Photo: Reuters
Photo: Reuters

Outlook for oil, its impact on India

Net oil imports have contributed to more than 40% of the trade deficit for India in the previous two fiscal years

Brent crude is hovering around an uncomfortable $80/barrel. Will it remain high, or trend higher? There are two forces acting on oil prices—tight supply situation and rising demand. On the other hand, won’t trade wars and rising interest rates slow growth? Won’t lower Chinese growth, widely anticipated, lower oil demand?

“The outlook for oil prices remains volatile," said the Asian Development Bank’s 2018 Outlook update released on Wednesday. The update has raised the forecast for Brent crude to an average $74/barrel in both 2018 and 2019.

In the near term, the extent of decline in Iranian oil exports, after the US sanctions kick in from 4 November, will be watched keenly. If current market conditions continue, once the sanctions on Iran are implemented, oil prices are likely to go higher, pointed out CARE Ratings Ltd in its 24 September report. This is on the back of an expected drop in supply from major producers Iran and Venezuela, and political and price escalation prevailing in the markets.

Given the current scenario, CARE Ratings believes the price of crude oil will rise to $78-80/barrel unless the number of rigs deployed by the US is increased. Infrastructure constraints may take a toll on US oil production growth.

Madhavi Mehta, assistant vice president (research) at Kotak Commodity Services Ltd, says: “US, Russia and Saudi Arabia (top producers) never spoke about reducing production. Their production has been rising and they intend to keep it high amid tighter global market."

What about demand? In its latest oil market report, the International Energy Agency said global oil demand growth estimates for 2018 and 2019 are unchanged at 1.4 million barrels/day and 1.5 million barrels/day, respectively.

However, signs of a potential turmoil are lurking around the corner in terms of trade war issues and weakness in some emerging markets. Over the medium term, it is possible that oil demand takes a hit because of the impact of a US-China trade war, as economic growth gets adversely affected. In the near term though, the market is likely to remain tight.

What do higher oil prices mean for us? Net oil imports have contributed to more than 40% of the trade deficit for India in the previous two fiscal years. “Expecting a surge of close to 30% in India’s crude basket, we see the net oil bill to cost close to $100 billion and contribute to almost 50% of the trade deficit this fiscal," wrote Ashray Ohri of ICICI Bank Ltd in a report last week. As the chart shows, the net oil deficit for the first five months of FY19 is already at $39 billion, accounting for a big share of the $82 billion trade deficit witnessed so far.

Higher oil prices are a threat to inflation as well. Corporate India will suffer incrementally, as rising oil prices coupled with a depreciating rupee, will increase cost pressures for most domestic market producers.

In particular, the margins of paint companies and lubricant makers will be under threat. Airlines will get squeezed further at a time when they are unable to raise airfares enough and rupee depreciation will increase their dollar-denominated costs.

Shares of state-run oil producers such as Oil and Natural Gas Corp. Ltd and Oil India Ltd have underperformed the BSE 100 index so far in FY19 despite the high oil prices. The key reason for the underperformance is that investors think the government may restrict the gains from high prices by asking these firms to share some subsidy burden.

In short, no respite is in sight on oil prices in the near term and the increased risks are already taking a toll on the markets

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