Watch crude oil for clues on rupee course

The global crude oil sector is hard to read due to the complexity of factors influencing supply and demand. Global growth is slowing. This will lead to softening demand and create downside pressure on prices.

But the shipping industry is due to shift to low-sulphur fuels by January 2020. Meeting the new demand for low-sulphur fuels from shipping implies refining an extra 2 million barrels per day (bpd) of crude oil. This is significant since global production is 81 million bpd. It could balance off low demand from a slower world economy and lead to higher diesel and kerosene (aviation turbine fuel) prices.

Supply is also hard to read, due to geopolitics. OPEC plus Russia have made production cuts designed to keep supply aligned to lower demand. Supply from Venezuela, and Iran, which are both under US sanctions, could be further curtailed. The US gave waivers to eight countries (including India) to continue Iranian imports until April 2019.  Will it renew the waivers? If not, Iranian supply could go off the market.

The USA is now the world’s largest producer and the largest consumer. Production has risen an amazing 15 per cent, to over 12 million barrels per day, in the last year alone. Higher US production could counter-balance the OPEC cuts.

Prices have swung in the current fiscal. The Indian crude oil basket peaked in October 2018 when it cost $80/barrel. It was down to $57-58 by December and back at $64-plus in February. The average price this fiscal (April 2018-Feb 2019) is $69.93/barrel. That’s much higher than in 2017-18 ($57.43 full-year) and 2016-17 ($47.56). 

Higher crude oil prices are the prime cause of pressure on the external account. Net imports of crude oil and petro-products, after accounting for exports of petro-products, hit $76 billion (April 2018-Jan 2019) in 2018-19. This is higher than 2017-18 ($66 bn for the full-year) and 2016-17 ($52 bn full year). Consumption over those 10 months is up 3.2 per cent in volume, over April-2017-Jan 2018, which is a sign of slow GDP growth.

When crude oil prices are up, producers gain and refiners/marketers suffer since their margins fall. India’s energy sector has little production capacity. There is excess refining capacity. This leads to product exports, which helps reduce the import bill. Apart from Reliance Industries (RIL), Nayara Energy (the erstwhile Essar Oil) and Cairn India (a subsidiary of Vedanta), all petroleum majors are owned and controlled by the government. The GoI is the majority shareholder in ONGC, OIL, BPCL, HPCL, IOC, etc.

Since India imports 83 per cent of its crude oil, global dependencies are huge. Refiner-marketers are, in theory, free to price most of their retail products as they choose. In practice, the government sets prices as the majority shareholder and manager. Pricing is done according to political compulsions rather than economic considerations.

Given elections, it’s unlikely that any crude oil price spikes will be reflected by commensurate hikes in retail prices till May at least. That means refiners/marketers are likely to struggle in the next quarter unless prices fall. When it comes to producers, the ONGC balance sheet is under stress due to the “buyout” of HPCL, which in effect, involved taking a huge loan on behalf of the government.

Coming back to global supply-demand, the US is the largest “swing producer” as well as consumer. A large proportion of US production is from shale, with operations that can start up within four-six months, if the price is right. Shale is expensive with breakeven in the $45-50/barrel range. This puts a floor on price since supply shrinks as US shale production falls if prices drop below $50.  On the other hand, it’s estimated that US production could go as high as 14 million bpd, if prices rise. That puts a ceiling on price, since supply will expand on higher prices.

Putting it all together, one guess is that crude oil prices will stay range-bound, within about 15-20 per cent of current prices, unless there’s chaos when the shipping changeover happens. The fate of the rupee is tied to crude. If crude prices stay high, the rupee will be under pressure. If crude prices fall, the trade balance improves and the rupee strengthens. This economic equation will be largely unaffected by domestic politics. Crude oil is worth tracking for that reason, among others.

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