‘Global commodity prices may slide 31% in 2016 if China fails to meet IMF projection’

By: | Updated: July 17, 2015 1:42 AM

Global commodity prices could slide up to 31% in 2016 if China's economic growth undershoots the International Monetary Fund's...

Global commodity prices could slide up to 31% in 2016 if China’s economic growth undershoots the International Monetary Fund’s (IMF’s) projection of 6.3% for the year by 200 basis points, according to a report by Crisil Research.

While the fall in commodity prices would help net-importer India in terms of lower inflation, trade deficit and subsidy burden in the short term, the operating profits of domestic public sector upstream oil companies could crash by more than 25%, or Rs 12,000 crore, in 2016-17 if their realisation declines to $35-40 per barrel, much lower than $45 per barrel witnessed in the last fiscal.

However, downstream oil PSUs would gain around Rs 2,000-2,500 crore if the price of brent crude oil eases to $45 per barrel in 2016-17, mainly due to a decline in their share of underrecoveries and lower interest payouts, says the Crisil report.

For the government, the drop in its oil subsidy burden could be as much as Rs 15,000-17,000 crore in 2016-17, considering that the fall in total under-recoveries could be in the range of Rs 24,000-26,000 crore. A decline in brent crude oil price by $10 per barrel would also cut the retail price of diesel by Rs 6 per litre, which would help reduce inflation.

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Given the resource-intensive nature of the Chinese growth, which has accounted for roughly 25% of the global GDP expansion over the last decade, any slowdown there would erode demand for raw materials and drive down commodity prices. As such, the country makes up for 44-47% of the world’s consumption of aluminium and steel, 23% of primary energy such as oil, natural gas and coal, and 25-30% of petrochemical items. It also accounts for roughly a half of global aluminium and steel production capacities.

If China’s growth drops 200 basis points from the IMF forecast, prices of brent crude oil could crash the maximum of 31% in 2016, followed by a drop of 23% in hot-rolled steel and 17% in Australian coking coal, Crisil estimates.

In brent crude oil, with no supply shock expected in the medium term, a decline in Chinese demand would increase surplus oil supply to 2.1 million barrels per day and drag down prices to $45 per barrel in 2016, it adds. China’s coal consumption could also drop by as much as 6%, against the base of 1.5%.

“The fall in commodity prices will impact Indian companies as well, but the magnitude will vary with metal players facing a significant downside risk compared with domestic oil companies,” the report says.

Domestic steel companies will start incurring losses at the EBITDA level, with domestic prices dropping below the cost of production in the next two years. Integrated players will be hit the hardest as they won’t be able to gain from lower ore or coal prices. Similarly, aluminium makers could see operating losses. Companies, including Hindalco and Balco, could increasingly depend on more-expensive captive coal from the second half of this fiscal.

Although India would benefit more from lower commodity prices in the short term, a spill-over effect of a Chinese slowdown could hit the country in the medium term, the report said.

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