The continuing slump in international crude oil prices is making it harder for India to cut its dependence on imports. It's a double edged sword since cheaper imports boost local consumption on one hand, and dissuade oil companies from investing in raising domestic production on the other. The combined impact of low crude prices and the depreciation in the rupee may result in a Rs 100,500-crore impacts on India's import bill along with a Rs 9,000-crore impacts on the petroleum subsidies. Subir Ghosh looks at the international oil politics and how it impacts India.
What essentially began as a game of one-upmanship between two nations has now spread so far and wide that every sector in any country which is even slightly reflective of the global economy is feeling either the pangs of it or reaping in the associated benefits. We are talking crude oil here, and the game in question is the one that is still ongoing between Saudi Arabia and the United States.
As this edition goes to the press, many speculators across the world feel oil prices would fall to $45 a barrel by October. Irrespective of whether that would have happened, certain situations are unlikely to change. It is worth taking a look at what has happened on the crude front in the last one year or so, and what kind of bearing it is likely to have on the textiles and apparel industry both worldwide and in India.
The international oil war
Global oil prices have always artificially been kept high by the Organization of Petroleum Exporting Countries (OPEC). With prices being on the higher side a few years back, there began the quest for alternatives to crude oil. The development of shale oil, mostly in the United States, started changing the equations. From being an importer, the US slowly turned into a major exporter. The shale gas industry in the US, which is not a member of OPEC, had everything going in for it - right from the high prices of crude oil to domestic industry incentives. Commercial production, therefore, was boosted.
The only hitch was that the shale oil industry was working under the assumption that global crude oil prices would always remain high. With a cost component of $60 per barrel, it was producing shale oil with a sufficient cushioning factor. At least, that's what the industry thought, till Saudi Arabia decided to take the fight right into the US camp. It kept oil production high, and believed that shale gas companies would soon go out of business if they were unable to compete with crude oil prices. The Saudi policy did have its impact: the number of wells producing shale oil dropped from 1,608 in October last year to 659 in June this year. Investments too suffered. But US oil production didn't; in fact, it went up to a 43-year-old high of 9.6 million barrel per day. Efficiencies are said to have increased dramatically in just a year.
US companies have been working feverishly to bring down drilling costs, and therefore remain competitive. So far, this counter-measure has worked: the cost for a barrel of shale oil has been substantially brought down to $40. Many analysts feel that the oil production policy will eventually backfire on Saudi Arabia. They feel that the country will go bankrupt in another two years; it has already been losing $12 billion per month because of the war of attrition that it had itself launched.
As of now, Saudi Arabia needs oil prices to hover around $105 so as not to be in the red. It is already said to be planning to raise $27 billion in bonds by the end of the year. The country has deep pockets in terms of foreign exchange reserves, and that is what had kept it going, apart from the fact that the cost of oil production is the lowest in Saudi Arabia compared to any other country. The foreign exchange reserves have dropped from $737 billion to $672 in the space of a year. It is expected to dip further. Saudi Arabia needs the bonds so as to continue with its social spending that it has been doing since the Arab Spring of 2011. For a country that generates 80-90 per cent of its revenue from oil, this is bad news. Saudi Arabia has other problems to contend with - two- thirds of its population is under 30, and unemployment in this age group is around 30 per cent. The Yemen War is another cost factor.
Right now there's too much of oil. US oil production has not been brought down, and OPEC production - led by Saudi Arabia and Iraq - has hit record levels. The oil war, which began in June 2014 after Brent crude peaked at $115 per barrel, galvanised the November 2014 meeting of OPEC member countries. They decided not to cut production in support of prices, sending oil into a free fall. Brent, the global crude benchmark, touched a six month low of $48.45 per barrel in the first week of August before stabilising at $48.61. The price fell by 23 per cent over the six preceding weeks alone. There will be still more once Iran, now free from the shackles of sanctions, starts ramping up its own production.
Even till end-August, Saudi Arabia kept the oil flowing. It continued to produce huge volumes of crude while maintaining its policy of prioritising market share over revenues. Its oil fields pumped 10.3 million barrels a day in August meaning that levels topped 10 million barrels per day (mbd) for six continuous months. The International Energy Agency's oil market report released early September believed this was a strong indication that Riyadh had no intention of backing down to some of its fellow OPEC member states calling for lower production to shore up prices. If that was not all, analysts at Goldman Sachs, known for its oil-price predictions, said the benchmark US oil price may have to tumble to as low as $20 a barrel-from current levels around $45-to clear out a global supply glut. "The oil market is even more oversupplied than we had expected and we forecast this surplus to persist in 2016," Goldman said in a note entitled 'Lower for even longer'.
With the US heading for elections next year, the public debate is already veering towards lifting its own oil ban. The US has banned oil exports since the 1970s so as to keep gasoline prices in check at home and for obvious national security reasons. Many senators now want the US to go in for a head-on clash with Iran, which has the fourth largest oil reserves in the world.
Impact on India
One doesn't have to be an oil expert to say that a drop in global oil prices augurs well for India. A news report in late August said the country would save as much as Rs 100,500 crore this financial year because of the drop in the price of the Indian basket of crude oil to $45.21. The Indian basket represents the average price of Oman and Dubai sour-grade and sweet Brent crude oil processed in Indian refineries (in the ratio of 72:28). The price of the Indian basket was the lowest since January 30, when it was $46.28 a barrel. Between April 1 and August 6 this year, the price has been an average of $55.50 a barrel. By and large, every $1 drop in crude oil price signifies a fall in the import bill by Rs 6,500-6,700crore, and the government's subsidy burden goes down by Rs 900 crore. A hitch, nevertheless, remains - the ongoing depreciation of the rupee. According to Petroleum Planning and Analysis Cell (PPAC), every Rs 1 increase in the dollar exchange rate increases oil import bill by Rs 7,455 crore.
The US-Iran nuclear deal will also benefit India. Many Indian refiners were buying crude oil from Iran, but payments could not be routed due to sanctions imposed by the West. India, the second biggest buyer of oil from Iran till 2006, had to cut down imports. In 2009-10, crude imports from Iran stood at 21.2 mt, which declined to 18.50 mt in 2010-11, 18.11 mt in 2011-12 and to 13.14 mt in 2012-13.
Usually, the first impact that a fall in crude oil prices has in India is on trade and fiscal deficit since 80 per cent of domestic consumption of crude is met through imports. A drop in crude prices has a positive impact on petroleum-based industries, and a negative impact on industries that rely on alternative energy sources. The earliest beneficiaries of this price drop are the automobile industry, transportation sector, fertilisers, petrochemicals, synthetic rubber and tyres industries, manmade fibre and textiles, paints industry, etc. The negative impact is on bio-fuels and other alternative sources of fuel and energy, natural rubber, cotton yarn and fabrics, etc, for which petroleum based products are used as substitutes.
The first to be directly hit was the synthetic yarn industry. Till December 2014, the continuous drop in crude oil prices led to domestic synthetic yarn makers incurring stock and margin losses. The fall in prices of petrochemicals, including key polyester yarn raw material like monoethylene glycol (MEG) and purified terephthalic acid (PTA), forced yarn makers to reduce prices. But there was a sluggish demand for yarn from mills around that time. Moreover, there was a disparity between the prices of crude oil and PTA/MEG as well as polyester yarn. While crude oil prices kept falling, it was not translated into a corresponding drop in polyester raw material and yarn prices. The immediate fallout was that the synthetic textiles industry suffered from low margins.
There were a number of reasons why the synthetic yarn industry kept taking hits. First, with the Chinese economy in a slump, export potential of synthetic yarn to that country dipped. Indian synthetic units began cutting production, some by almost 40 per cent. Second, the sector kept suffering from its lower export competitiveness and central excise duty on man-made fibres. Fitch Group Company India Ratings & Research, in a report, remarked that the industry also estimated price of polyester fibres to decline due to oversupply of cotton and cotton yarn over FY'16, coupled with lower crude prices. It said, "Unfavourable cotton-polyester staple fibre (PSF) spreads have hurt domestic synthetic yarn demand. Lower export competitiveness of Indian synthetic yarn also contributes to the subdued outlook as import and central excise duty continue on man-made fibres."
The situation turned worse in July, with reports that many factories were further cutting down production, and some halting it. Spinning mills in Tamil Nadu mid-July decided to stop production twice a week to arrest the decline in demand for synthetic yarn. Nearly 90 mills producing synthetic yarn under the Indian Texpreneurs Federation (ITF) decided to stop production on Saturdays and Sundays for a few weeks, so as not to pile up the stocks in various mills and till such stocks could be disposed of.
India Ratings maintained an overall stable outlook for the cotton textile sector for 2015-16, but revised the outlook for the synthetic textiles sector to negative from 'negative to stable'. "Unfavourable cotton-polyester staple fibre spreads have hurt substitution demand for synthetic fibres and synthetic yarn. Lower export competitiveness of Indian synthetic yarn also contributes to the subdued outlook as import and central excise duty continue on man-made fibres," the agency said.
Over-supply of cotton and cotton yarn over 2015-16 coupled with lower average crude prices could also cause the price of polyester fibres to decline. Apparel exports, however, could continue to show a positive growth trend in 2015-16, driven by the improving economic outlook of buyer countries. Although India has a relatively small share in the global textiles trade compared to China, it is well positioned to gain from weak input prices and growing demand for apparels and made-ups, India Ratings said. "The trends, if sustained in 2015- 16, are likely to improve the financial metrics of garment manufacturers," it said.
Both cotton and apparel exports could be hit - to those countries impacted by the drop in crude oil prices. The oversupply of cotton, however, will not continue, even as crude oil prices are expected to dip till mid-2016. The International Cotton Advisory Committee (ICAC), in early August, predicted, Stocks in 2015-16 are projected to decrease as consumption overtakes production for the first time in five seasons. World production in 2015-16 is forecast down 9 per cent to 23.8 million tonnes. Output is expected to fall from 2 per cent to 16 per cent in the five largest producing countries. India's production is forecast down just 2 per cent to 6.4 million tonnes due to improved yields from better monsoon weather this season and low prices for competing crops reducing the loss of cotton area."
In about a month, the ICAC said limited cotton consumption growth was expected in 2015-16. It said that high domestic cotton prices and low polyester prices in China, the world's largest consumer of cotton, had made its cotton spinning sector less competitive. The Cotlook A Index and the price of polyester in China were essentially equal during most of the 2000s, with cotton sometimes the cheaper of the two. However, polyester prices have also fallen during the same period, maintaining the spread between cotton and polyester. The committee said that world consumption growth over 2015-16 would be limited, because international cotton prices would remain higher than competing man-made fibres. Either way, the turbulence will continue.