With the benchmark Brent crude touching the $100 a barrel mark last month for the first time since 2008, the possibility of a further rise, and its impact on economies worldwide, has come into focus. Brent crude oil prices on Thursday (Feb 17) reigned at $104.24 a barrel. Experts have, by and large, attributed the rise in crude oil prices to the unexpected geopolitical circumstances that have arisen in the Middle East and the intense speculative trade in the commodity exchanges. Moreover, global demand was up 3% year on year (YoY) in 2010, and inventories in developed countries have remained low, contributing to higher oil prices. Although US and Europe have not seen any significant offtake of oil, Asia has been an exception, with the Chinese economy in particular increasingly displaying its appetite for oil in order to fuel its growing economy, followed by countries like India and Indonesia. A section of experts feel that oil prices will cool down as the tensions in the Gulf region ease out. However, this would be subject to demand remaining close to current levels in the short term.
Says, K Ravichandran, senior VP & co-head (corp. sector rating), ICRA, there is no reason for alarm, since all OPEC countries have a spare capacity to the tune of four to five barrels of oil per day. ?The market is well-supplied. There is also no dramatic change in the demand patterns in US and Europe. Unless demand substantially picks up, crude prices should ease.?
What will be the impact of this on oil companies? It is tempting to imagine that upstream oil companies will stand to gain from high crude prices. However, in the case of government-controlled companies in the upstream sector, the rising under-recoveries will create additional burden for them, since they share part of the burden of under-recoveries. Ravichandran says with rising crude prices, all input costs, including drilling costs, will see a spike, which is clearly negative for upstream companies. In a new report, Moody’s Investors Service has said that higher oil prices will have positive credit implications for upstream producers and negative ones for downstream refiners. However, it states that ?for exploration and production (E&P), continued high oil prices will likely intensify E&P activities in the industry, leading to higher capital and operational expenses, which will also reduce the benefits that otherwise might have accrued on the output side.?
At the same time, rising crude input costs will increase refiners? requirements for working capital, thus adding pressure on their cash flow from operations as well as financing requirements. Moody?s goes on to say that, in countries where fuel prices are government controlled, delay in payment of reimbursement would aggravate the impact on refiners. However, exporters of refined products can reduce the negative impact by passing on higher feedstock costs, it adds. Moreover, rising oil prices are also likely to take the price of acquisitions higher. Oil prices are still remaining well below their mid-2008 peak of $147. However, the impact they will have on the global economy will be far-reaching, requiring imminent state intervention, as in the case of India, to ensure consumers and corporates do not face the brunt of overheated prices.