The collapse in crude oil prices (down c50% in 2014) is roughly a $50bn (2.3% of GDP) bounty for India. At $50/bbl crude prices, India can have a current account surplus of 1% in FY16. At this price, assuming current retailing prices, Indian Govt / Oil companies may end up over-recovering $10bn, vs under-recovery of $23bn in FY14. In other words, there may not be any effective need for net subsidies for oil (0.8% of GDP in FY14).
If India can lock in current lower crude prices for say a year, it can get an assured window to sort out other macro issues for economic recovery, without having to worry about oil volatility. In absolute terms, the move from $110 to c$45 is big and further declines, if any, will be less significant, as far as impact on Indian macro is concerned.
Our due diligence suggest that the state-owned oil refiners (60% of total domestic demand) are not keen to hedge and they do not hedge crude prices as a practice historically. Accountability for any potential losses acts as a deterrent. They do hedge the currency risk though, and often the refining margins. Whispers in Delhi Power circuit suggest Govt had been considering hedging oil, on RBI’s advice, but no decision or progress seems to have been made.
India’s net imports of crude oil are approximately 1bn barrels annually (net of what is re-exported in the form of refined products). Total trading activity in oil futures/ options globally suggests that there is market depth for India to do the hedge. Volumes equivalent to over 400bn barrels of different crude varieties were traded on ICE and NYMEX, in 2014. Hedging costs / capital blocked towards margins may not be significant, in the context of the scale of the bounty, in our view.
Locking in current oil prices may not be adhering to free market economics, in which we believe, but yet may be an attractive option for the Govt. The local oil economy (subsidies, Govt fixing retail prices etc) has anyway not been adhering to free market economics. We Strongly Advise the Narendra Modi led Government of Good Governance to consider this option for at least 12 months if not 24-36 Months which I would have done had I been the Prime Minister of India.