THE CURIOUS CASE OF RISING CRUDE

about 1 year ago
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By Ruma Dubey

Crude oil is climbing high and with it, all these chest beating reports on India from World Bank could end up being just that – on paper, just a report.

Not to break the bubble…oops, balloon but seriously, as one climbs higher and higher up the Sensex and Nifty ladder, do look around – you might see crude going up alongside and that’s most certainly not a pretty sight.

Commodity prices have been firming and as Q3 numbers come in, we will see the effect of that on EBITDA though thanks to the festive demand, volumes will more than make up for this rise in commodity prices.

But crude oil is a much bigger headache as it impacts all facets of our life, right from industry to agriculture to day-to-day living. Yesterday, Brent crude hit a three-year high, going up to $69/barrel. And the latest news is that crude oil futures is traded 0.85% or Rs.34 higher at Rs. 4,037 per barrel at the futures market as speculators raised their bets, taking positive cues from global market. Likewise, the oil for delivery in February was trading higher by Rs. 29 or 0.72 per cent at Rs. 4,035 per barrel in 114 lots. Brent crude climbed another 2% to $69.16.

This could be a mere speculative run as USA is expected to announce its crude inventory stock tomorrow at 9 PM India time.  The fear factor of more fall in the stock stems from the American Petroleum Institute putting out a report stating that crude inventories fell by 11.2 million barrels in the week to Jan. 5 to 416.6 million; this is a huge fall compared to analysts predicting a decrease of around 3.9 million barrels.

If the actual fall in inventory is indeed as high as over 11 million, then it would be the second highest after the fall of over 14 million in the week of September in 2016. But then the point to ponder – despite the fall in inventory, price did remain around $40-50/barrel for the most part of the year, isn’t it? So why can’t we assume that one sharp fall, not to mention that consecutive 7 weeks of fall, would mean nothing?

Actually, this time around, we have to contend with the supply cut by OPEC. In fact they are cutting output more than what they had promised and this is reducing the oil stocks globally. 

Most oil analysts feel that this current price rise in being driven purely by speculative forces. Yesterday, U.S. Energy Information Administration stated that US crude oil production is expected to surpass 10 million barrels per day next month, which would be an all-time record high, much ahead of what others had predicted.

At the same time, remember that US has shale oil producers who are now pumping with great vigour. This increase in production will ensure that OPEC and Russia sit tight on their deal to curb supplies till the end of 2018.

Yet, most analysts say that the see oil price range bound at an average of $65 to $75 for most part of the year. This will put pressure on India.

The oil market pundits say that $70 would become really tough and beyond that, could be crushing. The main reason being that India has fully deregulated petrol prices; today the price of fuel changes every day, moving in tandem with the international crude price. In 2014, this deregulation made perfect sense as oil had slumped from over $100/barrel to $50 and we could take full benefit of the falling oil prices. But now, with the trend reversed, the fuel prices are going up. This directly impacts every single pocket – right from the fuel you fill up your car with to the fuel used in factories to make goods and fuel used to transport goods/people. Crude oil has a direct relationship in our day-to-day life and any sharp rise, will most certainly leave a telling impact.

Companies which will be hit directly from rising crude prices are mainly upstream oil companies like ONGC, Oil India and less OMCs. Other big losers 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 increase, margins will dent. Analysts say that a 10% rise in crude oil price will push down margins by at least 200 bps. Another loser will be tyre companies which also uses crude derivatives in its raw material. Sintex too could face the pressure as cost of its crude oil polymer, to make plastics will rise. Packaging costs will increase as it also uses petroleum derivative and that means pressure on margins for Essel Propack and even FMCG companies. Airline stocks will also feel the heat as rising crude will impact earnings– a 10% rise in crude will lead to a 300 bps fall in EBITDA margins.

In today’s time, no one wants to hear anything negative even if it is the truth; the trend is to shoot the messenger and forget the message! Yet, better to be informed than getting hit on account of ignorance.

 

Just for knowledge – brent crude is a combination of crude oil from 15 different oil fields in the North Sea, lighter than West Texas Intermediate (WTI). ‘Light’ refers to density of oil – lower the density, better is the blended fuel quality. It is best for making petrol. It is primarily refined in Northwest Europe, and is the major benchmark for other crude oils in Europe or Africa.

WTI is the other major global benchmark oil for price setting and is actually of better quality than Brent. It is extracted from wells in the United States and is considered to be a very sweet and very light crude oil. A major drawback is that it is landlocked meaning that transportation is more expensive and more involved than it is for a waterborne crude oil such as Brent. 

Brent blend is generally priced at about a $4 per barrel premium to the OPEC Basket price or about a $1-2 per barrel discount to WTI.

 

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