Crude oil prices, falling for the last eight months, rallied briefly in the fourth week of March after Saudi Arabia bombed neighbouring Yemen, leading to fears of supplies being disrupted. But it was a brief respite. Within days, all gains had been lost and prices were sliding further with the prospect of oil from Iran - sanctions against which are likely to be lifted - creating a bigger glut. On March 31, crude spot prices at the benchmark West Texas Intermediate (WTI) and Brent closed at $47.72 and $53.69 per barrel, respectively.
It has been a long way down for crude from an average Brent price of $108.1 per barrel in the January-March quarter of 2014 to $53.9 per barrel in the corresponding quarter this year. The WTI averages for the same quarters were $98.7 a barrel last year, and $48.5 a barrel this time. The reasons are well known - Saudi Arabia refusing to reduce production despite the glut, Russia's refineries increasing exports and high shale oil production in the US, reducing its dependence on imports. The decline has been welcomed by many in India as it is helping to reduce inflation, the fiscal deficit and the import bill. But the oil companies, be they in refining or exploration, or both, are suffering.
Drop in crude oil prices
Results in the new financial year are expected to be worse, since the base will be the financials of the first few months of 2014/15, when oil prices were still reasonably high. While refining companies can make some adjustments, purely exploration and production (E&P) ones like Cairn India will be hit hardest. "In the upstream business, the cost of production remains the same," says a Cairn official. "When the price falls, it directly cuts margins and profitability." Cairn India sells its crude at around 10 per cent discount to the Brent price. Around 75 per cent of the production from its largest oilfield in Barmer, Rajasthan, is bought and refined by RIL and Essar. Its public sector counterparts, like ONGC, will be affected less. "The government anyway takes away the surplus value above ONGC's net realisation of around $45 a barrel to subsidise the fuel," says analyst S.P. Tulsian. "Crude volatility will not make much difference to ONGC."
To offset losses, Cairn India will pursue a two-pronged approach. "First, we will only undertake projects that are economically viable at current oil prices," says the Cairn official. "Second, we will re-engineer and renegotiate existing contracts." (These are the contracts with suppliers of oilfield services and equipment.) Cairn's recent capital expenditure of over $4 billion in its Barmer oilfields will stand it in good stead. "The investment has put the company ahead of the cost curve and will allow it to be more selective about projects going forward," the official adds. He also hopes the government will lift the ban on exporting crude. "We can get a better price in some overseas markets, but are forced to sell in India," he says. Cairn produces around 28 per cent of India's oil, around 11 million tonne per annum (MTPA) against ONGC's 26 MTPA.
Oil price impact on leading oil firms
"Globally, GRM also tends to take a hit when crude prices go down," says Dilip Khanna, Partner, Transaction Advisory Services, Ernst & Young (EY). "But loss on crude inventory is short term." RIL officials, too, maintain they are not overly worried. "Our GRM did fall in the third quarter, but it was still higher than the benchmark Singapore GRM," says an RIL executive. "Revenue may fall due to the crude price decline, but profitability will be less affected."
RIL is also likely to gain from its new petroleum coke gasification plant at the Jamnagar refinery, its new refinery off-gas cracker, the expansion of its polyester/aromatics capacity and its import of cracker feedstock from the US. "RIL is executing four key downstream projects in its core refining and petrochemical business with estimated capex of around $15.5 billion? We estimate these projects will add around $3.2 billion in incremental EBITDA in the first full year of operations even in a low $70 per barrel oil environment," says Morgan Stanley Research's Asia Insight report. Even if the price falls to $40 per barrel, the reports estimate an additional EBITDA of $2.2 billion; if it rises, the added EBITDA could be as high as $4.9 billion.
Essar maintains its refining "crack" stable despite crude price volatility. It is setting up one more hydrogen manufacturing unit and converting vacuum gas oil in its effort to increase GRM by about a dollar a barrel.
What of the future? Many experts expect it to be just as bleak. Economist Frank A. Wolak of Stanford University, for example, claims oil prices could remain low for the next decade or two. Wolak's report cites reasons such as growing shale oil production in North America, the declining role of the once-powerful Organisation of Petroleum Exporting Countries (OPEC), the standarisation of oil well drilling technology and the lower price of natural gas as compared to oil. Indeed, oil inventories in the US are the highest in at least 80 years.