Oil’s rout on fall in prices

Oil’s rout on fall in prices

The fall in prices may bring cheer, but India will have to deal with a global slowdown.

Global markets, already teetering from the impact of the coronavirus, received a jolt over the weekend as Saudi Arabia cut oil prices and declared its intention to increase output well beyond what the oil market can absorb currently. The Saudi reaction followed the Organisation of the Petroleum Exporting Countries (OPEC) cartel and Russia, the largest non-OPEC producer, failing to reach an agreement to deepen existing production cuts to cope with the falling demand. Oil prices crashed overnight by almost a third to $31 a barrel consequent to the kingdom slashing prices and announcing its intent to increase output. The oil market is now set to witness the rare conjunction of a demand and a supply shock which is bad news for prices. Fears of a fall in demand following the outbreak of COVID-19 had already depressed oil prices in the last couple of weeks. China, a major importer, has cut its imports by a third from Saudi Arabia, its biggest supplier. The possibility of the market being flooded with excess production from Saudi Arabia and Russia leading to a supply shock, therefore, comes at a most inopportune time. There is still a large downside to prices from current levels especially if Russia joins the battle with Saudi Arabia and decides to hike its own output. Analysts are already talking of a floor of $20 a barrel.

While a fall in prices is good news for major consumers such as India and China which depend on imports for a major part of their oil needs, it may be bad news for the big oil companies and the smaller shale oil players who are highly leveraged. A collapse of these shale oil producers may set off defaults in the bond markets, setting off its own non-virtuous spiral starting with the U.S. markets. With stock and bond markets already in turmoil, the price war now set off in oil is only going to make the markets more volatile and murkier. For India though, the sharp dip in oil prices is good news, for now. This will reduce the oil import bill at a time when merchandise exports are likely to suffer due to the freeze in the developed economies. This will keep the current account deficit balanced. The fall in fuel prices will also drag down headline inflation giving the Reserve Bank of India elbow room to cut rates. But the oil price fall may be bad news for the Centre’s disinvestment programme as the sale of Bharat Petroleum Corporation Limited (BPCL) could run into headwinds. Big oil companies, which are widely expected to bid for BPCL, may either shy away from it or their bids may be much lower than expected as the company’s valuation may drop. In such an eventuality, it is quite possible that the government may step in to grab a slice of the windfall from falling prices, through higher excise duties to compensate for the loss from disinvestment proceeds. Any such decision is unlikely to go down well with India’s consumer middle class.