Iraqi unrest and Ukranian gas supply cut is Spoiler for Indian oil & gas sector: ICRA

India Infoline News Service | Mumbai |

Iraq is a major oil producing country in the world with crude oil production of about 3.3 million barrels per day making it the second largest crude oil producer among the OPEC countries and accounting for about 4% of the global oil consumption

Two recent geopolitical developments that are likely to have significant impact on energy prices globally are the violent unrest in Iraq and the gas supply cut by Russia to Ukraine. Iraq is a major oil producing country in the world with crude oil production of about 3.3 million barrels per day making it the second largest crude oil producer among the OPEC countries and accounting for about 4% of the global oil consumption. However most of the crude oil production in Iraq is from fields located in the southern part of the country, south of the capital city Baghdad, of which a large proportion is from the Basra which is located on the southernmost tip of the country. As per media reports, most of the unrest is currently concentrated in Northern Iraq, and the Southern part of the country is relatively unaffected. Accordingly the insurgency in Iraq is yet to impact oil production and exports. Nevertheless crude oil prices have climbed to levels of $112-113/barrel from levels of $ 107-108/barrel in April beginning; but in case the insurgency impacts crude oil production or if there were to be military intervention by other friendly countries, the rise in crude oil prices could be sharper.

Besides the Iraqi unrest, the Russian gas giant Gazprom has recently stopped gas supplies to Ukraine over large unpaid dues by the latter. While the Ukranian leadership has condemned the move by the Russian company as being politically motivated, Gazprom maintains that the dispute is strictly commercial. Ukraine meets a large proportion of its gas requirement from gas sourced from Russia. Besides, it is a transit point for pipeline gas supplies to European countries and hence in case the dispute persists the affected countries would have to scout for gas from other sources. The latter could add substantial new demand to the gas markets and this situation would get aggravated once winter approaches and gas demand escalates. With the large additional demand of natural gas from Ukraine and Europe, the demand supply dynamics of liquefied natural gas are bound to get impacted resulting in significant increase in LNG prices. Moreover, tensions in Ukraine could also impact oil prices through high geo political risk premium.

If the aforementioned increase in crude oil prices persists and/or prices increase further, the crude oil import bill of the country would significantly increase. Reflecting the higher requirement of US dollars to pay the higher crude import bill, the Indian Rupee has depreciated from the levels of INR/US$ 58-59 prevalent in mid May 2014 to over INR/US$ 60 levels now.

It was anticipated with the ongoing increase in retail prices of diesel by small amount (Rs. ~0.5 /litre) every month, the gross under-recoveries (GURs) would have materially reduced to around Rs. 1000 billion in FY 15 (from Rs. 1399 billion in FY 14) assuming Indian Basket crude oil price of US$ 108 /bbl and INR/US$ level of 60. However, as seen over the last few days, the global crude oil prices have shown sharp increase of ~4-5 US$/bbl due to political tension in Iraq. As per ICRA Research estimates, GURs could be around Rs 1375 billion in FY15 (similar to the level of FY 14) at Indian Basket crude oil price of US$ 120 /bbl and INR/US$ of 60 (with under-recovery of Rs. ~9.5 /litre for diesel, Rs. ~ 40 /litre for SKO and Rs. ~575 per cylinder for LPG). Thus, if crude oil prices increase further or sustain at elevated levels for the major part of the rest of FY15, the fall in gross under-recovery (from the level of Rs. 1399 billion in FY14) could be limited and hence, may offset the anticipated gains for OMCs and PSU upstream companies (for their under-recovery sharing burden). Besides, if increased import burden driven by higher crude oil prices leads to further depreciation in INR/US$ to average around 62 for the rest of FY 15, the GURs would tend to increase to Rs. 1500 billion in FY 15.

ICRA Research has estimated GURs assuming retail prices of diesel are increased by Rs. 0.5 /litre every month through FY15 till the under-recovery on diesel becomes zero. We have not assumed any hike in retail prices of LPG (domestic) and SKO (PDS). Further for our estimation of under-recoveries, we have factored in long-term average crack spreads of sensitive products over crude oil and if actual crack spreads are lower, the GURs could be lower than the projected levels.

Table 1: Projected Gross Under-Recoveries (Rs billion) for FY 15
Exchange RateIndian Basket Crude Oil Price
Source: ICRA Estimates

The higher GUR would also affect the OMCs liquidity position as there is delay of several months in the receipt of cash compensation from the GoI, which leads to higher level of working capital borrowings and interest burden for OMCs.

For standalone refineries, higher crude oil prices would result in higher crude import bill and higher product prices which could result in some inventory gains. Additionally in a scenario of depreciating Rupee there could be some translation losses for foreign currency borrowings and creditor payments, which could partly offset gains in GRM in INR terms.

Due to higher crude oil prices and depreciated level of Rupee against US$, private oil and gas exploration companies could gain materially as their realisations are denominated in US$ and the operating costs are a fraction of the realisation levels. However, the gains for PSU upstream companies could be largely offset due to higher GURs.

Earlier, in view of anticipated fall in under-recoveries, PSU upstream companies were expected to gain significantly from the fall in their under-recovery sharing burden. The absolute burden on upstream companies was expected to decrease in FY15 due to significant fall in GURs. However, if GURs level sustains at high level due to high crude oil prices, the burden on upstream companies could continue to be high in FY 15.



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