Oil price conundrum and its side-effects

  • J Mulraj, Hindustan Times, New Delhi
  • Updated: Dec 26, 2014 23:04 IST

Saudi Arabia wants to be king of the oil jungle and has allowed prices of crude oil to fall rather than cut production, which it did, hitherto, as a swing producer.

It has entered into a price war with the US, which is using the technology of horizontal fracturing to extract shale oil and gas, and slowly reducing its dependence on crude.

The fall in price from $115 to $60 per barrel translates into a $1 trillion shift in wealth from the producer to the consumer nations such as India. It ought to have resulted in consumer spending, which ought to have provided an impetus to economic growth. So far, it has not.

Whether crude oil prices pull back from here or keep falling is the conundrum many commentators are trying to figure out.

T Boone Pickens, a wealthy oilman, opined, on a CNBC interview, that they would go back to $90-100, within 18 months. Pickens bases his analysis on expectations that shale oil and gas producers will reduce the number of rigs, thanks to the low prices which make drilling unviable. Two service providers, Halliburton and Baker Hughes, have merged, anticipating a fall in new rigs.

But several commentators believe that the ‘who-blinks-first’ staring competition between Saudi crude and US shale will continue to lead to lower crude prices, some anticipating a drop to $40 per barrel.

The Eurozone’s economic growth is anaemic and no amount of monetary easing is helping it to revive growth.

The US announced a healthy third quarter GDP growth at the annual rate of 5%. However, a big chunk of that increase has come from the US government fudging the figures on healthcare spending.

US growth of jobs, as well as GDP, is also expected to be hit if shale producing states such as Texas (which has accounted for most of the job growth) reduce expenditure programmes. So, if crude oil prices remain low, job growth and economic growth will be hit and the US would blink.

China is also not as rosy an economic picture, if one is to believe Anne Stevenson-Yang, who maintains that GDP growth is far lower than the officially stated, and doctored, figure, and she fears a capital flight out of China.

In short, it is difficult to see how the lower oil prices would lead to greater demand for oil, and thus, if and when the US shale producers blink and reduce supply, oil prices would regain the $90-100 levels. This may probably take longer.

For India this means that its oil import bill will be lower, and its current account deficit more manageable. The lower prices of crude oil would not benefit car companies as much because state governments have hiked taxes on petroleum products to rake in revenue.

In any case, car sales are more influenced by a fall in interest rates than a fall in petrol prices. Maruti is likely to see record sales, with a 13% growth in number of cars sold. The Reserve Bank of India is expected to lower interest rates before the Budget.

Airlines can expect to gain from lower prices of aviation turbine fuel (ATF), which in India is amongst the highest in the world.

A lowering of interest rates, combined with the acceptance by the government to permit public sector banks to raise capital, even if its own share in them falls (though not below 51%) means that PSU banks may become interesting.

Should the government accept that it does not need to have a majority control in so many PSU banks, privatising the weaker ones, this space could become even more interesting.

The government’s intention to continue with economic reforms is clear from the fact that it brought two ordinances, to clear bills relating to insurance and coal, after the legislative process was stymied by the opposition.

Without going ahead with auctioning of coal blocks, India’s power sector would have been badly hit in 2015, and hence it was necessary to bring in an ordinance.

What’s in store for 2015?

The US will raise interest rates, which will lead to some outflow from emerging markets. But after that foreign money will return, provided that the government continues with its economic reforms.

The Make in India campaign would bring back jobs with Prime Minister Narendra Modi asking all his ministries to make it easier to do business in India.

A dip either caused by foreign institutional investment outflow or due to a harsher than expected budget or to a political crisis, should be an opportunity to enter the markets.

(J Mulraj is a stock market commentator and India head for Euromoney Conferences;views are personal)

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