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Oil price plunge is a mixed blessing for PM Narendra Modi's govt

The plunge in crude prices may come as a mixed blessing for the Narendra Modi government.

Oil price plunge a mixed blessing for Modi govt

(Illustration: Raj Verma)

Oil prices have been headed south for the last six months, almost halving in value in the period. On December 24, prices of Brent crude - to which most Indian imports are linked - fell to $60 a barrel. It has come as a respite to oil importing countries, including India, easing inflation and inflationary expectations. India imports 78 per cent of its crude requirement. In 2013/14, India paid $105 a barrel on average to import crude oil worth $168 billion - it stacks up to more than one-third of the country's import basket.

Most analysts expect crude prices to soften further over the next six months because of lacklustre global demand and oversupply. It's largely a consequence of weak economic activity and a growing shift from oil to other fuels. Also, the US has become the world's largest oil producer and significantly cut down on its imports of the fuel. All these factors combined have put pressure on prices. In the last six months, the world is estimated to have had an oversupply of one million barrels a day.

But already there is a raging debate in India among economists and senior bureaucrats on how long the country can continue to gain from falling oil prices. It is felt that if prices plunge way below $60, it could have some adverse fallout for the Indian economy.

Indian exporters, in particular, are concerned about the drop in crude prices. "A further slide would mean the erosion of buying capacity of other oil-linked economies, and hit export orders," says a machinery tool exporter from Punjab.

Ajay Sahai, CEO of the Federation of Indian Export Organisations, told Business Today that exports to West Asia, Latin America and Russia - the major oil producing regions which account for about a fourth of India's exports - are down by around 20 per cent in value terms. The slump in crude prices has severely dented the Russian rouble and has had some impact on the Indian rupee as well. The rupee slipped to 63.66 against the dollar on December 26 from 62.21 on November 30.

Endemic

Crude prices have slid in the last three years


It is an opportunity for India to fill its strategic oil reservoirs - one each near Vishakhapatnam, Manglore and Pudur - that have a capacity to store 5.3 million tonne of crude oil. These reserves are kept handy for emergency purposes.

"China is using this opportunity to buy a lot of discounted cargoes on the spot market and fill their strategic reserve. Hope India starts doing the same," says Aditya Gandhi, Director at Sapient Global Markets (India), a consultancy.

At current prices, India would require $2.5 billion (Rs 15,000 crore) to fill the reservoirs. India is looking for partners - preferably an oil producing country - for supplying crude and funding the initiative, and was negotiating with the UAE and Kuwait. But talks are making little headway. Kuwait, for instance, is unwilling to play ball - with crude sliding below $65 a barrel it would not break even on the oil supplied.

The slide in prices is also impacting domestic exploration companies, Oil and Natural Gas Corporation (ONGC) and Oil India Ltd (OIL). ONGC's net realisation - the final amount it gets for its products after providing discounts - was $40.9 a barrel in 2013/14, when the average price of crude oil was $105 a barrel.

The price slump is significantly eroding the profitability of the company. Analysts believe that the cushion provided by the gas price hike and reforms in fuel subsidies may still not be enough to ensure the same net realisation for ONGC, the country's largest oil and gas exploration and production company. Back-of-the-envelope calculations show that every one dollar drop in crude oil prices translates into Rs 800 crore revenue and Rs 475 crore profit loss for the company.

The finance ministry has shelved its plans for disinvestment in ONGC, concerned that it may not get the best price for the company's shares in the backdrop of falling oil prices. The ONGC stock has also taken a pounding in recent months, falling from over Rs 400 to about Rs 340 in the last six months.

If crude oil prices plunge way below $60, it could have some adverse fallout for the Indian economy.

Meanwhile, India has no option but to go slow in inviting bids for exploration licences. Most oil blocks are in deepwater where exploration is costlier compared with on-land. Global, and even Indian, companies may find it difficult to bid at a time when their profitability is getting squeezed. "Today, globally, oil is not a lucrative commodity to invest in. Most oil blocks in India require extensive investments," says R.S. Sharma, former CMD of ONGC.

Meanwhile, the government is trying to find a solution to the problem at hand. The petroleum ministry plans to make the Production Sharing Contracts more lucrative. A committee headed by noted economist C. Rangarajan has suggested doing away with the revenue-sharing model and adopting royalty-based contracts. This would mean that the companies would simply have to pay a fixed royalty to the government, irrespective of the amount of oil and gas produced from the block.

Another panel headed by economist Vijay Kelkar has suggested retaining the existing system - it allows operators to retain the cost of a project before sharing revenues with the government. However, it has come under a cloud after a dispute with Reliance Industries related to the D6 block in the KG basin.

Clearly, the tumble in crude prices may come as a mixed blessing for the Narendra Modi government. It will be stretched as it deals with the fallout - the policy response will have a direct bearing on India's growth prospects in the days and months ahead.

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