Geo-political risk premium to oil prices is expected:ICRA

October 5, 2019 3:11 pm

[vc_row][vc_column][vc_column_text]According to drone strike on September 14, on Saudi Arabia’s key oil facilities, also the world’s largest oil processing plant affected about production of 5.7 million barrels of oil per day (mbd). As per an ICRA note, the production affected constitutes about half the kingdom’s exports and 5 per cent of the global supply leading to jump of about $12/barrel in crude oil futures in the seconds after trade opened on Monday (September 16, 2019) which is the biggest intraday advance in absolute dollar terms ever. Besides oil, haven assets such as gold, treasuries surged owing to the uncertainty over the geopolitical fallout of the event.

As to the resumption of production, the Saudi Arabian officials have said that about a third of the oil supply can be brought online by Monday but bringing the entire production back would take weeks. Also, to soothe the markets the US President has ordered oil from the Strategic Petroleum Reserve be used if needed.

According to  K. Ravichandran, Senior Vice-President and Group Head, Corporate Ratings, ICRA, “While the oil markets await further updates on the resumption of supplies from Saudi Arabia, the oil markets will nevertheless be nervous as any retaliatory measures by Saudi Arabia and its allies will keep the market on tenterhooks. As a result, oil prices should factor in siseable geo-political risk premium which will be negative for Indian consumers. Nevertheless, this impact is likely to be shortlived as the market will rebalance swiftly once the tensions abate.”

For the Upstream sector, an increase in crude oil prices is credit positive as their realisations and cash accruals will increase. As per ICRA’s estimates, till an Indian Basket crude price of ~US$70-75/bbl, the PSU upstream companies may not have to bear material under-recoveries. Thus, their net realisation and cash accruals will improve unless the extant under-recovery sharing formula is changed. However, the GoI had not called upon the Upstream companies to bear the under recoveries during April-November 2018 when crude oil prices were consistently above $70/bbl and had breached $80/bbl in September-October 2018. Higher crude oil prices, if sustained, will lead to an increase in capex by the private players too.

The refiners are expected to benefit from inventory gains in the short-term due to increase in crude oil prices. Additionally, an increase in crude oil prices would lead to an increase in the working capital borrowings and interest expense of refining companies. Besides, the increase in crude oil prices would lead to an increase in under recoveries on LPG and SKO, delays in the reimbursement of which by the GoI, as had happened in FY2019, will also lead to higher working capital borrowings. Significant increase in crude oil prices has the potential to slow down global demand growth, already reeling under the impact of the US-China trade war, which could also adversely impact global crack spreads and thus, GRMs of the domestic refineries over the medium term, although IMO norms implementation for bunker fuels could offer some respite from Jan 2020.

As regards the impact on the consumers, Prashant Vasisht, Vice President and Co-Head, Corporate Ratings, commented “Higher petroleum products prices are expected to modestly impact the demand growth of petroleum products over the near to medium term. Industrial consumers may face pressure on the profitability with rise in input prices of crude derivatives besides possible increase in power and fuel cost. The retails consumers will face increase in inflation driven by higher transportation and logistics cost. Nonetheless, CGD companies will be well placed on the demand front as the price differential between CNG/PNG vs alternate liquid fuels widens giving them better pricing power”[/vc_column_text][/vc_column][/vc_row]