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Politics and/orSpeculation
LehmanBrothersCollapse
andFinancial Crisis
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PLUNGE IN CRUDE OIL PRICES: IMPACT ANALYSIS
Sustained low crude oil prices are positive for downstream companies, consumers
and Govt; to adversely impact upstream and oil field services companies
Analyst Contacts
K. Ravichandran
ravichandran@icraindia.com
+91-44-4596 4301
Anoop Bhatia
anoopb@icraindia.com
+91-124-4545 315
Prashant Vasisht
prashant.vasisht@icraindia.com
+91-124-4545 322
Pranav Awasthi
pranav.awasthi@icraindia.com
+91-124-4545 373
Aditi Nayar
aditin@icraindia.com
+91-124-4545 385
Website
www.icra.in
Crude Oil Prices: Key reasons for fall and outlook
Global crude oil prices have declined by ~ 55% from US$ 112/bbl (Brent)
in June 2014 to US$ ~50/bbl now primarily due to the following factors:
Significant increase in supply with US crude oil production at a 25
year high due to shale oil boom
o Improving technology to drill more oil per well
o Easy access to the debt funding for E&P companies even
as capital spending requirements are very high to develop
Shale oil fields
Demand slowdown in Europe, Japan and China
Decision of Saudi Arabia to protect market share rather than act as a
swing producer of oil
Cut in speculative positions; shift from unwinding of bullish bets in
commodity exchanges to panic selling
Chart 1: Crude Oil Price Trends
Source: Industry; ICRA analysis
The crude oil prices are expected to remain at low levels in the short-
term due to the above reasons. However, we believe that the oil prices
could marginally recover over the next 1-2 years with slower production
growth and demand recovery (aided by lower prices). The production
growth is expected to slow down primarily from highly capital-intensive
deepwater blocks and shale assets as shale-oil wells witness material
fall (60-70%) in output post first year of operations and slow down in
investments in these fields due to uneconomical crude price to reduce
supplies modestly in the short run (1-2 years). Further, shale oil
companies could face funding constraints due to negative free cash
flows, speculative grade ratings and reduced appetite in the US Bond
market for such papers. Besides, as per industry sources, the global
exploration and production (E&P) companies have started cutting capital
expenditure (capex). Estimates vary from 20%-30% on the likely decline
in the industry’s capital spending if the oil prices remain soft for a
ICRARatingFeatureJanuary2015
2. ICRA Special Comment Impact Analysis of Low Crude Prices
ICRA Rating Services Page 2
protracted period. Vulnerable projects include those involving high cost oil sands, deep water and
geologically challenging and risky assets. Further, the crude oil prices could face upward pressure arising
from any material escalation in geopolitical tensions. OPEC’s production discipline and US Fed tapering
programme resulting in higher interest rates could also affect the crude oil prices.
Even as crude oil exporting countries face significant pressure on their fiscal position, India will be a
significant gainer from the sharp fall in oil prices because of its import dependence. The impact of lower
crude oil prices on Indian companies, consumers and government fiscal position has been discussed in the
following sections:
Impact on Oil & Gas Sector
Upstream Sector
Profits of private players set to decline materially; revision in under-recovery sharing formula
would be the key for PSU upstream companies: Lower crude oil prices would materially impact profits of
crude oil producers; for instance the operating profit of Cairn India Ltd. could decrease by ~35% (yoy) for
average crude oil price of $ 85 /bbl in FY15. The impact on Oil and Natural Gas Corporation Ltd (ONGC)
and Oil India Ltd. (OIL) would be limited with around 15% hit on operating profit as ICRA believes that their
subsidy burden will go down with fall in under-recovery levels (discussed below). We project the decline in
under-recovery sharing discount to decline from US$ ~59 /bbl in FY14 to US$ 40-45/bbl in FY15. If crude
oil prices sustain in the range of US$ 50-55 /bbl, the extent of discount for upstream companies would be a
key driver of profits in FY16. Further, cash generation of overseas ventures of ONGC Videsh Ltd, OIL and
Reliance Industries Ltd (RIL) would decrease significantly. Besides, CBM players may witness lower
realisations with the fall in prices of the competing liquid fuels such as FO and LSHS.
The fall in GURs by 16% (yoy) in H1 FY15 has not helped the upstream companies as the GoI retained
large part of benefits of lower under-recoveries. The burden on PSU upstream companies, viz. ONGC and
OIL continue to be fixed at around US$ 56 per bbl of crude production. Unless the sharing formula is
revised, the softened crude oil prices would significantly impact the net realisation and profitability of ONGC
and OIL from Q3 FY15. For instance the gross realisation of PSU upstream companies could be around
US$ 75 /bbl in Q3 FY15 and with under-recovery discount of US$ 56/bbl, the companies may be left with
net realisation of less than US$ 20/bbl. However, this situation is unlikely as the GoI is considering reducing
the under-recovery burden of upstream companies in view of fall in GURs and possible material impact on
profits of upstream companies in absence of revision in sharing formula.
Chart 2: Under-recovery Estimates and Anticipated Burden on Upstream
Source: Annual Reports of Companies; ICRA Estimates
ICRA expects the GURs to decrease to Rs. ~788 billion for FY15 (estimated at Indian Basket crude oil
price of US$ 65/bbl and INR/US$ of 62.5 for H2 FY15). Assuming 60% share of upstream companies
(similar of H1 FY15), the burden on upstream companies is likely to halve at Rs. 160 billion in H2 FY15
(translating to discount of US$ 25-30 /bbl for H2 and US$ 40-45 for full year FY15). Further, ICRA projects
GURs to decrease to Rs. ~450 billon in FY16 (at crude price of US$ 60/bbl and INR/US$ at 64) following
diesel deregulation and soft crude oil prices. Assuming 50% upstream share, the upstream burden could
decrease to Rs. 230 billion in FY16 (i.e. discount of US$ ~20 /bbl). Overall, the impact on net crude oil
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FY13 FY14 FY15
(Projected)
Crude:65 $/bbl
INR/US$: 62.5
FY16
(Projected)
Crude:70 $/bbl
INR/US$: 63
FY16
(Projected)
Crude:60 $/bbl
INR/US$: 64
RsBillion
Total gross under-recoveries UR burden of upstream companies
% of GURs borne by U/S companies
3. ICRA Special Comment Impact Analysis of Low Crude Prices
ICRA Rating Services Page 3
realisation of PSU upstream companies may be marginal and the companies could report net crude oil
realisation of around 40 to 50 US$/bbl with gross realisation ranging from 50 to 75 US$/bbl.
GAIL has been requesting the GoI to exclude itself from the upstream companies’ burden as its revenues
are not linked with crude oil prices. GAIL’s share was only decreased to Rs. 5 billion per quarter from
earlier Rs. 7 billion per quarter. There is lack of clarity on GAIL’s share in upstream burden going forward.
Finding and development costs to trend downwards: The finding and development (F&D) costs1
of
upstream companies have been increasing in recent years due to the increase in cost of oil field services,
more exploration efforts in difficult terrain where exploration & development costs are higher and
redevelopment of mature fields involving significant development capex. However, the significant decline in
crude oil prices, if sustained, will lead to reduction of capex budgets of global E&P companies due to lower
realizations, deferment of development of complex fields, tar sands etc due to poor economics, increase in
idling assets of service providers due to decline in E&P activity thereby tilting the balance of supply-
demand towards E&P companies, which could put pressure on service providers to reduce rates.
Consequently F&D costs are also expected to trend downwards due to decline in rates of service providers,
greater E&P activity in on-land and shallow water blocks as development of complex fields could become
unviable and higher reliance on in-house expertise/services.
Leveraged Full Cycle Ratio2
, a key metric to monitor returns of E&P companies is expected to decline due
to the steep decline in crude realisations and slower decline in three year average F&D costs. However
leveraged Full Cycle Ratio of Upstream Public Sector Upstream players would depend on the discount
imposed post by the GoI post the decline in crude oil prices.
Oilfield Services Sector
Indian oilfield services companies not expected to face E&P spending cuts: The cyclical decline in oil
prices is not expected to reduce exploration activity significantly in India in the near-to-medium term. While
private players (such as Cairn India and Reliance Industries) will witness a decline in realisations of crude
oil, E&P activity in India is dominated by PSUs such as ONGC and OIL, for whom realisations net of the
subsidy burden would likely remain relatively stable or decrease only marginally. Moreover, exploration
costs for these E&P players would decline due to the global decline in the cost of drilling.
...but may face significant decline in day rates: The demand for oil field services is determined by
upstream capital spending, which is influenced by prevailing and expected oil and gas prices. Since it is
expected that there are no near-term catalysts to alter the supply-demand scenario globally, crude prices
may continue to remain low in the near term. In such a scenario, the demand for oil field services is
expected to be hit as international oil companies outside North America will likely reduce spending in 2015
by 10-20% depending on the prevailing oil prices if oil prices average around US$ 75/bbl and by 30%-40%
if oil prices continue to remain below US$ 60/bbl. The reduction in global E&P capital spending will reduce
earnings for oilfield services and drilling companies in particular.
Offshore drilling companies may be the most hit: Movement in day rates is largely a function of
demand-supply levels of drilling rigs and resulting capacity utilisation levels in addition to the prevailing oil
and gas prices. Day rates of drilling rigs have remained high in recent years due to high crude oil prices
leading to increased exploration activity and tight supply. Capacity utilisation levels of offshore drilling rigs
globally as well as in India have exceeded 80% levels for a large part of the past 2-3 years due to limited
supply, implying high capacity utilisation levels and resulting in high day rates. Coupled with healthy rig
investment economics in recent years due to healthy day rates, many players globally and domestically
(largely through offshore associates) have invested in newbuilds to be delivered in the next 1-2 years. The
drilling industry will now be faced with a dual pressure of the oil price crash and significant increase in
supply in the coming years, resulting in significant pressure on day rates. The scenario may be particularly
tough for offshore drillers, given the fact that offshore drilling entails relatively higher costs and hence
1
The finding and development costs expressed in dollar per Barrel of oil equivalent is a unit measure of the total
cost incurred to add and develop a barrel of new reserve to the point of production
2
Leveraged Full Cycle Ratio is defined as the Cash margin per barrel of oil equivalent production divided by
Three year Finding and development costs per barrel of oil equivalent
4. ICRA Special Comment Impact Analysis of Low Crude Prices
ICRA Rating Services Page 4
offshore drilling activity may decline globally in the wake of low oil prices. While such a decline may not
take place in India, players whose contracts are coming to an end will have to renew their contracts on
existing rigs at significantly lower rates. Players whose rigs are already contracted or who have recently
obtained contracts to be executed in the near term at healthy day rates may be able to weather the
downcycle given that these contracts are typically for three to five years. However, some of the domestic
players in the offshore drilling industry, for whom a substantial number of rigs are coming off contracts in
the near term or have already come off contracts may witness a reduction in day rates and hence,
revenues, profitability and financial flexibility will decline for such players. For land drillers also, day rates
may decline, although the impact may not be as high as that for offshore drillers as onshore drilling activity
is expected to continue at the same pace and day rates for onshore drillers are more region-focussed.
Nevertheless, decline in profitability is expected across the board.
Ability to keep rigs contracted to be critical from the credit perspective: For oilfield services
companies, the ability to get adequate contracts to keep assets operational and sufficient cash flow to
support debt repayment will be critical. For newer rigs, debt reschedulement/refinancing may sometimes be
required to match the cash flows. Companies which have uncontracted rigs under construction to be
delivered in the near term may witness cash flow pressures. The key mitigants to the credit risk profiles of
these players would be healthy cash reserves to manage liquidity position during the cyclical downturn and
/ or group strength.
Downstream Sector
Softened crude oil prices, if sustained, would improve profitability and liquidity position of OMCs:
The Gross Under Recoveries (GURs) of Oil Marketing Companies (OMCs) declined by 16% (yoy) to Rs.
511 billion in H1 FY15 from Rs. 609 billion in H1 FY14 primarily driven by 59% fall in under-recoveries on
diesel following monthly increase in diesel prices by around Rs. 0.5 /litre even as the price of Indian basket
of crude oil was stable at US$ 104.5/barrel in H1 FY15 as well as H1 FY14. However the significant decline
in the international price of crude oil in Q3 FY15, if sustained would lead to reduction in the price of Indian
crude oil basket of crude oil and accordingly the gross under recoveries of OMCs in H2 FY15. Lower crude
oil and product prices entail lower cash locked up in the working capital cycle as well as lower under-
recovery on the sale of sensitive products viz. PDS Kerosene and Domestic LPG. These factors would
continue to help OMCs to cut their short-term debt levels. The lower working capital intensity and resulting
decrease in short-term debt and interest burden would also improve the liquidity position of OMCs.
Source: PPAC, ICRA Research analysis, Note: FY13-FY14 figures are actuals, while FY 15 (P) and FY16 (P)
denotes projected figures. Figures reflect Indian Basket average crude oil price and INR/US$ for H2 FY15 and
full year FY16; Note: ICRA Research has estimated GURs assuming no 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. Further, any savings driven by lower leakage due to successful implementation of MDBTL
or direct kerosene subsidy have not been factored in the above GURs/subsidies.
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FY 13 (A) FY 14 (A) FY 15 (P)
Crude: $65/bbl
INR/$: 62.5
FY 15 (P)
Crude: $60/bbl
INR/$: 62.5
FY 16 (P)
Crude: $70/bbl
INR/$: 63
FY 16 (P)
Crude: $60/bbl
INR/$: 64
Rs.billion
Diesel Domestic LPG PDS Kerosene Total
Chart 3: Product-wise Under-recovery - Actual till FY14 and Projected for FY15 and FY16
5. ICRA Special Comment Impact Analysis of Low Crude Prices
ICRA Rating Services Page 5
....however downstream oil companies face significant inventory losses in Q3 FY15: Downstream oil
refining companies sustained large inventory losses in Q2 FY15 owing to about 15% decline in
international crude oil prices during the quarter. With about 40% further decline in international crude oil
prices in Q3 FY15, GRMs are expected to be negative or very low in Q3 FY15 on account of large
inventory valuation losses. The inventory valuation losses would be accentuated for inland refineries which
are saddled with large crude inventory of several million barrels in pipelines. However some support to the
GRMs would be available from the higher crack spreads witnessed during the quarter for several products.
Impact on Consumers
Benefit for industrial players with petroleum products as raw material and/or source of power &
fuel: Among the consuming segments, industries like paint, FMCG and tyres could be the major gainers
due to fall in the prices of raw materials. Further, the industrial units consuming liquid fuels for power & fuel
(FO, LSHS etc) would witness material fall in power cost. Besides, the lower crude oil prices have also led
to fall in prices of spot LNG, which would aid the players consuming PNG (industrial). Aviation industry may
also witness fall in losses in line with fall in prices of ATF.
...however, petrochemical and trading companies could suffer from inventory losses in the near-
term: The prices of crude oil derivates have been declining in line with crude oil prices, although with a lag.
The petrochemical players with naphtha as feedstock, polyester yarn/film producers etc. consuming crude
oil derivatives (PX, PTA, MEG etc) could suffer inventory losses during Q3/Q4 FY15. The extent of
inventory losses could be material for the companies which keep high inventory levels due to market
dynamics or import dependence. Further, the entities involved in the trading of crude oil derivatives,
polymers and chemicals could report material inventory losses in the near term.
Fall in retail petrol and diesel prices could boost the consumer expenditure: Despite recent hikes in
excise duties on petrol and diesel during Nov-14 to Jan-15, the retail price of Petrol (at Delhi) declined by
~17% from Rs. 73.6 per litre as on July 1, 2014 to Rs. 61.33 per litre now; while the price of Diesel (at
Delhi) decreased by ~13% from Rs. 57.8 per litre as on July 1, 2014 to Rs. 50.51 per litre now. The fall in
petrol prices from July 1, 2014 to now is expected to lead to annual savings of Rs. 157 billion for two-
wheeler consumers (equivalent to Rs. ~ 1400 per annum per vehicle) and Rs. 151 billion for passenger
vehicles (Rs. ~ 9400 pa per vehicle). The diesel price fall could save Rs. 39 billion for diesel PVs (Rs. ~
8100 pa per vehicle). Overall, the aforementioned savings in fuel expenses would leave additional money
in the hands of consumers, which could push discretionary expenditure leading to higher sales of consumer
durables and sales of vehicles if crude oil prices sustain at the lower levels for some time.
Impact on Govt Fiscal and Current Account Deficit
GoI to benefit from lower fuel subsidy along with higher excise collections; exports and capital
inflows likely to be hit: Lower crude oil prices are likely to ease the pressure on Government of India’s
(GoI’s) fiscal balances. First, GoI’s fuel subsidy burden is expected to decrease by Rs. 250 to 300 billion in
the current fiscal (FY15) as compared to FY14, and by a further Rs. 250 billion in FY16. Moreover, lower
crude oil prices have provided the opportunity to GoI to raise excise duties levied on petrol and diesel in
various tranches since November 2014, which are estimated to fetch GoI Rs. ~155 billion in FY15 and Rs.
~500 billion in FY16. The fiscal space created by lower fuel subsidy and higher excise collections in FY15
as compared to FY14 is estimated at Rs. 400-450 billion or ~0.3% of GDP, which is substantial when seen
in relation to the budgeted fiscal deficit of GoI of Rs. 5.3 trillion for the current fiscal (FY15). This would help
to ease the pressure created by factors such as the low growth of GoI’s tax revenues so far in FY15 (as
compared to the 20% growth targeted in the Budget Estimates for 2014-15), delay in raising of substantial
revenues through disinvestment, etc.
However, growth of sales tax revenues of various State Governments may dip following the reduction in the
retail prices of various fuels, as State-level sales taxes on several fuels are typically levied on an ad
valorem basis. VAT on POL products accounted for a sizable 30% of the VAT revenues of Indian States in
2012-13 (according to data published by the Reserve Bank of India). To safeguard their sales tax
collections, several States have recently increased the rate of VAT levied on certain fuels.
On the external balance front, net oil imports are likely to decline to US$ 80-85 billion in the current fiscal
from US$ 100 billion in FY14 due to lower crude oil prices. However, the current account deficit is expected
6. ICRA Special Comment Impact Analysis of Low Crude Prices
ICRA Rating Services Page 6
to record a muted reduction to US$ 28-30 billion in FY15 from US$ 32 billion in FY14, as the positive
impact of low crude oil prices would be partly offset by a rise in non-oil imports such as electronics (with an
expected revival in domestic economic growth momentum) and gold (following the withdrawal of the 20:80
scheme) and low export growth on account of weak demand from Europe and Japan. In FY16, net oil
imports are expected to decline further to US$ 60 billion, assuming an average crude oil price (Indian
basket) of US$ 60/barrel. Notably, a change in crude oil price of US$1 /barrel would impact India’s current
account deficit by US$ 1 billion. At present, we expect the current account deficit to be contained below 1%
of GDP in FY16, which would be comfortably financed by capital inflows, notwithstanding an expected
reduction in inflows from sovereign wealth funds, especially based out of West-Asia.
Conclusion
Overall, ICRA believes barring few segments such as Oil field services and some E&P companies, India
will be a significant gainer from the sharp fall in oil prices. While downstream oil companies could face
significant inventory losses in the near term, they will be benefited through lower working capital
requirements and fall in under recoveries (for PSU OMCs), once oil prices settle in a range. Even though oil
prices are anticipated to stage a modest recovery once supplies get curtailed due to uneconomical
operations for few high cost E&P players, the benefits could still be significant for India Inc in the near to
medium term.
January 2015
