Oil Price Impact & Forecast

Sanjiv Mehta  |  2018-06-11

India is a major importer of oil and therefore oil price has a significant impact on its economy and people’s daily lives. It can have political implications especially when elections are only one year or even less away.

Oil Price Rise
After a long time, Brent Crude oil prices reached close to 80 USD per barrel (about 159 litres). Average Indian basket price was 46 USD in 2016, 56.4 USD in 2017 and 65 USD in the 4th quarter of 2017-18 financial year. Presently it is trading in the range of USD 75 to 80.

Price of any commodity is dependent on demand and supply factors. IMF in a recent study says that 80% of oil price rise is due to deterioration in supply. Venezuela with its huge political and economic problems has seen a major decline in its oil output over the last 2 years. It has fallen from 2.3 million barrels per day (b/d) in January 2016 to 1.6 million b/d in January 2018.

OPEC and non-OPEC producers led by Russia agreed recently to extend oil output cuts until the end of 2018 as they try to finish clearing a global glut of crude while signalling a possible early exit from the deal if the market overheats.

Additionally, there is likelihood that USA sanctions on Iran could limit its supply by 500000 barrels a day. Similar sanctions in 2012 caused a reduction of more than a million barrels a day.

On the demand side, OPEC said it now expects the world’s appetite for oil to grow by 1.59 million barrels a day, up 60,000 bpd from last month’s forecast. That would put total global oil consumption at 98.6 million bpd in 2018.

Impact On Indian Economy
India was a key beneficiary of falling crude prices between 2013 and 2015. Almost the entire reduction of about 0.6% of GDP in India’s fiscal deficit during this time period could be attributed to the sharp fall in oil prices. These also contributed to the narrower current account deficit. Since the pass through to retail customers was curbed (the government retained a large part of the benefit by hiking excise duty), direct impact on CPI (Consumer Price Index) was muted.

Current rise is putting lots of pressure on twin deficits. Moreover, Indian 10 year bond yield has risen to 8 % from 6.43% just one year back. Indian Rupee has fallen to a level of 67.57 Rupees to one USD. CPI has shown an increase of 4.58% year on year while even more disturbingly core inflation excluding food and fuel has increased by 5%. There is a spill over effect on the monetary policy and it was no surprise that RBI increased interest rates (repo rate) in their bimonthly meeting on June 6, 2018 after a gap of 4 years to 6.25%. If the high prices of oil sustain, eventually it could have a negative effect on investment and consumption behaviour of Indian economy.

Ability to produce higher quantities of shale oil is a significant factor for oil price being self limiting and not breaching very high levels. OPEC cartel has a diminishing share in the global oil production and their ability to sustain prices at a higher level is reduced.

As soon as oil prices start rising, USA shale producers start pumping more oil to take advantage of higher prices. Although shale oil is not being exported, it replaces US crude oil imports, reducing the demand for oil in global markets, as do US exports of refined products. USA production has already crossed 10 million barrels per day for the first time in half a century, this quantity is more than that of top OPEC producer Saudi Arabia.

Expectation is that eventually OPEC will increase its output once the inventory overhang starts disappearing. Non OPEC producers will also follow suit.

However, several factors indicate that Venezuela’s crude oil production will likely continue to decline. The number of active rigs has fallen from near 70 in the first quarter of 2016 to an average of 43 in the last quarter of 2017. Reasons for decline include missed payments to oil service companies, a lack of knowledgeable managers and workers and decline in oil industry capital expenditures.

Demand for Oil is likely to remain firm. The drivers include steadily rising economic activity around the world, strong demand for transportation fuels like gasoline and jet fuel and a growing petrochemical industry, which turns by products from oil and natural gas into chemicals.

Overall, taking all these factors into account, the forecast is that the oil prices might reach 80-85USD per barrel in the next 6 months and then start falling. Goldman Sachs is forecasting that the Oil price might trade around 65 USD per barrel in the year 2020.

A big sustained move in the equity markets occurs when there is confluence of favourable macro and micro factors. India is currently showing good micro dynamics- earnings growth numbers for individual companies are expected to rise at a healthy rate. Additionally, economy is expected to grow nicely by 7.5% in 2018-19 and that is combined with good fiscal prudence and proactive anti inflation monetary policy.

However, there are important macro factors including Federal Reserve monetary policy, forthcoming Indian elections and oil prices which can cause uncertainty. Analysis and forecast in this article shows that oil prices are not likely to be a negative drag on the Indian markets in the medium term.

In subsequent articles, we will keep on analyzing other important factors one by one to see whether a big sustained move can occur in the Indian equity markets and that will help us in determining our asset allocation strategy for each individual portfolio we manage.