The S&P BSE Oil & Gas Index has been on a roll as oil is on the boil again.
Brent Crude – the Asian benchmark – gained over 27% in the month on November and is up around 6.5% so far in December. These gains for consecutive months have led to an over 20% rise in the benchmark oil & gas index in the same time period.
Infact the gains posted by the S&P BSE Oil & Gas Index in the months of November and December is highest for that month since 2005 and 2003, respectively.
Recently the Brent Crude crossed the $50 per barrel mark for the first time since early March. Well, this time to accompany, Asian LNG (liquified natural gas) prices rose to over a two-year high to $11 per mmBtu (million British thermal units).
Here’s a short video summarising the post
Why This Rise?
The oil-market recovery was fueled by supply curtailments and rollout of coronavirus vaccines which will lift global fuel demand. While gas-market recovery was due to high demand for heating, a supply crunch and increasing freight rates.
Oil has risen in anticipation for a 2021 global economic resurgence. Buoyant demand from China also is boosting oil prices after the world’s largest commodity consumer largely contained the pandemic. Traders are also hoping that travel picks up globally next year, boosting energy consumption while large oil suppliers remain disciplined with production cuts.
Temperatures in Beijing, Tokyo and Seoul are expected to be lower than average over the next two weeks, increasing gas demand for heating. The rise in imports in China, as the economy recovers, and the lack of shipping availability is also helping to push gas prices up.
Impact Analysis
Higher crude prices will definitely inflate India’s import bills but would benefit a host of PSU oil companies.
Upstreams – ONGC & Oil India
It goes without saying that oil producers would benefit the most due to rising crude prices. Oil is their product and a rise in oil prices mean they will earn more from selling their product. The rise comes as a relief for the producers – ONGC and Oil India Ltd. – as crude prices are now hovering around the upper-end of its ‘acceptable’ levels.
According to ONGC’s CMD, Shashi Shanker – the price of an oil barrel in the range of $40-$50 is acceptable, though it still poses significant cash flow risks.
Usually, the total cost of production for every barrel of crude is around $35-40, while crude prices are currently trading around $50 a barrel. The operational cost for producing every barrel of crude is on an average around $25-30 per barrel, plus taxes at 31-32% of the crude prices. This brings the total cost of production for ONGC in the range of $35-40/bbl.
This coupled with some sequential volume growth would definitely support earnings of oil explorers.
Downstream – OMCs
Oil refiners and marketers such as Indian Oil Corporation Ltd., Hindustan Petroleum Corporation Ltd. and Bharat Petroleum Corporation Ltd. are indirect beneficiaries of a rise in crude prices.
A rise in crude prices lifts the value of their crude inventory. Oil refiners maintain an inventory. If the market price increases, refiners that bought the existing stock at lower prices end up selling through retail outlets at higher rates, and vice-versa. At the end of Q2, the average value of crude inventory held by these oil refiners was around $43 per barrel as against the current prices of $50.
However, there is a downside to this.
In India, retail fuel prices are de-regulated and revised on a daily basis. Petrol and diesel prices have been de-regulated in India since 2010 and 2014 respectively. Which means that prices should be revised based on international crude prices.
But that has not been the case of late. Despite the surge in crude prices, retail petrol and diesel prices in India have remained unchanged for 16 consecutive days till December 23. If the rise in prices of crude – raw material for oil refiners and marketers – is not being passed on by the OMCs, then the same will eat on to their margins.
Gross marketing margin is what an OMC earns on selling every litre of petrol and diesel.
One of the main reasons why this is not being passed on to consumers – retail fuel prices are already at a two-year high, despite crude prices being lower. This is because of two times jump in taxes collected by the Central Government during the pandemic.
In early May, the Government of India hiked excise duty on petrol and diesel given that crude prices and consumption were low. However, since then not only the consumption of retail fuels has jumped, compared to last year, even crude prices have surged. That has led retail fuel prices to surge to a two-year high.
As the crude prices and retail fuel prices are currently not moving in tandem, the gross marketing margin earned on the sale of every litre of petrol and diesel is taking a hit.
GAIL
After a series of disappointment, things have now turned around for India’s largest gas distributor. A rise in crude prices aids two segments – LPG and gas marketing (partially) – of GAIL.
GAIL produces liquified petroleum gas using domestically produced gas – the prices of which is set by the government every six months. While input cost if fixed, the selling price of LPG is a function of crude price. Now with a rise in crude prices, the prices of LPG will also increase with a lag. This is in turn would benefit the LPG segment earnings in the coming quarters.
On the marketing side, GAIL buys LNG at contracted prices from the international market and sells it at contracted and/or spot prices in both the domestic and international markets. Currently, GAIL has four active long-term LNG contracts to buy gas – one each with the U.S., Russia, Australia, and Qatar. Of these four contracts, the U.S. LNG contract which was troubling the company for a while will now help the company earn profits.
Earlier the selling price of this gas was lower than the buying price. However, now due to a surge in gas prices, most of these contracts are profitable. Currently, the spot LNG prices are at a premium of 42% to the landed cost of the U.S. LNG in India. While for the crude linked prices, the discount has narrowed to 10% from 15% in the earlier quarter, compared to the landed cost of the U.S. LNG in India.
Nearly 50% of imported LNG volumes are from the U.S. and the prices of the same are linked to Henry Hub – benchmark gas price in the U.S. As per the contracts, LNG is bought at 115% of Henry Hub price plus a fixed liquefaction charge of $3 per million British thermal units (mmBtu).
As an example, If the Henry Hub price stands at $2.6/mmBtu, then the price at which GAIL can buy the LNG at the U.S. port will stand at $6/mmBtu. Add to this, the transportation cost which ranges between $1.5-2/mmBtu.
City Gas Distributors
City gas distribution companies generally provide gas to three segments of the society – vehicle users (CNG or compressed natural gas), industrial and commercial user and households (PNG or piped natural gas). Only IGL, among the listed players, also provides gas to other city gas distributors. Basically, it acts as a transporter of gas and earns a fixed margin of ₹ 2/scm.
Now the prices of gas procured to supply to vehicle users and households are fixed and set by the government every six months. However, the gas supplied to industrial and commercial users is procured based on spot prices. Thus, the recent spike in Spot LNG is negative for industrial margins of all the city gas distributors.
Gujarat Gas is most vulnerable to this because the company derives a little more than two-thirds of its revenue from selling gas to industrial users. Gujarat Gas sources 43% of its gas requirement on spot prices, followed by Mahanagar Gas which sources 13% of its gas requirement on spot prices.
What Lies Ahead
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- Vaccine driven demand recovery to aid crude prices, especially as air travel returns to normalcy, will benefit upstream companies
- Oil price recovery will aid GAIL’s LPG segment and gas marketing segment partially
- Most probably, the Indian Government will roll-back the higher excise duty as crude prices have risen, and demand is above normal; This will help OMCs to earn decent marketing margin
- With an increase in fuel demand, GRMs could also increase which in turn will aid OMCs
- A recent surge in Spot LNG prices is expected to be shortlived, which will be partially negative for GAIL and positive for the CGDs
- Concerns over CGDs will persist in form of competition, rise in domestic gas prices and a possible rise in dealer commission
