Crude realities! Up or down, reasons for all seasons

R. Venkataraman, IIFL | Mumbai | February 01, 2016, 14:53 IST

It is interesting to note that in the last two years, crude prices have come down but the effective petrol price in the hand of the Indian consumer has not changed. Whatever benefits the Indian consumer would have enjoyed has been taken away by the government in the form of higher excise duties. Effectively, the net disposable income in the hands of the Indian consumer has not changed.

On Dalal Street, news of lower crude prices sent the Sensex down, because of apprehensions that such low rates might lead to shale oil companies going bankrupt in USA, causing a banking crisis similar to sub-prime crisis of 2008, until realization that India’s current account deficit has improved dramatically on low crude prices pushed the market up, before it went down because of expectations of net FII selling because of wide spread redemptions from Middle East based sovereign funds, only to rise further on back of rising crude prices on realization that bankrupt shale oil companies will not be producing even a single barrel of crude and to decline sharply when wisdom dawned on all that rising crude prices will worsen India’s current account deficit.   
- The above is inspired by a cartoon from Howard Marks (Oaktree Capital) newsletter 
 
Nothing summarizes the current market situation better. Recently, markets fell on fears that crude price is crashing. Now when crude has rallied from its bottom, markets are not showing any signs of stability. Earlier analysts used to wax eloquently why India is a mega beneficiary of falling crude prices and now the same analysts are arguing why such low crude prices are very bad for world economy especially India.
 
Earlier when crude prices rose, markets used to fall because of expectations of inflationary pressures, remember the oil shock of 70s. Most countries across the globe are net consumers of crude and hence a beneficiary of falling crude prices.
 
What has changed that suddenly traders across the globe want high crude prices to revive the global economy. Articles now postulate that such low energy prices are not healthy because of supposed threats to banking system which has huge commodity exposure. I am sure banks especially in the West have seen commodity cycles and in fact in the 90s, crude had fallen and magazines had cover stories of crude being a perma bear market. One just has to look back a few years when Goldman Sachs analysts predicted that world has to get used to high crude prices and $100 barrel for crude was the new normal.
 
It is interesting to note that in the last two years, crude prices have come down but the effective petrol price in the hand of the Indian consumer has not changed. Whatever benefits the Indian consumer would have enjoyed has been taken away by the government in the form of higher excise duties. Effectively, the net disposable income in the hands of the Indian consumer has not changed.
 
Effectively, the crude oil bonanza which the government has got has not been passed on to the consumer. It is being used by the government to bridge the fiscal deficit. A better way of using this windfall would have been to spend on infrastructure, especially mass transit. Everywhere, including rich countries, people use mass transit. Although it is crowded, people in Tokyo use trains to work as it is convenient, cheap, fast and available. Having spent two decades in Mumbai, there has hardly been any upgradation in the local trains, save for a few rakes which have been added with better colors and now the East West mono rail.
 
There is an urgent need to improve the travel infrastructure so people can opt for public transport. This investment may well help governments win elections rather than debating on trivial issues like beef or porn ban.
 
Coming to the bigger issue, why is falling crude a concern? Most people are afraid that a continued decline in crude will lead to bankruptcy in the developed world, a kind of unknown unknown risk. And this might trigger a repeat of the sub-prime crisis of 2008.
 
India will get one more jolt because of Middle East countries. Apart from exports, we get remittances as a large number of Indians who are in Middle East send money to their families in India. A state that is most likely to get hit hard will be Kerala and we can only hope one more Airlift is not needed anytime soon.  
 
Then there are sovereign fund redemptions. Most of oil producers used the high commodity prices to set up sovereign funds that had invested in stock markets across the globe including emerging markets. They are forced to redeem to cover up for local government deficits and that is reflected in the net FII sales figures you see daily.
 
Last but not the least, falling commodity prices are causing new set of geo political and social tensions not only in Middle East but also in far flung areas like Russia and Brazil. How these tensions will take shape is another unknown – You know it might lead to some chaos but in what form remains unknown.
 
These are some of the factors that are giving traders across the globe sleepless nights.
 
To end on a positive note - when crude prices rise, the government would have an excise buffer. Should crude prices flare up, excise can be cut to avoid any inflationary impact. Hence continue keeping the faith and hope we have some Achche Din.

 

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