden, but industry executives and analysts cautioned the fall could be shortlived.
Brent crude oil, trading at $103.85 a barrel at the time of writing this report, has declined 10.8% in the past week and 11.8% over a month, mainly because of worries about the health of the US and European economies. It briefly dipped below $100 a barrel for the first time in six months to touch $98.74 on Tuesday.
Financial services company Standard and Poor’s downgraded the credit rating of the US by a notch on Saturday, raising fears of a recession in the world’s largest economy.
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Risky assets have turned cheaper in recent days as “renewed fears of recession have mounted”, said a Bank of America Merrill Lynch (BoA-ML) report released on Monday. Brent crude is expected to break below $80 a barrel briefly in the event of a mild recession, it said.
Oil prices have been a key driver of the high inflation that has plagued the Indian economy for nearly two years, as the prices of all essential commodities, which have to be transported from farms and production facilities to the market, rise along with oil.
State-owned oil marketing companies Indian Oil Corp. Ltd (IOC), Hindustan Petroleum Corp. Ltd (HPCL) and Bharat Petroleum Corp. Ltd (BPCL) also want oil prices to fall as it lowers their losses because of selling fuel below the market price.
The government pays the state-run oil marketing companies to offset part of their losses, while the rest is absorbed by these companies. So, falling oil prices will also bring down the government’s subsidy bill.
The so-called under-recoveries, or losses because of selling fuel below the market price, for oil marketing companies are estimated to be Rs 1.15 trillion for the current fiscal year. The amount could have been 32% higher had the government not raised the prices of diesel, kerosene and cooking gas in June.
A $10 drop in crude oil prices could lead to under-recoveries for Indian OMCs coming down by roughly Rs 20,000 crore, said Alok Deshpande, oil and gas sector analyst at Elara Securities (India) Pvt. Ltd, the local unit of a UK-based brokerage.
S.K. Joshi, BPCL’s director of finance, said the sharp drop in oil prices appeared to be a kneejerk reaction to economic worries in the US and Europe. Oil marketing companies, he said, will have to wait and see where the price finally settles.
“It has happened in the past that crude prices fall and then reverse in three or four days,” Joshi said. “Petrol prices are now linked to the market and if crude prices remain low, its prices will come down as well.”
An executive at another state-owned oil marketing company said a clearer idea of the impact of falling crude prices on under-recoveries will emerge only after 15 August, in a fortnightly review of oil prices. The executive asked not to be identified.
BoA-ML also said imminent monetary measures to spur demand in the US and Europe can see crude prices rebound.
“A recession driven pullback in Brent crude oil due to economic weakness could be short-lived,” the BoA-ML report said. “Thus, we still lean towards maintaining our average Brent forecast of $114 per barrel for next year, despite growing downside risks.”
If, however, the fall in crude oil prices sustains, then state-run oil companies could be the biggest beneficiaries.
“After analysing other domestic energy majors, we think that only the oil marketing companies has the potential to double its valuations over a three-year period, driven by robust business growth and valuation kickers in the form of reduced under-recoveries,” an Elara Securities report, dated 5 August, said.
Oil marketing companies’ stocks have outperformed other companies in the oil and gas industry over the past week, and have been among the few gainers in an overall declining market.
Share prices of IOC, BPCL and HPCL on the Bombay Stock Exchange gained 8.5%, 4.76%, and 5.48%, respectively, over the last week. The bourse’s benchmark equity index, the Sensex, lost 7% in the same period, while Reliance Industries Ltd and Cairn India Ltd lost 23% and 18.2%, respectively.
Reuters contributed to this story.