Oil - for a few dollars less

Transcription

1 Economy 8 June 2012 Oil - for a few dollars less Oil < USD100 is a game changer for India Brent crude is below USD100/bbl after a gap of 15 months, down 23% from the recent peak of USD126/bbl. The decline in oil price comes as a significant relief to the Indian economy. We estimate that every USD10/bbl decline in oil price would result in the following: CAD/GDP would go down by %. Fiscal deficit would improve by 0.3% of GDP. Inflation will fall 40bp (under no pass-through) and 97bp (if there is complete pass-through). Oil at USD100 today is equivalent to USD80 in FY08 in terms of the stress it creates for the economy. We believe oil <USD100/bbl is a game changer for India. Oil falling to USD100 levels 23% decline from recent peak of USD126 Major potential positives: CAD/GDP down %, fiscal deficit/gdp lower by 0.3%, inflation down 40-97bp 100 equal to 80 in FY08 Oil < 100 a major game-changer for India: positive spin-offs on growth, corporate profits and valuation Ray of Hope will highlight the bright spots in an otherwise bleak scenario in the economy or any sector or company. Brent crude below USD100/bbl, though intra-sector anomalies persist: Brent crude price has fallen 23% below the peak of USD126/bbl scaled in March It has declined to below USD100/bbl after a gap of 15 months, driven by concerns on the European economy and overall slowdown in demand. While structural anomalies like (a) price differential between WTI and Brent, and (b) delinking of gas price from oil are likely to continue in the medium term, US efforts to become energy independent could alter the oil markets forever. Significant relief to India's external and internal balance: High dependence on oil imports (~80% of India's requirement is imported) makes India susceptible to international oil price fluctuations. Oil price directly affects current account deficit (CAD), fiscal deficit and inflation. It also has an indirect impact on corporate performance, and to a lesser extent, on growth and employment. Our estimation of the direct impact of every USD10/bbl decline in oil price on the three key macroeconomic variables is as follows: CAD/GDP ratio would decline by % even after factoring in reduced export proceeds, co-movement of oil prices with other commodities, and possible decline in remittances from the Middle East. Fiscal deficit would decline by 0.3% of GDP under current conditions. The government has the ability to withstand oil price of USD110/bbl only at an exchange rate of INR48/USD, but this improves dramatically to INR60/USD, if oil price comes down to USD90/bbl. The government's subsidy provision for FY13 merely equals its 4QFY12 obligation. Thus, even at oil price of USD100/bbl, there is a risk of fiscal slippage of 0.4% of GDP. At the current exchange rate and domestic product prices, the zero-subsidy breakeven crude price is USD76 for diesel, at USD65 for LPG, and USD25 for kerosene. Inflation benefit would vary between 40bp (under no pass-through) and 97bp (when there is complete pass-through). Falling oil price gives the government higher flexibility on pass-through pricing, the first step towards deregulation. Oil < USD100 is a game changer for India: Oil at USD100 today is equivalent to oil at USD80 in FY08 in terms of the stress it creates for the economy. Lower oil price would augment corporate profits. Financials, Autos and Oil companies are direct beneficiaries. Moreover, receding fears of inflation increases headroom for monetary easing and investment revival. All of this is a major sentiment booster for higher valuations. Dipankar Mitra (Dipankar.Mitra@MotilalOswal.com); Harshad Borawake (HarshadBorawake@MotilalOswal.com);

2 Brent crude hovering around USD100/bbl Intra-sector anomalies persist: WTI discount to Brent, oil-gas price divergence Brent crude price has fallen 23% below the peak of USD126/bbl scaled in March It has declined to below USD100/bbl after a gap of 15 months, driven by concerns on the European economy and overall slowdown in demand. While structural anomalies like (a) price differential between WTI and Brent, and (b) delinking of gas price from oil are likely to continue in the medium term, US efforts to become energy independent could alter the oil markets forever. Brent crude price below USD100/bbl after 15-month gap Brent crude price has fallen 23% below the peak of USD126/bbl scaled in March It has declined to below USD100/bbl after a gap of 15 months, driven by currency movement, the European economic crisis, slowdown in China and moderation in the Iran conflict, among others. Crude oil inventory in the US, a crucial determinant of international oil price, has increased rapidly and is currently at a two-decade high. Oil below USD100/bbl after 15 months Source: Bloomberg, MOSL 8 June

3 US crude inventories have grown rapidly in recent weeks (mmbbl) Source: Bloomberg, MOSL US quest to become energy independent could alter oil markets forever Structural factors have created certain anomalies within the oil sector, which may persist in the near term. These include (a) price differential between WTI and Brent, and (b) delinking of gas price from oil. Further, increased shale gas production and tight oil production led by improved technology is expected to reduce US dependence on oil imports (gas imports already nil) over the coming decade. This will not only have implications for oil price but will also lead to a structural shift in oil market dynamics: WTI at discount to Brent: Infrastructure bottlenecks and continuing heavy oil supplies from Canada are creating a glut in Cushing, Oklahama (where most regional oil pipelines converge), resulting in depressed WTI prices. Despite WTI crude being of superior quality than Brent, it is trading at a discount of ~USD15/ bbl. While reversal of Seaway pipeline should ease some pressure at Cushing, oil supplies from Canada are likely to prevent narrowing of Brent-WTI gap. Oil-gas price relation disrupted: Historically, prices of gas have been governed by regional demand-supply dynamics due to its low fungibility v/s oil. However, the price relationship between oil and gas was largely being maintained. Post the emergence of shale gas, the price relation has collapsed in the US. Likely exports from the US in LNG form are threatening to disrupt the worldwide price relation between oil and gas. Brent-WTI price differential (USD/bbl) Oil-gas price relation has broken * (x) * Ratio of monthly average WTI price and US Henry Hub gas price Source: Bloomberg, MOSL 8 June

4 Apart from lower demand, increase in domestic production has reduced US crude imports (mmbbl/d) (RHS) US natural gas production increasing rapidly, led by shale gas Source: Bloomberg, MOSL 8 June

5 Significant relief to India's external and internal balance Lower CAD, fiscal deficit and inflation High dependence on oil imports (~80% of India's requirement is imported) makes India susceptible to international oil price fluctuations in various dimensions of economic and corporate performance. Oil price is seen to affect at least three macroeconomic variables directly - current account deficit, fiscal deficit and inflation. Its impact on growth and employment is however, indirect, much less pronounced and with a considerable lag. CAD/GDP declines by 0.7% with every USD10/bbl decline in oil price Our calculations indicate that with every USD10/bbl decline in oil price, India's net oil import bill declines by USD10b. This amounts to nearly 0.5% of GDP. Even if the saving is less, accounting for synchronous reduction in oil export proceeds, co-movement of oil price with other commodity prices and lower remittances from Middle Eastern countries, the CAD/GDP ratio would decline by % for every USD10/bbl decline in oil price. Every USD10/bbl decline in oil price can bring down CAD/GDP by 0.5% Source: Govt of India, MOSL Fiscal deficit would decline by 0.3% with every USD10 decline in oil price Our calculations indicate that with every USD10/bbl decline in oil price, the fiscal deficit would come down by 0.3% of GDP. Exchange rate plays a crucial role in determining the actual amount of under-recovery and subsidy. We present below grids showing the under-recoveries and the government's oil subsidy bill at various levels of oil price and exchange rate. In the exhibits, we have highlighted the government's zone of comfort from a fiscal perspective. We note that even the current levels of oil price and exchange rate would require continued subsidy. 8 June

6 Under-recoveries at various levels of crude price and exchange rate (INR b) Brent (USD/bbl) ,043 1,248 1,658 2, ,015 1,228 1,442 1,869 2, ,192 1,414 1,636 2,080 2, ,138 1,369 1,599 1,830 2,291 2, ,067 1,306 1,546 1,785 2,024 2,503 2, ,227 1,475 1,723 1,970 2,218 2,714 3, ,131 1,387 1,643 1,900 2,156 2,412 2,925 3,437 Shaded area denotes government's zone of comfort Source: Govt of India, MOSL Fx rate (INR/USD) Oil subsidy bill at various levels of crude price and exchange rate (INR b) Brent (USD/bbl) , ,121 1, ,248 1, ,098 1,375 1, ,071 1,214 1,502 1, ,034 1,182 1,331 1,628 1, ,140 1,294 1,447 1,755 2,062 Shaded area denotes government's zone of comfort Source: Govt of India, MOSL Fx rate (INR/USD) The government has made a provision of only INR436b for petroleum subsidy for FY13 (v/s INR685b for FY12), of which it has already earmarked INR360b to meet its accrued obligation to oil companies for 4QFY12. Thus, even at oil price of USD100/bbl there is a risk of fiscal slippage of 0.4% of GDP, purely on account of oil. We would need an extraordinary fortunate circumstance of oil price dropping to USD70/bbl coupled with an exchange rate of INR45/USD to reach the near-zero level of petroleum subsidy for FY13 envisaged in the budget. The subsidy burden might be greatly reduced if oil sector reforms are taken forward and the government uses the decline in oil price as an opportunity to raise retail prices to their breakeven levels. Even if the retail prices are held static, with the fall in crude price, the retail prices are closer to the breakeven levels. With oil price at USD100/bbl, the breakeven price for diesel is INR47.2/liter, if the exchange rate is INR50/USD, and INR51.3/liter, if the exchange rate is INR55/USD. With every USD10/ bbl decline in oil price, the breakeven price of diesel reduces by INR3.7/liter at INR50/ USD, and by INR4.1/liter at INR55/USD. As the extent of subsidy support varies greatly across petroleum products, the breakeven crude price too varies, accordingly. We compute the breakeven Brent crude price at USD76/bbl for diesel, at USD65/bbl for LPG, and at USD25/bbl for kerosene at the current exchange rate. 8 June

7 Required retail diesel price (INR/liter) at various levels of Brent crude price Zero-subsidy breakeven Brent for petro products (USD/bbl) Source: Govt of India, MOSL Inflation/inflationary expectations would come down significantly Another very direct benefit of a decline in oil price is a decline in inflation and inflationary expectations. With every USD10/bbl decline in oil price, inflation would ease by 97bp if the government passes on the entire benefit of the oil price decline to the consumers. If it leaves the regulated prices (diesel, LPG and kerosene) unchanged at current levels, the impact on inflation would be limited to the extent of 40bp. How much of the benefit/loss due to oil price decline/increase the government passes through depends on the oil price trend, fiscal strength and political compulsions. It would be reasonable to expect materially greater/lower pass-through only at the outer values, that is, when oil price softens materially to reach below USD80/bbl or when it rises again beyond USD100/bbl. This asymmetric response is likely to maximize the government's benefit from oil price fall, when the oil price is in the range of USD80-100/bbl. Falling oil price gives the government an opportunity to deregulate petroleum product prices de facto, even if it leaves the regulated prices unchanged. Very significant decline in inflation as oil price falls Source: Bloomberg, MOSL 8 June

8 Oil < USD100/bbl is a game changer for India Favorable spin-off on growth, corporate profits and valuations Oil at USD100/bbl today is equivalent to oil at USD80/bbl in FY08 in terms of the stress it creates for the economy. Lower oil price would augment corporate profits. Financials, auto and oil companies are direct beneficiaries. Moreover, receding fears of inflation may trigger a major change in monetary policy stance. Lower inflation and energy cost also help to boost the GDP and close the demand-supply gap. Above all, it is a major sentiment booster to enrich valuations. USD100/bbl today equivalent to USD80/bbl in FY08 Over the years, the Indian economy's capacity to withstand higher oil price has improved. If oil price holds at USD100/bbl in FY13, the stress for the economy in terms of net import and subsidy bill would be similar to that of FY08. Thus, oil at USD100/bbl today is equivalent to oil at USD80/bbl in FY08, in terms of its direct impact. USD100/bbl today is equivalent to USD80/bbl in FY08 Source: Bloomberg, Govt of India, MOSL Multi-fold benefits of oil price declining to below USD100/bbl Decline in oil price is a major sentiment booster, especially for the corporate sector. Besides the direct beneficial impact on external balance, government finances and inflation, it indirectly helps to boost growth. For its per capita income, India's energy cost is one of the highest in the world. Lower oil price helps to augment corporate profits. Financials, auto and oil companies are direct beneficiaries. Moreover, receding fears of inflation may trigger a major change in monetary policy stance. Lower inflation and energy cost also help to boost the GDP and close the demand-supply gap. Above all, it is a major booster of market sentiment, leading to richer valuations. 8 June

9 Oil is a game changer in more ways than one Source: MOSL Negative correlation between oil price and corporate/market performance Source: Bloomberg, MOSL 8 June

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