I.

Oil and Gas industry Structure

A clear understanding of the Oil and Gas (O&G) sector necessitates a basic understanding of macroeconomic factors and at the same time facilitates a clearer understanding of all allied sectors. This sector
in India is a critical component of the countrys economy, accounting for 15 per cent of the countrys
gross domestic product (GDP). Also, the economic growth is directly linked with energy demand. The
demand for fuel has increased substantially with increased urbanization and manufacturing facilities and
this increase is primarily met through imports. Thus any change in the fuel prices has a direct bearing on
the Indian economy.

The oil and gas sector consists of three segmentsupstream, midstream and downstream.
Upstream segment comprises of companies engaged in exploration & production activities
Midstream segment comprises of players in storage and transportation, and
Downstream segment comprises of players that are engaged in refining, processing and
marketing of petroleum products

II. Why has the oil price been falling?

Crude Prices dipped 49% in FY-2014 from $107.8/ barrel on January 1, 2014 to $55.02 on December
31, 2014. The slide has continued into 2015 to levels of $48. The international crude prices is
determined by the simple market forces of demand and supply. Robust supply and low demand have
been the key factor for the sharp drop in prices.
On the supply side, US is producing 8.5 million barrels per day (mbpd), its highest amount of crude in
the last 28 years. The Organization of the Petroleum Exporting Countries (OPEC) are also producing at
the specified 30 mbpd limit.
As against this, demand for OPEC crude is estimated at 29.5 mbpd in 2014. In 2015, it is seen averaging
29.2 mbpd. The demand have been subdued on account of slowdown in major consumers of crude oil
like China, Euro zone, Japan and other advanced economies.

Another key determinant of oil prices is the strength of dollar against other currencies. Expectations
of a tighter US monetary policy has boosted the value of the dollar.

III. What it means for the industry?

Oil and Gold
Cheaper oil means lower inflation. This means gold should be affected negatively since its usually
considered a hedge against inflation. Lower oil prices are a positive for Indian spending on other items.
This signals better economic prospects, which in turn is positive for equities and negative for gold,
which is considered as a reserve of money during gloomy times.
Oil and Oil exploration and marketing companies
The softness in crude oil prices will benefit upstream players like ONGC as they provides huge discount
(nearly 80 per cent) to the oil marketing companies. Downstream oil and gas companies (OMCs) who
sell the fuel through retail outlets as HPCL, BPCL and IOC stand likely to gain due to fall in crude oil
prices as the entire benefits of reduced prices is not passed onto the end consumers. This will help
OMCs to reduce losses and improve margins.
Oil and Transportation/ Tyre Industry
The most direct beneficiary of the global commodity softening are the transportation and manufacturing
sector where input costs comes down proportionately.
A drop in crude prices will also be positive for tyre companies which have already seen operating
margins expand to double digits in the last few quarters due to a steady fall in natural rubber prices. On
a year-to-date basis, rubber prices plunged nearly 35 per cent in the domestic markets till December
2014.
Oil and Auto Industry
Auto companies will also benefit because ownership cost of vehicles will come down because of falling
oil prices. As per a study, a fall of Rs 3 per litre in petrol prices will lead to annual savings of around Rs
4,200 for car owners. This saving augurs positive for current and prospective car owners.
Oil and Paint industry
The fall in crude prices is also beneficial for paint companies as it will lead to better gross margin. Raw
materials for paint companies include titanium dioxide, additives, pigments, resins and solvents - most
of these are crude derivatives. As per industry estimates, a 10 per cent drop in crude prices will improve
gross margins by 150-250 basis points.
Oil and Rubber industry
Natural rubber is the main raw material used in manufacturing tyres, although synthetic rubber is also
used. Synthetic rubber is produced from the polymers found in crude oil. The other primary ingredient
in tyre rubber is carbon black. Carbon black is a fine, soft powder created when crude oil or natural gas
is burned with a limited amount of oxygen.

Oil and FMCG/ Packaging industry

Petroleum products are also used to form raw material for packaging in the form of tubes, bottles,
covers etc. Packaging costs constitute a major cost for FMCG companies. Companies like Colgate
Palmolive, Emami and HUL are the key beneficiaries of lower packaging costs. Fall in packaging cost
may improve operating cost of these companies in near future.
Oil and Plastics Industry
Plastic companies are also the biggest beneficiaries of falling crude prices as crude is also used in plastic
making as main raw material. We believe, the fall in crude oil prices will soften the polymer prices.
Oil (Aviation turbine fuel) and Airline Industry
Airline companies which are hard compressed for margin on account of cut throat competition in the
affordable travel segment are obvious beneficiaries of fall in ATF prices.

IV. Jargons and news developments

1) Under-recoveries/Subsidies
It is the gap between the local price of fuel and what would have been the price if the fuel were
imported. It is a notional loss in revenue to the extent the international price of the fuel is higher.
This subsidy is ultimately borne by the government and partly shared by state owned OECs.
With the deregulation (explained below) of petrol prices in 2010 and the complete deregulation
of diesel price in October 2014, the burden of under-recovery should come down substantially.

http://articles.economictimes.indiatimes.com/2011-11-07/news/30369629_1_diesel-margins-petrol-and-diesel-prices-oil-companies
http://www.thehindubusinessline.com/todays-paper/tp-investmentworld/distilling-the-concept-of-underrecoveries/article2327863.ece

2) Deregulation of prices
Deregulation means letting the market determine fuel prices through the forces of demand and
supply as against government administering the prices. Deregulation is a boon for OECs and
OMCs as the under-recoveries reduce substantially post deregulation. Currently petrol and
diesel prices have been deregulated and Kerosene and LPG subsidy comprise the underrecoveries.
3) Shale gas boom and fracking - US energy independence
Shale gas refers to the natural gas that resides in the underground shale rocks and have emerged
as potential competition to OPEC suppliers. Fracking is the process of drilling and injecting
fluid into the ground at a high pressure in order to fracture shale rocks to release
natural gas inside.
http://www.theneweconomy.com/insight/shale-gas-extraction-explained
4) National Exploration and Licensing Policy (NELP)
http://www.business-standard.com/article/companies/nelp-x-a-primer-114011300350_1.html

5) Oil Bonds
The Govt. of India (GOI) issues special oil bonds to govt. owned oil marketing companies as a
share of their subsidies. The OMCs make a loss selling petroleum products due to govt.
restrictions on pricing. The govt. of India compensates this loss by issuing special oil bonds.
However, the OMCs face a yield and liquidity issue on these bonds.
6) Gas pricing in India Ranjarajan Formula
http://mrunal.org/2013/02/economy-rangarajan-gas-pricing-production-sharing-contract-pscapm-non-apm-issues-recommendations.html