OPEC supply cuts

Over the last few years, the OPEC has been losing its clout as the swing oil producer. That mantle has been taken over by the US, with its record shale production. Saudi Arabia is now the third largest producer of oil in the world after the US and Russia. However, the new OPEC-Plus alliance also includes Russia, Mexico and Kazakhstan, apart from the traditional OPEC nations. In fact, oil got a boost after Saudi Arabia agreed to expand its supply cuts by another 1,000,000 bpd in the last meet. 

US action is favorable for oil

Two developments on the US front have also helped hold oil prices. Firstly, the US stockpiles of crude have fallen sharply hinting at a surge in demand for oil. That has been positive for oil prices. Secondly, Biden’s election as the next US president spells trouble for oil supply as he has been long averse to the idea of fracking on Federal lands. The US oil story has been largely driven by shale fracking after Trump gave the oil sector a free hand. If Biden puts restrictions, it could be positive for crude prices. 

Indian markets to benefit

Ironically, Indian stock markets have benefited from a rise in oil prices. There are some valid reasons for this trend. Firstly, any spike in oil prices globally is associated with an improvement in growth and the spill-off impact has been positive for India. Secondly, if you look at the composition of the indices like Nifty and Sensex, they derive a good part of their market cap weight from oil dependent companies. These include names like Reliance Industries, ONGC, BPCL, IOCL, GAIL, HPCL etc. All these names benefit from higher crude prices. While upstream oil companies benefit due to better price realization, the oil downstream companies benefit from improved GRMs and better marketing margins. That explains why the Nifty has rallied in tandem with crude prices. 

Challenge for Indian economy

All will not be hunky dory for the Indian economy if oil stays higher. For Dec-20, the trade deficit is estimated to have scaled $15 billion. That is likely to put pressure on the current account deficit as well as on the value of the rupee. The other big impact of high oil prices will be on inflation, due to the strong externalities of oil. In the last 5 years, the government has earned billions of dollars by hiking duties on petrol and diesel in the midst of falling crude prices. Rising crude and limited fiscal leeway could be the new challenge!