Impact of Decontrol in oil

prices in India and its effect on India's

Wholesale and Consumer price

Indices since 2010

Oil Prices And EconomyFuture in 2 types of Economies :

Frontier Level Technologies Resources Under the crust

Oil reserves across the globe

Oil Prices And Indian EconomyIndia's growth prospect largely hangs on where the oil prices are headedIndia ranks among the top 10 largest oil- consuming countries Oil forms 30% of India's total energy consumption.Imports about 70% of its total Oil consumption.India’s Rough Production is about 0.8 million Barrels per day where global oil production is 84.

Oil Reserves in India

Consumption Position Country Consumption In MBD

1 United States 20,698,000

2 China 7,855,000

3 Japan 5,041,000

4 India 2,748,000

5 Russia 2,699,000

6 Germany 2,393,000

7 South Korea 2,371,000

8 Canada 2,303,000

9 Brazil 2,192,000

Consumption Of Top 15 Countries

Unite

d Sta

tes

China

Japa

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dia

Russia

Germ

any

South

Kor

ea

Canad

a

Brazil

Saudi

Ara

bia

Mex

ico

Franc

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Unite

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5,000,000

10,000,000

15,000,000

20,000,000

25,000,000Consumption in Million Barrels per Day

(MBD)

Consumption in Million Barrels per Day (MBD)

How Oil affects India’s EconomyIMF report :

Largest impact is felt in :

GDP growth rate Balance of payments

Mostly India , Korea , Pakistan & Phillipines.USD 5 per barrel increase would lead to

1.3% increase in Inflation1% drop In GDP

ImpactSkewed Balance of Payments

Deterioration in Its balance of payments.Downward pressure on exchange ratesImports more expensiveExports Less valuable

Inflation Soars

High oil price leads to Inflation Increased input costs Lower investment in net oil importing

countries Tax revenues fall and budget deficit

increases High interest rates Value of the country’s currency

decreases

What determines oil price?Supply and demand Market sentiment The price of oil is actually set in the

oil futures market. An oil futures contract is a binding

agreement that gives one the right to purchase oil by the barrel at a predefined price on a predefined date in the future. Under a futures contract, both the buyer and the seller are obligated to fulfill their side of the transaction on the specified date. 

Supply, demand and sentiment toward oil futures contracts, which are traded heavily by speculators, play a dominant role in price determination.

Cyclical trends in the commodities market may also play a role. 

Governments shielded us from the true market price of petroleum through price controls and subsidies

Oil marketing companies (OMCs) are making under-recoveries of Rs.3.73 a litre on petrol, Rs.3.80 on diesel, Rs.17.92 on kerosene, and Rs.261.90 a cylinder on domestic LPG

The decision to protect consumers, despite rising oil prices over the past few years, came at a great cost for the government. It added over Rs 150,000 crore to the country’s debt burden and public sector upstream companies lost over Rs 120,000 crore.

Decontrol Of Oil Prices In June 2010 , EGoM took a major policy

decision on the country's retail fuel pricing. After long deliberation for more than a year,

the EGoM has freed the price of petrol from the government's control.

Diesel prices are to be deregulated in a phased manner.

However, cooking fuels will continue to be subsidised.

DeregulationDefine ‘Deregulation’It is the act of doing away with the government administered price regime and replacing that with a market determined one.

Why ‘Deregulation’ has gained so much of Momentum?•India relies on imports for 75% of its energy needs•Govt sets fuel prices to cushion the poor•Loss to the private companies•Can’t bear revenue losses more than 12,000 crore .•Action Plan taken after G-20 Summit

G-20 Summit

G-20 Summit was held in toronto

Declaration:•full return to growth with quality jobs,•to reform and strengthen financial systems,•and to create strong, sustainable and balanced global growth.

Private sector Units

The policy change is a significant step in the right direction and has come as a positive surprise for PSU oil companies, viz.

ONGC, OIL India , GAIL, IOC, HPCL and BPCL.

Downstream oil companies are likely to be key beneficiaries of the deregulation on the following counts:

Reduction in overall subsidies to manageable limits Subdued outlook on crude oil prices Improved profitability situation of upstream companies post the APM(Administered Pricing Mechanism) gas price hike, enables them to bear a relatively higher subsidy burden Government efforts towards divestment in IOC

Impact of the EGoM decision on under recoveries

After incorporating the EGoM's decision, under recoveries in the sector are expected to reduce by around 29% to Rs54,516cr for FY2011E from the earlier estimate of Rs77,213cr.

Subsidy-sharing mechanism going aheadThe likely beneficiaries will be determined on

the basis of the subsidy-sharing structure between the various stakeholders, viz. the government (via cash subsidy), upstream companies (discount on crude and products sold) and OMCs.

However, the subsidy-sharing arrangement is based on the paying capacity of the companies involved, which is further contingent on the overall subsidy level and level of crude oil prices.

Deregulation of retail prices - On a firm footing

In April 2002, in an attempt to phase out subsidy on petroleum products, the government dismantled the administered pricing mechanism (APM), paving the way for free pricing mechanism for petrol and diesel, while prices of kerosene and LPG were still kept under the regulator's purview.

At that time, the government gave limited freedom to OMCs to revise retail prices within a band of +/-10% of the mean of rolling average of the last 12 month's and the last 3 month's international C&F prices.

•In case of breach of the band, the matter had to be taken up with the Ministry of Finance for modulation in excise duty rates. •Oil companies were given some freedom to determine the prices based on the international petroleum market. However, the euphoria of dismantling was short-lived.• When crude prices started to increase in 2004 and oil companies wanted to pass on the same, the government's interference halted the free pricing of petrol and diesel in June 2004.

Subdued outlook on crude pricesCrude oil prices to be range-bounded in the

near future, on account of relatively subdued demand outlook in OECD (Organization for Economic Co-operation and Development) countries, along with growth in production of NGL(Natural Gas Liquids) by OPEC countries.

On account of the same,can expect crude oil prices to average US$75/bbls in FY2011E and FY2012E .

•Considering the same, the required changes in the price of petrol and diesel will not be significant. Though there is no mention of the pricing band as was the case in erstwhile dismantling of APM, the government is likely to provide pricing freedom to OMCs until US$90/bbls (thus providing a tentative pricing freedom of 15% from the current crude levels).

Wholesale Price IndexWPI was first published in 1902, and was one of themore economic indicators available to policy makersuntil it was replaced by most developed countries bythe Consumer Price Index in the 1970s.

WPI is the index that is used to measure the change inthe average price level of goods traded in wholesale market.Movement in Prices of commodities In all Trade.Available on weekly basis with time lag of only 2 weeks.

Composition of WPIWholesale price index (weight=100):Primary articles (wt.=22.0)cereals, pulses, Fruits and vegetables, egg, oil etc.

Fuel power,Light and Lubricants (wt.=14.2)Mineral Oil, Electricity,Coal Mining

Manufactured Products (wt.63.8)Sugar, edible oils, textiles, chemicals, iron &steel, machinery, transport equipment, etc

Consumer Price IndexIt is a price index that tracks the prices of a specified basket of consumer goods and services, providing ameasure of inflation.

Cost of Living Index

Too much time lag in reporting Numbers.

CPI calculated on a monthly basis whereas Inflation In India is Calculated on weekly basis.

Headroom for further reformsEven if crude oil prices were to register a

significant increase, the government has certain levers in the form of reduction in excise and custom duty to address the situation of under recoveries.

Moreover, any favorable development on the issue could widen the headroom available for further corrective measures in the event of spiraling increases in crude oil prices.

Impact of Auto fuel deregulation on ONGC

ONGC to report net realization of around US$60/bbls (in FY2011E and FY2012E) as the large part of the benefit on account of reduction in under recoveries is retained by the government and OMCs.

However, in case of ONGC, on the back of reduction in overall under recoveries, the risk associated with variability in earnings estimates of ONGC has reduced to an extent

Key financials-ONGC

Effects of deregulation Private marketers likely to benefit from the

deregulation While the public sector OMCs got

government protection, private players crumbled under price pressure and had to close shop

Reliance Industries (RIL) and Essar Oil (EOL), which went into oblivion a couple of years ago when international crude prices skyrocketed to touch $150 a barrel are now likely to benefit from the deregulation.

RIL has also started opening its retail outlets, and the company would get more aggressive if the government policy regarding the complete deregulation of diesel prices gets clearer.

RIL, in particular, could ramp up its retail operations at a much faster pace, as in the past the company was able to ramp up its share in the diesel segment to 14% in three to four years. Given that the company has its retail outlets in place, regaining the lost market share would not take more than two to three quarters.

BPCL, due to its overlapping presence with RIL in the highway segment, is likely to be the most affected on account of increased competition due to the deregulation.

But now in the decontrolled regime, private companies, including MNCs, will not only enter the market with renewed vigour but also pose stiff competition to the oil PSUs and here the would be consumers.

Private companies will now compete with state run companies to sell their products.

Effects of deregulation conti… Inflation will rise. There is no doubt over the same. In the short

term and medium term overall inflation will rise. But in the long term the higher base effect will negate all the rise.

   Interest rates: Higher inflation will in higher the cost of borrowing

and hence higher interest rates.Hedging: Now even a single petrol pump owner will resort to

hedging of petrol. For example a petrol pump owner has 10,000 litres of petrol in his stock today (25th June 2010) and say on Monday 28th June petrol prices will be changed. The petrol pump dealer (A) Will sell crude oil futures in MCX or any other commodity exchange if he expects petrol prices to fall on Monday (28th June). (B) If the petrol pump owner sees a short term bottom being formed in petrol prices he will buy crude oil futures in MCX or any other commodity exchange

Other side of DecontrolWith heavy subsidies No one gave a thought of saving oil.Fuel efficient automobilesDecreased import billLower inflationBenefit economically less privileged.Less pollution

Just for 21 yearsIndian Oil will last just 21 yearsChina ‘s oil reserves would last for 12 yrsSaudi Arabia : 66 yrsOnly Iran ‘s oil reserves is expected to last for 174 years and Iraq’s 106 yrsOn an avg if overall production continues like last year , oil reserves would last for 41 yearsOil production declining 4-6% & consumption Increasing by 2-3 %.