The overall trend for crude oil looks weak and prices will continue to witness bouts of volatility as storage fills, but some respite from these lower levels is quite likely
The historic rout in oil markets sent the US crude oil prices to negative USD 40 a barrel. The collapse in oil prices can prove to be a boon for India as it is the time for the country to fill its strategic reserves with cheap oil. Sugandha Sachdeva, VP, Metals, Energy & Currency Research of Religare Broking Ltd explains why state-controlled oil marketing companies (OMCs) refrained from changing the petrol and diesel prices in India for over 45 days. She also elaborates the buying opportunity in oil marketing companies stocks and advises investors to invest in a phased manner. Here are the excerpts of Sugandha Sachdeva’s interview with Surbhi Jain of Financial Express Online.
1. Is collapse in crude oil price a blessing in disguise for India?
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Crude oil prices have witnessed an absolute collapse due to the double whammy of significant demand devastation due to the coronavirus crisis gripping the world economy, coupled with a massive supply glut. On one hand, lockdown situation for almost 90% of the world and travel curbs has sapped the demand for oil and on the other hand, producers have continued to pump record amounts of oil. Alongside this, storage constraints in the US have led to the unprecedented decline in oil prices sub-zero levels.
As India is the third-largest importer and consumer of crude oil, which imports more than ~80% of its requirement, sharp decline in oil prices would be a windfall for the economy if prices remain at lower levels for rest of the year, considering the fact that global growth is likely to remain subdued this year. It would continue to import crude oil in a measured way around the current rates ($20-25/barrel) to fulfil its requirement in future and that would help in improving the country’s fiscal health, boosting tax revenues as well as in easing the inflationary challenges. However, as demand has plummeted severely due to the lockdown, and storage is also a constraint, India may not be able to get significant benefits, due to this sharp decline in prices in the short term. The caveat here is that if the lockdown is extended, there would be no revenues to the government if no one buys petrol. Also, steep depreciation in rupee and decline in FII flows from Middle East sovereign funds has offset some of the gains from the recent decline in oil prices.
2. Is it a time for India to boost strategic reserves?
The dramatic crash in oil prices shall act as a boon for India supporting its efforts to boost energy security efforts. It’s an opportunity for our economy that imports 80% of its crude requirements to fill its reserves with cheap oil. India currently has a total capacity to store 5.3 million tons at Visakhapatnam, Mangaluru and Padur supporting 10-12 days of our net imports. Government is in a process to fill these reserves with the recent deliveries and has also advised state refiners to place their excess crude supplies to these reserves.
The only challenge is the limited time left to ship buys to its storage facilities as the offloading at this port may not happen once the monsoon breaks. Government is setting up an additional 12.5 MT storage capacity in the second phase in Odisha, Rajasthan and Gujarat adding 12 days of crude storage. In the current scenario, it’s imperative for the government to build additional storage space in the country to take full advantage of such a low price environment. Even downstream oil companies can look at locking in the price today via hedging.
3. Why petrol, diesel prices in India haven’t changed in over 45 days despite crash in oil prices amid scanty storage?
The historic collapse seen in US crude oil futures does not mean proportionate fall in domestic petrol and diesel prices as well. Firstly, the Indian basket of oil is dominated by the Brent crude oil prices, which were still trading higher in comparison to WTI oil prices even when prices slipped into the negative territory. The problem was peculiar to WTI May contract, due to the storage constraints at Cushing, Oklahoma. Secondly, even though Brent prices have slipped by 60 % since the beginning of this year, but petrol and diesel prices have not fallen in line as their pricing includes a huge component of domestic charges including taxes and duties. Also, amid nationwide lockdown, the government is trying to mop up more taxes from fuel to offset losses from low tax receipts otherwise. In fact, the government has recently increased excise duty on petrol and diesel by Rs 3 per litre and can further raise it by Rs 8 per litre in future. Additionally, road cess was also hiked by Rs 1 per litre, each on petrol and diesel to Rs 10. Furthermore, oil marketing companies have been badly hit due to low demand and huge existing inventories and in order to make up for those losses, they are not passing the benefit of low oil prices to the retailers.
4. Goldman Sachs warns of another crash in crude oil prices. Your comments.
The bizarre crash witnessed in WTI May contract did spill over to the June contract and resulted in a further squeeze with US ETFs shifting to contracts for later delivery. The fundamental drivers behind the ailing oil markets still remain the same as they were last week, where demand remains quite feeble as the global economy is in a standstill mode, with literally no space for storage. Sentiments remain quite fragile in oil markets, however, there is some light at the end of the tunnel here- Firstly the prognosis here is that oil producers facing a shortage of storage space will be forced to halt drilling and cut production in the US and that would underpin prices to some extent. Secondly, some US oil producers running out of commercial space for storage have also started making deliveries to the nation’s emergency stockpile. Third point-prices would get some support due to supply cuts of around 9.7 mbpd by OPEC+ producers that will come into effect from 1st May. Last but not the least, the fact that various countries are gradually relaxing lockdown restrictions, we may see a gradual pick-up in demand, leading to modest recovery in prices. Though we expect oil prices to overall remain soft, some relief is likely in the near term.
5. What’s next for crude oil futures?
The overall trend for crude oil looks weak and prices will continue to witness bouts of volatility as storage fills, but some respite from these lower levels is quite likely. For WTI crude, prices are likely to gyrate in the range of $6 -$28/bbl, while prices at the domestic bourses look to trade in the range of Rs 400/bbl -Rs 2100/bbl mark in near term.
6. What is your near to medium-term outlook for energy, and oil & gas stocks?
Crude Oil prices have witnessed both demand and supply shock. The lockdown in many countries has eroded demand by around 25-30 mbpd, while the production cuts announced by the OPEC+ members of around 9.7mbpd, look quite insufficient to rebalance the market. Even with various countries easing their lockdown restrictions, it would still take long time for the demand to recover fully and oil prices may remain suppressed.
Given the backdrop, we would remain cautious on oil exploration companies and refining companies, at least in the near term. On the flip side, given the sharp fall in oil prices, we expect oil marketing companies to do well despite fall in demand due to the lockdown.
7. Is it a time to buy energy, and oil & gas stocks? What are your top stock picks?
The performance of the energy basket in the past two years has not been very encouraging barring few stocks. However, at the current price levels, the valuations seem attractive and there can be value buying opportunities in the sector.
Given the low oil price, our house view is that the oil marketing companies (OMCs) like BPCL, HPCL etc could be a safer long-term bet as their marketing margins are likely to expand as demand starts picking up again. However, the decline in demand due to countrywide lockdown and a probable hike in excise duty pose a threat for them, which may impact their performance in the coming quarters. We thus recommend investing in a phased manner and with limited exposure in one’s portfolio. Further, one can pick stocks like IGL, MGL and Gujarat Gas which are likely to perform well, citing the government’s focus on clean energy and network expansion as well their own strong fundamentals.