The silver lining in the market crash
Perhaps all we can say of the silver lining of falling oil prices is: This too shall pass
Thanks to the fall in the stock markets, could the most painful headwind for the Indian economy—crude oil prices—turn into a tailwind?
Brent crude oil prices recorded a new one-month low of $62.79 a barrel last week.
What’s the reason?
Ritesh Jain, chief investment officer at BNP Paribas Asset Management India Pvt. Ltd, said, “The more crude oil prices went up, the more speculative positions were created. The same guys played each and every asset class.”
He added, “Problem is once you start losing money in something big—say for example equity, which is by default the biggest asset class—the leveraged positions in other assets have to be brought down as well and crude is no exception to that.”
There are signs and portents that the high crude prices are bringing forth more supply. The US energy information administration estimates US crude oil output averaged at a high of 10.2 million barrels a day in January. That would have added to the downward pressure on prices.
Lower crude prices bring plenty of benefits to India, which imports most of its oil requirements. They lower inflationary pressures and have a positive effect on the current account. If oil goes below $60 a barrel then India’s fiscal situation will dramatically improve, said Sandeep Chordia, executive vice-president, Kotak Securities, adding, “This will bode well for equity markets.”
The million dollar question, then, is whether oil prices will drop further.
They could, to an extent, but prices are unlikely to remain lower on a sustained basis. Kotak Securities doesn’t expect oil prices to drop below $60/barrel in the medium term citing that Opec (Organization of the Petroleum Exporting Countries) is known to manage output levels.
For one, Opec can totally rely on the deep crisis in Venezuela’s oil industry to help Opec’s output cut plan.
“In December, OPEC supply edged down to 32.23 mb/d, as a sharp decline in Venezuela offset higher flows from elsewhere,” said the International Energy Agency last month.
The plunge in Venezuelan output raised Opec compliance in December to 129%, the highest so far, pointed out the Agency.
The mess in Venezuela is expected to persist.
Mexico has production issues too. “It’s worth remembering that there have been no new oil discoveries in the last few years,” said BNP Paribas’ Jain.
Further, the improving global economic growth outlook should support higher oil prices. Global growth forecasts for 2018 and 2019 have been revised upward by 0.2 percentage point to 3.9%, said the International Monetary Fund recently.
According to Chordia, “Oil should settle between $60-65 per barrel.”
When Brent crude oil went up about $10/barrel in such a short time some selling had to come and that is what is happening now, pointed out Jain. “Once this clears out, there is no doubt in my mind that crude is on a strong wicket,” he added.
And what about shale oil production—which was expected to permanently put downward pressure on oil prices?
Lenders to shale producers are much more circumspect than before following the financial problems of many shale producers following oil’s collapse to a low of $27 a barrel in January 2016, said Christopher Wood of CLSA in a report on 8 February.
Perhaps most interestingly, we have begun to read that some of the best shale drilling areas are showing the first signs of “field exhaustion,” elaborated CLSA.
“Our tentative conclusion is that investors should be prepared for a much higher oil price than we had previously supposed, even assuming no Middle East conflict. This is clearly a risk for India and its budget,” reckons CLSA.
Perhaps all we can say of the silver lining of falling oil prices is: This too shall pass.
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