Can the RBI's Action Plan Resolve The NPA Crisis?

Wed, 24 May Pre-Open

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Saudi Arabia pledged to do 'whatever it takes' to the end the crude oil supply glut. Following a terrible week for crude oil, the big producers are naturally worried. The latest data found that, while production had fallen, crude oil exports didn't fall as much.

Either countries were getting rid of excess stocks, which would be temporary. Or they weren't actually cutting production, which is more likely.

The situation presents a further challenge to Saudi Arabia and other OPEC members, which historically held the power to turn supplies on and off when needed.

In the 1970s, the OPEC cartel accounted for over half of global crude oil production. Their market share was more than 50% at one time. If they cut production, the impact on price was immediate. And it persisted. But today, OPEC's market share is down.

And this is largely due to the fear that US production may neutralize the effect of every barrel of oil that is cut by OPEC and other countries. Outbound shipments of crude from USA have surpassed 1.2m barrels a day, more than last month's daily production of Algeria, Ecuador or Qatar - each a member of OPEC.

Further, other OPEC nations, which did not participate in the previous cut, like Nigeria and Libya, will be adding more oil in the market and would continue to do so. Data released on Thursday shows that even Saudi Arabia has increased sales in the market by 275,000 barrels a day.

What does this mean for crude oil prices? The current oil price movement suggests that a production cut would most likely continue, the only contentious part is the time frame. Reports suggests that a time line of 6-9 months is likely to be agreed upon. This however, would not be enough to keep oil prices buoyant given that the US supply taps are open.

If prices were to go up due to OPEC or other factors, new supply would come onto the market. We won't see US$100 crude oil anytime soon. A few years ago, US$100 for a barrel of oil seemed cheap!

For oil importing countries, this is great news. Over the last few years, India's budget deficit has fallen considerably. Mostly due to a lower oil import bill.

Further, lower oil prices reduce cost of fuel and loss wastage (cost incurred for running the refinery and the fuel lost in the system) for oil marketing companies (OMC's). Also, sharp crude oil price movements in a short period of time determine inventory gains and losses for these companies. Shares of OMCs have outperformed the benchmark Sensex by a good margin in the last one year, capping near-term upsides.

For upstream oil companies like Oil and Natural Gas Corp. Ltd and Oil India Ltd, lower oil prices don't augur well, as they translate into lower net price realization. These stocks have outperformed the Sensex in the past one year too. However, lower crude oil prices pose a risk to any potential expansion in valuations in the near future.

Sentiment in one market can impact securities and commodities in other markets. In the past, weakness in the crude oil market caused equity markets to fall and vice versa.

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