Tight oil will help create an American revival - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
Tight oil will help create an American revival A  A  A

12 JANUARY 2013

The US Energy Information Administration predicts that US imports of liquid fuels (including crude oil and petroleum products) will fall to 6 m. barrels/day, half of its peak a few years ago and the lowest in 25 years .

In a few years, the US will equal, or overtake, Saudi Arabia as the largest producer of crude oil. This would have tremendous implications, both economic and geopolitical. The price of crude oil would fall; it has already started doing so. This would provide huge relief to countries like India, which is running an unsustainable current account deficit of 5% of GDP, thanks mainly to imports of crude oil. This means that India would need to borrow less, which would improve its global credit rating. Last week, rating agency Fitch threatened to lower India's rating to below investment grade.

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Rating agencies though, have lost a lot of their credibility for their continued failure to assess countries. Ireland and Spain, for example, were rated AAA for about 7 years and 4 years, respectively, until 2009! . Greece, now bankrupt without EU assistance, was rated A+ for over a year.

Having said that, the threat of a ratings downgrade to junk status, is sufficiently a threat for the UPA Government to rise, a la Rip Van Winkle, out of its policy paralysis slumber, and take long overdue action. That is to the good.

It has raised diesel prices, and has capped the entitlement to subsidised LPG cylinders to 6. Alas, the pace of further hikes in diesel prices is, at Rs 5/ month, even slower than the proverbial tortoise. The Government is waffling over the cap on subsidised cylinders, and plans to raise it to 9.

Tight oil, or oil which is trapped in petroleum formations of low porosity, and hence difficult to extract, is being recovered thanks to the twin technologies of horizontal drilling and hydraulic fracturing (fracking for short). These were first used to recover gas from shale rock, which helped sharply bring down cost of natural gas in the US. It is now being successfully used to extract shale oil.

Now, prices of natural gas vary significantly between markets, primarily due to the absence/shortage of facilities to transport it from one destination to another. Transportation requires natural gas to be first liquefied, at extremely low temperatures, carried by special LNG tankers, which are in short supply, and then regassified at the receiving end. Thus prices of natural gas are very low in the US, compared to Japan (see chart below)

Source: www.eia.gov

The price in the US is a fourth of that in Japan and half in the UK.

This is leading to a revival of manufacturing in the US, fuelled by cheap natural gas. With such low prices, manufacturers of things like steel, aluminium, chemicals and plastics are planning expansions in the US. Truck owners are converting their fleets from diesel to CNG and this alone will cut the crude oil imports of the US significantly.

It is in this perspective that the recent recommendations of the Rangarajan Committee to rethink the production sharing contract for oil and gas contracts, is to be appreciated. We have been caught up in the modalities of pricing/recompensing the capital cost and have not concentrated enough on the economics. Entrepreneurs would invest when they see a profit in it and hopefully the new PSC would usher in a much needed production boom in oil and gas, as is being witnessed in the US now and which is likely to see a speedier recovery of the US economy than many expect.

Another factor that needs to be revisited is labour reforms. The general thinking is that a more flexible labour policy, which allows a greater leeway to manufacturers to negotiate or to shut down facilities should conditions change, of course with the mandated compensation, would be anti labour. Actually, as Spain has shown, it is the other way around.

Prime Minister Rajoy of Spain permitted companies to opt out of collective wage agreements, emulating what Germany did a decade earlier . This has helped create new jobs.

In corporate news of interest, Infosys came out with a better than expected guidance of revenue growth of 5%, prompting the stock price to jump a phenomenal 17% in a day! This indicates a huge interest by foreign investors and a huge appetite for the India story. Stock prices of Tata Consultancy Services (TCS) and Wipro, which will announce results later, also went up, albeit not as much.

The Supreme Court rejected the plea for an urgent hearing by two Sahara group companies, through which they sought to defer the deadline for payment of Rs 10,000 crores, to Securities and Exchange Board of India (SEBI), which would be used to repay some 30 million investors in these companies' OFCD instruments. The group, which had also released an ad. claiming to have 1 million employees and field agents, (to show that it has been a responsible corporate citizen) has been sent a notice by the provident fund commissioner asking for details about PF payments for these 1 million.

Since other corporate entities are not given the courtesy of notices prior to being raided, one has to see how this would ultimately pan out. Political carpets have so much dust shoved under them that they oftentimes hit the ceiling.

GMR Infra has cancelled a Rs 7,200 crore road project with NHAI, citing the latter's inability to get environmental clearance and to notify revised toll rates. One needs to examine whether the PPP (public private partnership) model is working as effectively as it ought to.

A degree of practicality over dogma also seems to be in evidence, perhaps, in the Vodafone case, where newspaper reports suggest a compromise is forthcoming. The Government had sent Vodafone a reminder, asking it to pay the tax (payable by the seller, Hutchison Whampoa) it ought to have deducted before making full payment to Hutchison, when it bought a controlling interest in Vodafone India. The Government may, perhaps, agree to waive penalty, and maybe interest, so as to provide it with some fiscal relief.

After raising diesel and LPG prices and introducing FDI in multi brand retail, the Government has been emboldened to try and set the railways on the right track, so to speak. Kudos to Rail Minister Bansal for raising fares, across classes, in a bid to mop up Rs 6,600 crores of revenue. India desperately needs more public transport, if it is to curtail its dependence on imported crude oil for private transport and this can be done only if organisations such as the Railways, have surplus funds to expand networks. Mamata Banerjee had myopically and impetuously, sacked her colleague who tried to, as Railway Minister, do the same thing.

The BSE sensex lost 120 points last week to end at 19,663, and the NSE-Nifty dropped 64 to close at 5,951.

All eyes will now be on whether the Reserve Bank of India (RBI) Governor would lower interest rates; if he does, the sensex could rally to the 20,500-21,000 resistance mark.

For a sustained economic and stock market rise, the Government would need to continue with reforms and to provide a framework which encourages productivity and innovation, not hampers it. There is less economic sense and more ideological noise coming out of Delhi. They ought to concentrate less on shibboleths and more on 'such boley'.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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