It will be an understatement to say that oil prices have been volatile over the last two months. The prices have been broadly in between the US$ 40 and US$ 20 levels. The fundamental factors that have been at play for the oil economy has been the slowdown or sluggishness in the economies like China and India. This decline in demand was gradually affecting the prices. Further uncertainty was brought in by factors like the increasing shale gas production and the recent price war between Russia and Saudi Arabia, and the likely rise of energy alternatives including electronic vehicles. So, there have been host of factors which made the oil economy difficult.
The last straw on the camel’s back is the rapid spread of the pandemic. In the last issue of Navigator, we had mentioned the likelihood of the delinquencies in the US debt market could rise as the interest cover of a large chunk of corporates was going below 1. This was the direct result of the fall in earnings and the rise in interest costs. The shale oil business has been based on cheap credit and the probability of cheap credit drying up is very high at this point of time mainly on account of the global lockdown. Whiting Petroleum Corporation has become the first company to file for bankruptcy. Reports suggest that there will be a string of bankruptcy filings that are going to likely to follow soon.
Reliable sources put the total debt which the US energy sector owes to the system at close to US$ 200 billion, and that some of the leading bankers like Citi, JP Morgan, Wells Fargo and Bank America are likely to set up special purpose vehicles or companies which will handle the work at these weak companies as the lending is against reserves of oil and gas. Even if oil price is going to rise later this year the weak companies are bound to face problems relating to their accumulated debt unless a longer-term plan is put in place to salvage the situation.
With a broad agreement in OPEC+ on the need to curtail output, the prices may move up back to the US$ 40 levels. This may be aided to a large extent by the restoration of movement of traffic and vehicles across the globe on early signs of recovery from the pandemic. But the real challenge would be whether lost ground can be recovered, after almost a decade of demand has been destroyed in the lockdown.
The world is divided into two theatres. Those who buy or consume oil and those who produce it. As far as those who consume are concerned, they may not need more than what is available at this time. Oil is not something, the consumption of which, increases with a fall in price. But consumers benefit from lower prices. As far as producers are concerned a fall in prices would lead to uncertainties in the viability of their business. As far as countries like India is concerned, we may benefit from a fall in prices, but the impact of the fall in oil prices may have a negative impact on sentiment. If oil prices fall too much it means that the overall economic conditions are not good. In a booming economy the demand for fuel will be robust. So, if the prices fall it means that growth may be slowing down. But over a period of time after the economic impact of the pandemic comes down, and the oil markets stabilise, prices may start gradually moving up towards the US$ 35-40 levels.
The Indian crude basket is a mixed basket, a third of which is Dubai sour crude and one third is Brent sweet crude. Brent is currently at the US$ 19-20 levels, and the Dubai sour crude is at US$27-28 levels. Therefore, the arithmetic is slightly different from a WTI. But we stand to benefit from the fall as the import bills have been close to US$ 150 billion per annum and even a small savings on that would be substantial. We also need to take cognizance of the fact that the Dollar-Rupee exchange rate is also a crucial determinant of how cheap we will be able to get the stuff. Unfortunately, at sometimes in the past, a fall in oil prices and a fall in the Rupee happened simultaneously robbing us of a part of the gains that would have otherwise accrued to us. To look at both the things through an optimist’s lens, the fall in the oil prices will bring down our import bill, and a fall in the Rupee will make us more competitive in our exports.