No more (c)rude shocks: Courtesy 5 master strokes of Modi Sarkar

India is the fastest growing economy in the world. But is it growing at its optimal rate?

Perhaps not!

What are the roadblocks?

The volatility in energy prices and India’s heavy reliance on oil imports make the Indian economy vulnerable to external shocks.

According to RBI estimates, every US$10 per barrel rise in crude oil stokes inflation by approximately 49 basis points and pushes the fiscal deficit higher by 43 basis points, should the government soak up the entire shock. Moreover, it reduces India’s economic growth by 20 to 30 basis points.

Soon, these estimates might become a thing of the past.

India is likely to become drastically less vulnerable to oil shocks thanks to five master strokes of the Modi government.

Masterstroke 1:  20% ethanol blending will significantly lower India’s oil imports

Starting this fiscal, the Oil Marketing Companies of GOI will increase ethanol blending to 20% by 2022.

Source: ISMA

 To make this viable the government has increased the prices of ethanol derived from 100% sugarcane juice from Rs.47.13 to Rs.59.13, while the prices from ethanol derived from B-Grade & C-Grade molasses have also been raised to Rs52.43/43.46 per ltr from Rs.47.49/43.70  and given impetus to sugar mills to increase production. Ethanol manufacture form agri waste has also been given a fillip.

Government also eased the lending norms on loans for ethanol capacity expansion and raised the subsidy loans to Rs.6,139 crore, which includes soft loans of Rs.4,440 crore and interest subvention of Rs.1,699 crore over a period of 5 years.

This masterstroke will mean multiple benefits:

• Despite sharp increases in our fuel requirements, import volumes will be capped. Even a static crude oil bill would mean sharply lower trade, current account and consequently, a lower fiscal deficit.
• This would not only lower borrowing but slow the rate of INR depreciation.
• Supply-side inflation will also be under check, making the RBIs job of interest rate management much easier. All other things remaining constant, inflation too will be tamed to a certain extent.
• Farm income is also expected to go up, especially in Maharashtra and the economically backward state of UP, which are the largest sugar producing states.
• This will also benefit farmers in the form of lower cyclicality in the sugar industry.
• Pollution from burning agri waste will also sharply be lowered. Besides farmers will also get remuneration for disposal of farm waste, thereby by contributing to their income.

Masterstroke No 2: Fast roll out of CGD network to improve the composition of this cheaper gas in the fuel mix, besides lowering pollution

Traditional fossil fuels are the chief pollutants of the global economy. The 9^th and 10^th round of bidding will ensure that over the next 8 years, over 70% of India’s geography will have access to natural gas, which is considered a clean and low-cost fuel source. Its benefits are immense.

• It will lower India’s dependence on volatile crude oil even further.

Source: BP Statistical Review 2018, PNGSTAT

• With domestic gas production rising, CGD has been given priority in its allocation. Also, the pricing of domestic NG is fixed every 6 months. As a result, piped gas for cooking and CNG for local transport will remain stable. Both PNG and CNG will replace the need for LPG, diesel and petrol, leading to further savings in the oil import bill.

Source: Standing Committee of Petroleum & Natural Gas

Source: PPAC and Thomson Reuters

• CNG pricing is at a sharp discount to fossil transport fuels and this will further improve the economics of transport.

Source: PNGRB

• Global gas reserves are expected to last for at least 50 years. With multiple countries turning gas exporters, viz. US, Russia, Africa and Australia, gas pricing is expected to be relatively stable in comparison to OPEC-based oil pricing.

• Supply glut in the gas market resulted in stable LNG prices. Coal prices improved in the recent past; however, LNG prices remained low.

Source:  PPAC, Index Mundi & Thomson Reuters

• Despite aggressive commitments for higher domestic natural gas production, domestic natural gas could fall short of meeting the upcoming demand. Therefore, India is rapidly building LNG terminal capacities to fill in the demand gap.

LNG Terminal Capacities in India

Source: PPAC

• With 70% geographical coverage, pollution levels will drop of significantly and help improve India’s image from being the world’s largest polluter (India has 13 of the 15 most polluted cities in the world, according to a WHO report in 2018).

Masterstroke 3: Negotiating payment terms in INR will help stabilize currency depreciation

India has already experimented with Iran for payments in INR for crude imports. With UAE also accepting INR payments, the pie just got bigger.  Forex reserves are expected to get a further boost from lower outgoes. Earlier, 45% of the oil bill payment to Iran was made in INR and 55% in Euros. Going forward, 100% of the oil bill payment to Iran will be made in INR with 50% of those payments being used for exporting items to Iran.

Masterstroke 4: Beefing up India’s Strategic Oil reserves

Currently, Indian refiners maintain 65 days of crude storage, which is estimated to go up to ~87 days. The government is using natural caverns along the coastline for storage. This strategy to augment our Strategic Reserves has a number of advantages.

• India is totally dependent on the Middle East for a bulk of its crude oil. The Middle East is a geo-political hotbed and inter-country conflict can erupt anytime. By building reserves we are beefing up our preparedness for any contingency.
• This reserve will help plan oil requirements and especially when crude oil rates are rallying these reserves can be drawn down to avoid buying crude when the markets are heated. Later, as prices cool off, these Reserves can be replenished to take advantage of the lower oil prices.
• The caverns have been leased to UAE for storage. So effectively, the ownership is transferred to the Arabs but at the same time, they are based out of India. This is a huge win for the diplomacy of the Modi government and ensures that UAE would be a dependable source of supply during emergency times
• Recently, Abu Dhabi National Oil Company (ADNOC) agreed to hire half of the 2.5 million tonnes underground strategic crude oil storage that India has built at Padur in Karnataka. As per an MoU signed in Nov 2018, ADNOC will store oil in two of the four compartments of 0.625 million tonnes (MT) each. The remaining half storage will be filled up by auctioning the space.
• Allowing foreign companies to use the storage for storing crude oil helps the government save on the cost of filling the reserves.

Masterstroke 5: NELP to HELP to boost India’s Oil exploration 

Hydrocarbon Exploration and Licensing Policy (HELP) is a policy adopted by the Indian government on March 10^th, 2016, indicating the new contractual and financial model for the award of hydrocarbon acreages towards exploration and production (E&P). HELP is applicable for all future contracts to be awarded.

Benefits: -

1. The uniform license will enable the contractor to explore conventional as well as unconventional oil and gas resources, including CBM (Coalbed Methane), shale gas/oil, tight gas and gas hydrates under a single license.
2. The concept of Open Acreage Policy will enable E&P companies to choose the blocks from the designated area.
3. The earlier contracts were based on the concept of profit sharing, where profits are shared between the government and the contractor after recovery of cost. Under the new regime, the recovery of cost factor won’t apply and the government will participate in the revenue sharing from the onset of the discovery of oil. This is in tune with the government’s policy of “Ease of Doing Business”.
4. Recognizing the higher risks and costs involved in exploration and production from offshore areas, lower royalty rates for such areas have been provided as compared to NELP royalty rates to encourage exploration and production.

Due to heavy reliance on imported oil, India’s energy security has always remained questionable. In the past, higher dependence on imports also made inflation and fiscal management difficult. This is likely to change soon.

With a decisive government at the helm, India is expected to do a lot better on the energy security front. Modi government’s astute external affairs policies may further aid India in getting good bargains with major oil and gas producing nations even in the future.

Investing in oil and gas theme will help investors immensely. However, stocks selection is the key!

We recently released a report titled City Gas Distribution that discusses attractive investment opportunities in the gas distribution space. This report not only offers you company-specific analysis but also helps you understand how the whole landscape has changed for gas distribution companies due to masterstrokes of Modi Sarkar.

Disclaimer: Ventura Securities Ltd has taken due care and caution in compilation of data for its web blog. The information has been obtained from different sources which it considers reliable. However, Ventura Securities Ltd does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. Ventura Securities Ltd especially states that it has no financial liability whatsoever to any user on account of the use of information provided on its web blog. The information provided herein is just for the knowledge purpose and shouldn’t be construed as investment advice under any circumstances.