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Lower crude prices are helpful but with covid-19 looming large, the gains get mostly offset (Reuters)
Lower crude prices are helpful but with covid-19 looming large, the gains get mostly offset (Reuters)

Why India barely gains from the historic drop in crude oil prices

  • Tax collections from the petroleum sector have been affected due to slowdown in economic activities
  • For India, gains from lower crude oil price will be offset by the impact of covid-19 lockdown

The May futures contract of West Texas Intermediate (WTI) crude fell into unchartered territory on Monday, with sellers willing to pay buyers $37.63 a barrel to take delivery. The big problem, of course, was that there is hardly any storage capacity available, so buyers were shying away as well. Note that WTI crude futures contracts expiring in September are trading at $30 a barrel.

Since there are more settlement options for Brent crude futures, their prices haven’t fallen as sharply. Even so, Brent crude, which is the more relevant benchmark for India, has dropped over 65% so far in 2020.

Still, with the ongoing impact of covid-19 related lockdown, the gains from lower crude oil price get offset to a large extent. “It is imperative to note that the current fall in global crude oil prices is not a pure positive supply shock, which benefits oil consumers like India (at the expense of oil producers) but is also a result of a weak demand induced shock and hence the positive impact on growth gets somewhat offset," said Tanvee Gupta Jain, economist at UBS Securities India Pvt. Ltd. “The benefits from lower crude prices to India’s fiscal position will be limited as tax collections to the government from the petroleum sector get affected due to slowdown in economic activities owing to Covid-19 shock."

Crude bonanza.
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Crude bonanza.

Of course, India runs a current account deficit and hence will gain from lower crude prices, as the oil import bill will narrow. Besides, lower oil prices will soothe inflation. But severe mobility restrictions due to the lockdown means consumption of petroleum products has fallen sharply. Also, savings from lower fuel costs in the hands of consumers is unlikely to result in a boost to consumption and hence growth.

The government has also been known to raise excise duties and taxes on auto fuels whenever global oil prices fall in order to supplement its revenue collections, which prevents any sharp decline in retail prices.

From here on, analysts anticipate a gradual recovery in oil prices, as economies start easing restrictions and demand-supply balance is restored over the medium term.

In the interim, low oil prices would cast a shadow on the fortunes of state-run oil producers Oil and Natural Gas Corp. Ltd (ONGC) and Oil India Ltd (OIL). Shares of both firms fell by 5-6% on Tuesday on NSE. Kotak Institutional Equities’ analysts believe ONGC and OIL are not the best plays at current levels as both stocks are already pricing in a sharp rebound in dated Brent crude price to $47-48 a barrel, while ignoring risks from a prolonged weakness amid surplus supplies. The brokerage has downgraded its ratings on both stocks to “Sell" from “Buy", in a 21 April report.

State-run oil marketing companies are comparatively better placed as higher marketing margins are likely to offset the pain from lower refining margins and volumes.

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