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Wednesday / March 29.

Dark Side of the Fall

By Krishna Koundaniya

Edited by Nandini Bhatia, Senior Editor, The Indian Economist

Oil prices are falling down, falling down, falling down; Oil prices are falling down, my big economy.

-an economist

6 months ago, the oil prices were hovering above 100$/barrel and all the costs were directly bore by the retail customers. Arguments were heard that such high oil prices will result in inflationary pressures on food and basic supplies, which was true. Policy makers prayed for the heat of global oil prices to subside and the wish was granted in the form of the shale oil revolution resulting in an all-out war between Oil Sheikhs and Shale Barons resulting in a crash of oil prices to a six and half years low of 50$/barrel.

Now another question arises, is such an oil price crash good or bad for the economy?

Here are the negative aspects.

India’s demand for petroleum products was 155.4 metric tonnes in the 2012-13 financial year and India’s oil refiners produce 217.18 metric tonnes of oil. We have surplus refining capacity. Hence a fall in oil prices will no doubt reduce the burden on the exchequer but at the same time will hit the dollar reserves as the export revenue also becomes less. It’s a double edged sword. Hence the net effect of oil price crash is not of a great benefit.

Any one trading on the stock market will be aware of the turn of events at Dalal Street few days ago. Sensex fell by 3% in just one day (which is 855 points). Other factors such as the slowdown of the Chinese economy and the Grexit are also contributing factors but the primary factor is the fall of the oil prices.

Indian oil companies like ONGC, RIL, BPCL, Oil India bought huge oversees energy assets when the oil prices were running above the 100$/barrel mark. This itself will result in a plethora of problems like

  1. Valuation of the oil fields will fall thereby eroding the value invested in them. For example, the Mozambique gas field was acquired for around $25 billion by ONGC and Oil India. Now all the investment is blocked and the value erosion seems inevitable.
  2. Unviable leverage by oil firms will result in stock price crash. Since domestic loans are expensive, many firms (including oil) chose the ECB route of raising money. Most of the overseas acquisition was debt funded. This will be a double impact in the form of weakening rupee and erosion of oil field value. If this continues it’s only a matter of time before the entire things bursts.
  3. Fostering consolidation will lead to oligarchy in oil industry. Last time we had such price crash, it lead to an acquisition spree by the global oil giants as smaller firms became unviable. Bigger firms owing to their financial clout will be happy to bear with the losses and would make a killing once the tides turns which eventually would happen. End result would be a highly uncompetitive, hegemonic oil regime which would prove to be very expensive for retail customers.

Once these companies start Corporate Debt Restructuring (CDR) or worse, defaulting, this entire burden would be passed onto retail borrowers in the form of high interest rates which in turn will create credit crunch especially from supply side. RBI will again bring in stricter norms and this will eventually result in the contraction of the economy and the promise of acche din will be kicked out of the window.

Latest development on the scene is the death of Saudi’s King Abdullah. Immediately speculators began to bet and prices soared when the heir King Salman gave an appearance of stability in the times of turmoil. It was made clear that there will be no change in the extra production stance of the desert kingdom and prices will be expected to stay low. If this happens for a year or so, Saudi’s expected reserves of $750 billion would take a hit. It would become hard to persuade other OPEC countries to artificially keep the prices low and chances are good that prices would bounce higher. Meanwhile, its arch rival, Iran would slowly gain ground in oil production at Saudi’s cost. The best thing to do for India is to build a war chest of oil reserves like that of US or China, keep its forex reserves in a healthy shape and wait for next round of bouts.

Hence we can conclude that falling oil prices is definitely welcome for an energy guzzling economy like India but there is a flip side which can mushroom into something sinister if proper care is not take when it should be.

Krishna Koundiniya is an entrepreneur, Co-Founder of an e-Commerce start up. He holds MBA from IMT–Ghaziabad, B Tech gold medallist, state level boxer, cricketer, amateur musician & graphologist (AP Judiciary). He worked with Deloitte, Infosys, Vizag Steel specializing in IT, Finance. He assisted CFO, GMs in financial valuations and planning. He co-founded a robotics platform for R&D and successfully implemented home automation projects, car tracking and vibration test rigs using smart phone, https://www.facebook.com/krishna.koundinya.7, [email protected].