What does the fall in crude oil price mean for India's economy? (Part 11 of 12)
Red turns green
The subsidies, past and current, aren’t just a problem for the government. They also hurt oil marketing companies, or OMCs. The government expects OMCs to shoulder the burden of under-recoveries along with it and upstream oil companies—like the ONGC (Oil and Natural Gas Corporation) and Oil India Limited.
Under-recoveries for OMCs result when they sell fuel to consumers at lower-than-market prices. Since it’s a notional loss in revenue, it doesn’t necessarily lead to losses. The distinction between under-recoveries and losses is that under-recoveries result when market prices are higher than sales prices. In contrast, losses are incurred if the cost price is higher than the sales price.
In fiscal year 2014, under-recoveries amounted to 1.4 trillion rupees, or about $22 billion in today’s terms. 855 billion rupees, or 61%, was borne by the government. Most of the remaining amount was borne by upstream companies.
The recent deregulation of diesel helped OMCs make over-recoveries. Combined with falling crude oil prices (XLE) (OIH) (XOP), this helped the government raise excise duties on diesel and gasoline twice in the past two months. This is a positive development. It boosts revenue for the government—at least while the crude oil price doesn’t reverse its course.
Refiners
Indian refiners’ stocks did benefit from falling crude prices. However, in the long run, persistent low crude prices don’t benefit them. They plan to upgrade their refineries to enhance their capacity and produce higher-quality fuel. Investments are expected from foreign companies in refining—apart from other avenues.
However, if demand doesn’t recover and bring prices equal with the supply, there won’t be much chance of attracting foreign investment for these avenues. In such a scenario, domestic companies will be hesitant about making additional investments.
Since India doesn’t produce much crude oil, the adverse impact due to that is absent. Refining companies may end up reporting low growth. A slowdown in oil and gas companies’ growth will be negative for Indian ETFs with large exposure to the sector—like the WisdomTree India Earnings Fund (EPI) and the PowerShares India Portfolio (PIN).
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