However, in this sector, there is a drastic divergence happening currently. Although upstream firms such as Oil and Natural Gas Corporation and Oil India Limited have been gaining momentum in the equity markets, downstream firms dealing in oil marketing, which includes Indian Oil Corporation, Bharat Petroleum Corporation Limited and Hindustan Petroleum Corporation Limited, are under extreme pressure owing to the fears of under-recovery being pegged at ₹2 lakh crore.
With the steep surge seen in the energy sector, it must be mentioned that the oil prices in international markets continue to remain strong owing to geopolitical tensions in West Asia and worries about disruption in supplies through the straits of Hormuz. Reports indicate that the prices of the Brent crude have crossed the significant level of $100 per barrel.
Why Are ONGC and Oil India Rising?
The main reason behind the rally in these upstream oil companies lies in one simple word—high crude oil prices.
ONGC and Oil India are engaged in the exploration and production of crude oil. Higher global crude oil prices mean higher realizations per barrel of crude produced by these companies, which translates into higher revenues and higher margins for them.
A second big catalyst was the Indian government’s decision to rationalize royalty rates under the Oilfields (Regulation and Development) Act. Oil and Natural Gas Minister Hardeep Singh Puri called this decision a “new era” for the Indian upstream oil and gas industry.
Brokerages have been more optimistic about ONGC in recent weeks since the regulatory overhaul. According to brokerage firm CLSA, ONGC stocks could surge by as much as 44% based on the impact of the royalty cut and lower risks of windfall taxes.
The expectation now is that upstream companies will be major beneficiaries of elevated crude prices over an extended period.
Reasons for Concerning OMCs
While upstream companies thrive in a world of high oil prices, downstream companies are at loggerheads with them.
OMCs procure crude oil from overseas sources, process it, and supply petrol, diesel, LPG, and other fuels to end-users. Political pressure and inflation considerations usually hinder them from passing on the full effect of increased crude costs to consumers.
This results in what is called “under-recovery,” which means the difference between the cost and retail selling price of fuel.
According to reports, OMCs may end up incurring under-recoveries amounting to about ₹2 lakh crore in case oil prices remain high while the prices of fuels are held down.
The current scenario becomes even more sensitive considering the fact that Prime Minister Narendra Modi has requested citizens to cut down their use of fuel and move towards using electric power in vehicles.
This would mean that the government will be very cautious about imposing steep fuel prices, thus burdening the balance sheet of OMCs.
Three Major Problems in India
1. Inflation Threat
India sources most of its crude oil requirements from outside. If the price of crude oil goes up, then there will be a resultant effect on the costs of logistics, transportation, production, air travel, and consumer products.
In case there are sharp rises in the prices of petrol and diesel, inflation might once again go through the roof, thereby lowering consumption levels.
The aviation sector, paints, tires, and chemical companies will be facing the heat because of rising input costs.
2. Implications for India’s Fiscal Deficit
In case OMC losses keep mounting, it is likely that the government will be compelled to subsidize or finance state-owned oil companies.
This will place additional fiscal strain at a juncture when the government is trying to juggle between investments in infrastructural development, social welfare schemes, and economic growth considerations.
An extended period of an oil crisis will further deteriorate the trade balance of India as the country is extremely vulnerable to imported fuels.
The situation may become even worse in case geopolitical unrest in West Asia escalates, and there are disruptions to shipping via the strategic Strait of Hormuz.
3. Depreciation of Rupee and Volatility in Markets
More imports mean that India will have to pay more in US dollars; hence, this implies extra pressure on India’s rupee.
A weakening rupee increases costs for imports further and causes extra inflationary pressure. It should be noted that Indian financial markets have been highly sensitive to these problems.
For instance, recent reports emphasized the increased volatility in the Indian stock exchange and foreign exchange markets due to high prices for oil globally.
Additionally, foreign investment tends to decline in emerging markets during times of geopolitical tension and commodity shocks.
What the Investors Should Look Out For
Looking ahead, investors would be on the lookout for three important factors:
Whether crude prices move up or down beyond $100 per barrel
Whether the government decides to increase fuel prices or subsidies
Other geopolitical events related to Iran, the US, and the Strait of Hormuz
Should crude prices stay high, then upstream oil majors such as ONGC and Oil India should perform better. The downstream oil companies would, however, continue to struggle until retail fuel prices are increased.
India’s task is to reconcile energy security, inflation management, prudent fiscal management, and economic growth at the same time.
The next few weeks might turn out to be very important not only for energy companies but also for the entire Indian economy.
