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Energy: Y2K bug - Views on News from Equitymaster
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  • Jan 3, 2001

    Energy: Y2K bug

    The year 2000 began on a euphoric note as the global rally in new economy stocks continued to gather momentum. With the markets in an ecstatic mood not many noticed or anticipated the surge in crude oil prices. While companies and Governments safeguarded themselves against the dreaded Y2K bug they were left exposed to the cartel's mercy in Y2K.

    Towards the end of FY99 the Organisation for Petroleum Exporting Countries (OPEC) undertook three rounds of production cuts to pull prices from their 25-year lows of $10 / barrel. Consequently, giving thrust to the rally in global crude prices.

    As the sunrise of the new economy turned to sunset, the markets also realized the dark clouds hanging over the real economy, as energy prices carried on with their unrelenting upward march. Fears of a global economic slowdown arose across borders as oil markets continued to heat up over year 2000 to touch a 10-year peak - since the Gulf War - of $35 / barrel for Brent Crude.

    With the domestic up and downstream sectors segregated the Indian refining companies could not reap the bonanza of high oil prices, which was the case of their foreign counterparts. These governments contemplated of charging integrated oil companies a windfall tax in view of the favourable environment. Whereas, the operating margins of Indian refining companies came under severe pressure in 1HFY01 as feedstock prices shot through the roof without a corresponding rise in refined product prices.

    Upstream players such as ONGC also could not exploit the favourable situation as the Government is said to have capped domestically produced crude prices to $16 / barrel. This is below the price, which domestic crude producers were likely to receive under the original administered pricing mechanism (APM). Under the APM domestic crude was linked at 80% of import parity price.

    Over FY00 and FY01 all the three oil PSU behemoths have announced bonus shares. Further Kochi refineries also announced a 1:1 bonus issue in FY01. Another important development in the sector has been the implementation of the Sengupta committee recommendations. The committee called for merging the stand-alone refineries with the refining and marketing companies. Based on these recommendations the Government has announced that IOC will acquire Chennai Petroleum (CPCL) and Bongaigon Refinery (BRPL) while BPCL will acquire Kochi Refineries (KRL) and Numaligarh Refineries (NRL).

    Over the month of December'00 the prices of the natural resource have come off quite sharply. Brent blend crude oil has plummeted by approximately 33% from above $30 / barrels to $21.6 / barrel. A key reason for the precipitous fall has been the allaying of fears regarding the shortage of fuel oil in the developed western markets over the ongoing winter months.

    With the decline in oil prices refining margins are expected to improve in 4QFY01. Further, oil prices are expected to continue to decline in year 2001. The OPEC, however, could spoil the party early by once again undertaking production cuts. Markets are also awaiting positive news on the disinvestment front.



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