Fall In International Crude Oil Prices Technical Issue; Domestic Fuel Rates May Stay Put

It is a grim situation playing out in the oil markets, grabbing the eyeballs of the entire investor fraternity and defying logic. The absolute collapse of West Texas Intermediate (WTI) prices is primarily owing to the expiry of May WTI futures contracts on New York Mercantile Exchange. In overnight trade, May futures for US crude oil fell to minus $37.63 per barrel level, ahead of their Tuesday expiry. The trend was seen at a time when 90 per cent of the world is under lockdown and there is virtually no demand for crude oil.

WTI is the benchmark crude for North America. The New York Mercantile Exchange (NYMEX) is a division of the Chicago Mercantile Exchange (CME), which lists futures contracts of WTI crude oil. These are physically settled contracts.

The drastic fall in crude oil prices is because of significant demand destruction due to lockdowns in several countries and supply glut in oil markets. Simply put, the sellers are paying the buyers. Oil traders are unwilling to take the delivery owing to lack of storage space. In complete contrast, Brent crude prices are trading at about $25 per barrel (bbl). The reason for this sharp divergence is that WTI needs to be physically delivered only at Cushing, Oklahoma, US, whereas for Brent contract, deliveries can be done offshore at multiple locations.

Cushing is a major trading hub for crude oil and a price settlement point for WTA on the NYMEX.

Pointing out that the WTI May contract on NYMEX collapsed was a technical issue, Sugandha Sachdeva VP-Metals, Energy & Currency Research, Religare Broking explained, “One has to note that the WTI June contract is still trading higher. The storage constraints at Cushing, Oklahoma has led to dumping and unwinding in May contract and market participants moving to June contract”.

The crude shock in the international market took its toll on the stock prices of Oil and Gas companies. The BSE Oil & Gas index, a sectoral index comprising 10 stocks, saw its constituents falling in the range of 0.6 per cent to 7 per cent individually while the index outnumbered the benchmark S&P Sensex to shed 3.54 per cent (to close at 10,944 points). The Sensex closed with a loss of 3.20 per cent at 30,637 points.

Global crude oil benchmarks are at a nearly two-decade low as more than 90 per cent of the world is under lockdown, with economies at a complete standstill. Even China, which declared its Q1CY20 GDP data, highlighted a contraction in the economy for the first time since 1992. OPEC+ has recently announced a record production cut of 97 lakh barrels per day (bpd) starting May; however, the announcement has failed to excite the oil markets. Efforts to ramp up the economy once the lockdown is lifted, may take a toll as labour shortage as well as lack of demand may strike down hard on industrial activity.

“In light of the recent raucous data sets, we further revise down our Brent price forecast to USD40/50/bbl (from USD52.5/60/bbl) for FY21/22 respectively,” says Motilal Oswal Institutional Equities in a research note to its clients.

Another reason for the weak crude oil demand is that cost of transportation has risen due to widespread lockdown. Viram Shah, CEO and Co-Founder, Vested Finance says, “Amidst the lockdown in excess of 90 per cent of the locations, the transportation cost of shipping oil has gone up three times since March 2020”.

Hitesh Jain, Lead Analyst - Institutional Equities, Yes Securities, says, “The exaggerated weakness in the expiring WTI May contract was certainly more of a speculative activity and unwinding of derivative positions. Looking forward, we remain bearish on Oil, as demand side shocks (more than Saudi-Russia price war) will result in a huge surplus particularly in the first half of this year. Brent Oil projected to be in a range of between US$20-25/bbl over the next three months, while a recovery in the second half of the year can take prices towards US$35-45/bbl.”

If you have been expecting a big cut in petrol and diesel prices in the domestic market after US crude oil rates plunged below the $0 mark into negative territory for the first time in history and Brent touched multi-year low of $26 a barrel, then you could be termed as highly optimistic.

Naveen Kulkarni, Chief Investment Officer, Axis Securities, says, “Decline in crude prices is a big positive for the Indian economy as we import bulk of the commodity. In general, sectors that may benefit from the scenario include FMCG companies, Paint companies and OMCs. However, the fall in crude prices is not a standalone event. It is a manifestation of multiple factors which include global demand and structural geopolitical challenges. So, while the benefits of lower crude prices are clear, there will also be an impact of global demand challenges, which could outweigh the benefits of lower crude prices".

Barring a hike in few cities like Mumbai, Bengaluru and Kolkata due to an increase in VAT by some state governments, fuel retailers have not changed their selling price of both the fuels for more than a month now. Petrol and diesel prices were last reduced on March 16.

However, the falling crude prices and expectations that this commodity prices may hover around lower levels for quite a longer period is good news for India. “For oil importing countries like India, this scenario might be an opportunity to improve its oil reserves,” says Shah.

Brent crude oil prices, on which fuel price is based in India, have collapsed around 60 per cent since the start of the year while in the domestic market price of diesel has fallen only by 10 per cent and that of petrol by 8.5 per cent from their peak rate on January 11.

Ravindra Rao, VP- Head Commodity Research at Kotak Securities, says, “The International Energy Agency expects demand for crude oil to drop by 2.30 crore bpd. So until the virus threat is on, demand for oil will be extremely low as people avoid travel and oil usage is low. The selling might continue until the supply glut remains and demand doesn’t pick up.”

As the demand for petrol and diesel have fallen by over 60 per cent due to curbs on travel and industrial activities during lockdown in India, oil marketing companies (OMCs) have been forced to reduce refining capacity and deal with inventory losses.

For most refiners, crude is purchased about 2 months in advance, based on prices prevailing at the time. Petroleum ministry data shows the cost of Indian basket of crude was at $20.56 a barrel on April 17.