A business article

On
Crude fall in oil price and its impact on
India

By
M Ganesh
Section-A

On
10th January, 2015

Abstract
The article analyses the current trend in crude oil price and the reasons for its decline around
the globe. The article then goes to explain the effect of falling crude oil price on Indian
economy, especially fiscal deficit and inflation, followed by its negative effects like rupee
devaluation. Then it explains the effect on various Industry sectors starting from upstream
and downstream oil companies. It is followed by impact on Aviation and auto industry.
Finally the article concludes that falling crude prices in the medium term, has positive impact
on India.

*No. of words - 100

Crude fall in oil price and its impact on India

Brent crude oil prices have fallen from $114/barrel from June 2014 to less than
$60/barrel by end of December 2014. Black gold as it is popularly called has been losing its
sheen even though crude oil consumption is still taken as a major economic indicator. In this
article, the reasons for the current downfall in crude prices and its impact on India are
analyzed.
Reasons for the current slump
Crude oil price is partially determined by demand and supply and partially by demand
expectations of the future. The sharp decline in crude prices can be attributed to three major
reasons. The first is the decrease in demand for oil because of global downturn in economic
activity and increasing efficiency of systems. The second reason is the threat of competitors growth of new competitors - increased production from countries like Libya and Iran as well
as increased threat of substitutes like American shale gas and increased use of alternate
sources of energy. The third reason is the OPEC cartel responsible for 40% of crude oil
production has decided not to control price fall by reducing production. Saudi Arabia and its
allies have decided to maintain market share rather than to increase the price of crude oil.
The Indian basket of Crude Oil represents a derived basket comprising of Sour grade
(average of Dubai & Oman) and Sweet grade (Brent Dated) of Crude oil processed in Indian
refineries in the ratio of 72.04:27.96 during 2013-14. If crude contains more than 0.5% of
sulphur, it is called sour crude.

Indian Crude basket 2014

$120

109.05
106.30
105.29 106.19 105.30 105.56 106.85
$110
101.89
$100
$90
$80

96.96
86.83
77.58

$70
$60
$50
42005 42036 42064 41730 41760 41791 41821 41852 41883 41913 41944

Impact on Indian Economy

As we can see from the data from Petroleum Planning & Analysis Cell (PPAC)
website, crude oil price has been on the decline since June 2014. India imports more than 190
million tonnes of Crude oil every year with an annual cost of 140 billion dollars which
accounts for one-third of Indias import bill. It is estimated that with every 1 $ decrease in
crude price, Indias import bill comes down by Rs. 4000 crores. So, the decrease in crude oil
price will reduce the fiscal deficit currently budgeted at 4.1% of GDP.
Moreover, the phased increase in diesel prices from February 2013 along with the
recent decrease in crude prices has made complete deregulation of diesel prices possible.
Deregulation will also decrease the fiscal deficit.

Diesel has a trickledown effect on WPI inflation. It will help in reducing the transportation
cost and thereby the price of all commodities will reduce by an appropriate fraction of diesel
price reduction. Moreover, the recent decline in Crude oil has also resulted in lower prices of
cooking gas, resulting in more disposable income. But the Indian government is not fully
passing on the benefit of lower crude prices to end users. In order to fund the ambitious
infrastructure development programme of the government, particularly the building of
15,000km of roads during current and next fiscal, the government has decided to increase
basic excise duty on petrol and diesel by Rs.2 per litre, the finance ministry said in a note.
So effectively the retail prices of petrol and diesel have reduced but not proportional to the
crude oil prices. Lower crude prices have made excise duty hike possible for the government,
which will fetch additional revenues for the government.

There is a flip side. Falling crude oil prices means lesser income for oil-exporting
countries, resulting in a reduced demand for Indian exports. FII inflows have reduced to $17
billion from $24 billion in 2012. As US interest rates are expected to increase, the demand for
rupee from FIIs will reduce, resulting in further devaluation of the rupee.
Impact on the Industry
State Oil Marketing company PSUs - IOCL, BPCL and HPCL will be the biggest
beneficiaries since their under-recoveries will reduce. The total under-recoveries faced by
these three companies in 2013-14 amounted to Rs. 1,39,869 crores. Deutsche Bank estimates
that every 50 paise increase in diesel margins could push up earnings per share (EPS) of
HPCL by 43%, IOCL by 19% and BPCL by 23% in fiscal 2015. In addition to that, there will
be a decrease in working capital for these PSUs, further improving their profit margin.
Consider private upstream companies like Cairn Indian Ltd and Aban offshore, which
are primarily involved only in oil exploration. They had a downgrade in investment rating by
Macquarie Capital following the slump in oil prices. State-owned ONGCs stock prices
increased as the negative impact of weak oil price will be more than offset by subsidy
reduction.
Indian aviation and Auto industry also seems to have benefitted from reduced oil
prices. According to consulting firm Capa center for Aviation, high fuel costs and fierce
competition has resulted in a loss of $1.4 billion for Indian aviation Industry. A 10% decline
in fuel costs will increase EBITDA by 300 to 400 basis points, thereby increasing the
operating margins of aviation companies. Auto firms will also benfit as demand for small cars
which are dependent on petrol prices will increase.
Apart from these industry segments, Industries, which use crude derivatives as raw
materials like the tyre industry and paint industry, will see an increase in their profit margins.
Packaged consumer goods industry may also see a slight reduction in packaging cost because
of lower cost of packaging material like high-density polyethylene.
Thus to conclude, the recent slump in crude prices, therefore, seems to have helped in
improving macroeconomic factors like fiscal deficit and inflation and reduce our import bill.
Manufacturing, packaging and distribution costs of industries have declined with crude prices
though the effect in their results will appear after a lag of three to five months. Even though

there may be a decrease in Indian exports and FII inflows resulting in a depreciated rupee
value, in the medium term the effect on Indian economy is going to be positive.

References
1. Ami Shah, (October 16, 2014), Fall in crude prices may help brighten balance sheets
http://www.livemint.com/Industry/FfDyFM1cRHVmPansShF5dI/Fall-in-crude-prices-mayhelp-brighten-balance-sheets.html
2. Petroleum Planning & Analysis Cell reports,
www.ppac.nic.in
3. Biswajit Baruah, (December 15, 2014), Falling crude prices may adversely impact India,
global markets
http://articles.economictimes.indiatimes.com/2014-12-15/news/57071927_1_crude-pricesneelkanth-mishra-brent-crude
4. ET bureau, (December 8, 2014), Why oil price is falling?
http://www.economist.com/blogs/economist-explains/2014/12/economist-explains-4