Low oil price regime and its impact on the profitability of downstream Indian oil companies

Abstract

Global oil prices are notorious for their volatility. What actually explains this volatility? Does the demand supply framework offer adequate explanation? Or is it speculation that deviates the oil prices from their fundamentals? What are the causes of the present depression in global oil prices and what implications oil prices can have on the profitability of downstream Indian oil companies? The CCS report aims to answer the above questions with a historical analytical perspective. The report is intended to analyze the factors behind determination of global oil prices as well as the impact of volatility in oil prices on the profitability of downstream Indian oil companies. Global oil prices have seen high volatility in the past primarily due to monopolistic control over production and supply of crude oil by organizations such as OPEC. In addition, global oil prices are subject to geo political risks as exemplified by “oil shock” on the 1970s and the U.S invasion of Iraq in 2003. Apart from the demand-supply economics and geo politics, speculation in oil derivatives such as oil futures is also widely perceived to be a major cause of volatility in global oil prices. Studying the fluctuations in global oil prices has been an area of keen academic interest with different authors ascribing the volatility to different factors. The study for determining factors behind determination of global crude oil prices has been done primarily on the basis of secondary data available on web and research papers using Brent crude and West Texas Intermediate as price benchmarks in global oil trading. For studying the impact of oil prices on profitability of downstream Indian oil companies, 2 Indian companies viz. Reliance and Indian Oil Corporation Limited (IOCL) have been chosen in order to represent the private sector and public sector respectively. The Annual reports of these companies for the period 2000-2015 have been referred to for getting the required Cost, Price and operational data that affects their profitability. Data for Brent crude spot prices from 20th May’1987-15th -Jun’2015 was analyzed to calculate % change in oil prices over a daily and monthly basis. Months where change in prices over previous month was greater than ±20% were identified and the causes of such deviation were determined. The causes were classified into 3 types viz. Geo political, Supply and Demand. It was learnt that the demand shocks were greatest in frequency followed by supply and geopolitical shocks. Further, role of hedge funds in influencing oil prices was analyzed and it was found that there doesn’t exist any empirical evidence to show that speculative positions taken by the hedge funds can influence oil prices in the long run. The reasons behind the current regime of low oil prices were studied and it was attributed to slowdown in global demand primarily due to recession in the Eurozone, import substitution by the U.S and weakening of demand from the emerging economies such as India and China. Further, OPEC hasn’t been able to cut down its production proportionately so as to stabilize the prices.