Crude oil price rise spells bad news for India

The global energy market is likely to see some volatility. The Kingdom of Saudi Arabia (KSA) is going through internal upheaval. Many members of the ruling clique have been arrested, including several royals. This purge is said to be part of a cleanup campaign by the ruler's son. Economic reform is on the agenda, including stake sales in oil assets.

Figuring out KSA’s internal politics is much impossible for an outsider. There are thousands of royals and clerics of varying degrees of fundamentality, with varying influence. Plus, there’s a populace that may, or may not, be rebellious. The KSA’s role as guardian of Islam's holy places also gives it huge influence in other Islamic states, which are also key Organization of the Petroleum Exporting Countries (Opec) members.

It’s not necessary to understand KSA politics. A trader can rest assured that, every time the KSA's politics hits the headlines, crude oil prices move. The KSA is not only a very large exporter; it has the most spare capacity and is the most influential of Opec members. It has “swing” power, it can influence prices by varying production.

KSA is said to have been a key proponent of keeping Opec production high to force less efficient shale producers out of business. Crude demand isn't very price-elastic. If supply is surplus to demand, prices fall sharply and vice-versa if supply is lower.

Better technology has led to soaring shale production. But, shale costs much more and Opec tried to drive less efficient shale out of business by keeping production high. In addition, the Iran-KSA rivalry and the fact that Russia is outside Opec has meant that production cutbacks are tough for Opec.

Overproduction has been only partially successful as shale has become more costefficient. Some shale operations are profitable in the $3740 per barrel range and more shale comes into the market if prices rise beyond $55. If there is political turmoil in KSA, it could mean that KSA policy will change. Or there may be supply disruptions.

The crude equation has obvious implications for India. India's Fiscal Deficit is said to worsen by around 0.1 per cent of gross domestic product or GDP for every $10 per barrel hike in the price of the Indian crude basket. The Current Account is impacted by 0.4 per cent of GDP. Plus of course, higher energy prices invariably feed into higher inflationary pressures.

If prices do rise over a sustained period, it will create a problem for the government. Prices fell in September 2014 and have stayed down since. That enabled the government to free retail prices and to tax fuels. Given electoral considerations, high crude prices would force it to either cut taxes on fuels, or impose price controls on the retailers it controls. Either way, finances are impacted. One estimate suggests that a ~1 drop in excise rates could mean ~13,000 crore less in annual collections. The Reserve Bank of India also reckons that GDP growth reduces by 0.15 per cent for every $10 rise.

The direct impact of crude volatility for traders and investors is not very palatable. Traders could go long in the futures market perhaps. Even if more shale production comes in, it would take several months.

Producers - that is ONGC and OIL, “should” make more money if allowed to. Retailers like BPCL, HPCL and IOC will make less. If the government reverts to a subsidy/ price control policy, it will probably ask ONGC to share the burden. Refining margins will drop. That could affect Reliance Industries' grandiose plans, including the push into telecom.

Will any of this happen? It all depends on what’s going on in KSA. So, watch the headlines carefully.

Better technology has led to soaring shale production. But, shale costs much more and Opec tried to drive less efficient shale out of business by keeping production high