OIL PRICE CRASH

Impact of Coronavirus

Global demand for oil has taken a hard hit amid the coronavirus pandemic. There have been production cuts by manufacturers all around the world. People have been fearful about the coronavirus and are reluctant to go out. Several countries like China, Spain and Italy have imposed nationwide lockdowns due to the rising coronavirus cases. Recently, many Indian states have ordered the closing down of malls, pubs , schools, colleges and advised MNCs, Indian companies to allow work from home for their staff.

 

Demand - Supply Action

All this collectively around the world has led to a decrease in consumption of fuel in shipping , air travel, manufacturing & transportation activities and for personal uses. Seeing this, OPEC nations (Organisation for Petroleum Exporting countries which has 14 Members led by Saudi Arabia) decided to decrease the consumption by 1.5 million barrels per day to keep the prices stable and hence avoiding losses arising out of reduced demand. They also called off a meeting of OPEC+ nations(an alliance made between the OPEC nations and 10 other non-OPEC oil producing countries, including Russia). The OPEC nations asked OPEC+ countries to reduce the production of oil, so as to control the falling prices. However, Russia denied the request to cut production and on the contrary started producing even more with the intention of hurting and capturing the market share from US Shale companies producing oil. As increasing supply will lead to fall in prices owing to less demand, thereby incurring huge losses to Shale US companies including many of the small scale producers who will not be able to cover their costs and have to sell in losses.

This decision by Russia led to the start of an Oil Price War with Saudi Arabia, as Saudi Arabia also started producing more oil to maintain their market share even if it meant suffering temporary losses. Brent crude & WTI crude, the global benchmarks for oil prices have seen a sharp fall this year amid coronavirus pandemic from the levels of 60-65$ per barrel in January to 18 & 17 year lows at the levels of $20.37 and $24.67 per barrel on 14 th March, 2020.

 

Profit for all Importing Nations

Oil Exporting Countries have been incurring huge losses due to the falling oil prices. However, the crashing oil prices could be highly beneficial for oil importing countries like India. In the financial year 2019, India had paid $112 billions for importing oil but it is being expected that at the new reduced levels, India’s Oil import bill will come down to around $64 billions which is almost half. This is expected to have a highly positive impact on the Indian economy once the turmoil due to the pandemic is over.

 

Petrol Prices in India

So, even after this much fall in the price of Brent crude, why is it that the prices of petrol in India are still at a similar level as earlier?

Here are petrol prices for Petrol, Diesel & WTI Crude prices as a comparison as of 20th March and 1st January 2020.

                                     Petrol       Diesel     WTI Crude

1st January 2020      Rs. 75.14     Rs. 70.14       $61.17

20th March 2020      Rs. 69.59    Rs. 62.29        $26.63

 

WTI Crude prices have more than halved to $26.63 from the start of this year, but this has had minimal impact on the petrol & diesel prices in India.

 

Here are the reasons why the fall in the prices of oil at global level is having a very little impact on Indian Petrol/Diesel prices:

● High Tax Rates

Tax rates have a big impact on the prices of Petrol/Diesel. There are excise duties, cess charged by the Central government and VAT (varies from state to state) charged by the state governments. This whole number consisting of excises & taxes works out to be more than the base price of the oil itself.

After the big fall of WTI crude prices, Indian government has announced a hike in excise duty on each litre by Rs.3.

Below is the updated breakup of petrol prices in New Delhi

C:\Users\hp pc\Desktop\ZFUNDS\petrol price breakup.PNG

                                                                                                          Source: Indian Oil Corporation

 

Seeing this, the various taxes work out to be almost 118.70% on the dealer’s price plus commissions. So the major component of the petrol represents taxes and that’s why it’s still expensive even though crude is much cheaper at this time. The tax component is used by the governments to fund their budget and make them economically stronger.

 

● US Exchange Rates

Crude oil all over the world is traded in US Dollars, so the rupee-dollar exchange rate also has a major impact on the prices of petrol/diesel in India. Indian Oil Companies pay in US Dollars for importing/purchasing the crude oil from oil exporting countries. So when the rupee weakens against the US dollar, the oil companies in India have to pay more for the same amount of units and hence this adds to their cost.

Rupee dollar exchange rate was Rs 71.13 for 1 USD on 1 st January 2020 but after that it has been weakening since then to come at a rate of Rs 75.13 for 1USD as on 20 March 2020.This weakening is due to the low investors confidence and the coronavirus pandemic. Even in the event of falling crude prices, if we have a weakening currency against the US Dollar, it costs oil importers a lot by the way of high forex rates and it becomes difficult to pass on the benefits to the general public.

 

Going Forward

We expect the global oil prices to remain under pressure until the coronavirus pandemic blows over. Only, once the threat from the virus is dealt with do we expect businesses and travel to start moving back towards normal. There may be some temporary escalation in case a deal is reached between Saudi Arabia and Russia. However, given the demand situation, the rally can only be expected to be temporary in nature.

 

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