Understanding the Dynamics of the Oil & Gas Industry

Inflation is sky-rocketting these days and one of the major factors impacting the rising inflation includes the rise in prices of oil related commondities.



When reading articles about the oil & gas industry in newspapers and magazines there's industry specific jargon that one may not be aware with. To acquaint with the same, this article looks at some of the commonly used terms. While reading, you would also understand how oil industry actually works..



Firstly we shall bifurcate the oil and gas industry according to the nature of work done-it can be divided into mainly two categories-upstream and downstream sectors. The upstream sector includes companies engaged in exploration and production of oil & gas. The downstream sector is into the refining as well as the selling & distribution of oil & gas products. So all the products made from oil refining-including LPG, gasoline & diesel oil are produced by the downstream sector. Oil Marketing Companies (OMC) are part of the downstream sector. Popular OMC's in India include Indian Oil, HPCL, BPCL etc. Upstream companies in India include-Oil India, ONGC & GAIL.



Although the prices of petrol have been deregularized and there is much hue & cry amongst the price-sensitive aam aadmi, the fact remains that diesel & LPG is adminstered at prices lower than the international prices. OMC's suffer heavy losses due to difference between the selling price(i.e. the price at which is sold finally to the Indian consumers) and the market price (the price at which it is sold internationally). This is called under-recoveries. The burden of under-recoveries is borne by the government (which provides cash compensation to OMC's), Upstream Co.'s (in the form of price discounts to OMC's) & finally by the OMC's themselves. The large chunk, however is borne by the government which is almost equal to 70%. One may think that the losses of OMC's should subside due to deregualtion of petrol last year. However, the irony here is that petrol constitutes only a tiny portion of the fiscal burden that the government has to bear due to under-recoveries. Diesel and LPG consitute the large chunk.



Recently oil touched the $100 per barrel mark (& rising...) due to the political turmoil in Egypt and the middle east, this would definetely hit the balance sheets and financial reports of OMC's bad.



Although OMC's suffer heavy losses due to under-recoveries, the concept of losses and under-recoveries should not be used interchangably. Under-recoveries occur due to difference in the market price and the selling price of oil products whereas losses occur if cost exceeds the selling price.



If we carefuly look at the quarterly and the annual financial statements of OMC's, we would find there is great variablity in the profitability position amongst consecutive time intervals. This is due to the fact government compensation to the OMC's for under-recoveries is often delayed. Due to this OMC's profits yo-yo widly according to when they receive the compensation from the government. When there is delay in compensation, OMC's infuse huge amounts of cash to keep the show going.

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A quick trivia: After the collapse of Bretten Woods, one of the key reasons why the US Dollar bounced back was because oil per barrel was denominated in terms of USD. Sufficient oil reserves & a resurgent demand of US currency helped the US Dollar get back on track..!

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By:Tejas Singh

CHINA's Growth Story-The Way Forward....

THE BIG QUESTION: Will the economic miracle run out of steam?

China’s growth story so far has been spectacular to say the least. According to data released on 16^th of August, the world’s no. 1 exporter has surpassed Japan to become the 2^nd largest economy; just behind the U.S. -Japan had managed to keep its second spot in terms of economic muscle for the last 43 years, so dethroning Japan was a significant milestone. But “wait” before you think everything’s fine with the dragon economy-it is slowly, but surely losing its steam.

There’s no denying the fact that it had recorded a massive 11.9% GDP growth in the first quarter of 2010. But Q2 figures haven’t been that encouraging-10.3% is the growth rate, a sharp fall of about 1.5%. There are several economic threats that are haunting the Chinese economy.

A major contributor to the slowdown has been the “Real estate bubble” that has been building up. Excessive investment and speculative purchases is driving prices in the real estate sectors to unsustainably high levels. The government has phased out $586-billion stimulus spending, tightening curbs on lending and checking spiraling property prices, and thereby cooling growth in the property sector. Curbs on spending would directly and proportionally affect growth in the coming time.

Second factor that seems to plaguing the Chinese economy is the apparent upsurge in workers who have begun pushing for higher wages and better working conditions. According to estimates by Deutsche Bank –“the minimum wage increase is to be around 20 per cent in most provinces and cities”. Another report by World Bank mentioned that the average rural wages rose 16.4 per cent in the first quarter of the 2010 from a year earlier.

The third problem that China faces is rising raw material prices. China's export growth remains strong, though rising costs for raw materials have eroded the country's cost advantage. It would be worthwhile to note here that during the first half of 2010, the total value of imports and exports, accounted for nearly 37 percent of the Chinese GDP.

Other factors include the steep fall in Industrial Production. It experienced a surprisingly sharp slowdown to a growth rate of 13.7%, down from 16.5% in May 2010. Some economists are also worried that stagflation -- inflation coupled with lower growth -- could emerge, although it seems highly unlikely.

It is imperative for China to raise the bar when it comes to the quality of economic development. In 2009, China’s urban rural divide widened to its highest since 1978. The fact of the matter remains that China is still a developing nation over 40 million below the poverty line. Overtaking Japan in terms of GDP is not going to change the basic truth. China’s per capita income is over 10 times lower than Japan’s and its population is 10 times bigger. It is a rapidly ageing country and its one child policy shows signs of becoming a burden.

China’s growth is not sustainable. It has polluted rivers, severe air pollution & large scale deforestation. By 2020, China is expected to have 400 million tonnes of rubbish, which is equal to the entire waste generated on the planet in 1997.

Despite all this, the Chinese are optimistic about their economy. The government has said that a slowdown is good in the long-term as policymakers try to reduce the country's heavy reliance on exports and investment to drive growth. The government sees this phrase as mid course correction period rather than a slowdown of the economy. The focus is now being shifted to domestic markets to compensate for slowing of export markets. China has more than one million-millionaires today. Relatively strong job creation in the recent times has helped support robust consumer demand which is strengthening China’s inward growth.

A long-term estimate by the World Bank research suggests that China's annual economic growth rate will fall to an average of 7 per cent in 2016-2020 - about the level the government has said is its target for sustainable growth.

So, to sum it all, China faces a lot of economic challenges in the form of above mentioned problems. However through effective policy formulation, they can slowly get back on the track of growth-growth which is both sustainable and inclusive.

-Tejas Singh

Dow Theory Unplugged

The Dow Theory UNPLUGGED…!

The legacy of Charles Dow’s thoughts have continued to exist in the form of the Dow theory for more than 100 years now and with new believers joining, this theory is expected to remain popular for years to come.

What is THE DOW THEORY?

• The Dow Theory believes that stock market prices follow a trend.
  

• Dow, through his observations, arrived at the conclusion that prices move in a pattern.
  

• If the market is going through an uptrend, then the prices will continue to rise until the uptrend changes into a downtrend.
  

• The evidence of any change in the trend can be gathered by observing price charts.
  

• In a way, the Dow Theory is based on the presumption that stock prices convey everything that is worth knowing about the stock.
  

• Be it future earnings or fear of the future or just hope, almost everything is reflected in the current stock price.
  

• But the focus of the Dow Theory is always on the changes in average price as reflected by some market index.
  

• The Dow Theory relies upon the Dow Jones Industrial Average and the Dow Jones Transport Average for its analysis. But the theory should work as well with any other market index.
  

• The focus on a market index helps in minimizing discrepancies that might creep in when observing individual securities.

Q. How can one know about the current market trend or the overall mood of the market by analyzing stock prices?

The Dow Theory says that three kinds of trends are seen working in the market.

Ø The first is the primary trend, which lasts from a few months to many years, and could be either bullish or bearish.

Ø Then we have a secondary trend that lasts from a few weeks to some months and that moves in the direction opposite to the direction of the primary trend.

So if the primary trend is bullish, then the secondary trend would come in the form of temporary corrections or fall in prices, and if the primary trend is bearish then the secondary trend would bring a temporary rally or rise in prices.

But once the secondary trend is over, the market continues its march in the direction of the primary trend.

Apart from primary and secondary trends, the market also sees day-to-day fluctuations that can last from one day to a week, during which the prices could move either in the direction of the primary trend or in the opposite direction.

Interestingly, day-to-day fluctuations don’t have much of a role in the Dow Theory. The main focus lies on identifying the primary trend and making investments based on that. Changes in the secondary trend are observed for deciding the direction of the primary trend. You can know about the overall direction of the market by watching both the trends simultaneously.

When you watch both primary and secondary trends, you would observe something like this:

The overall direction of the market over a period of, say, one year or two is decided by the direction of the primary trend, with the secondary trend acting as a temporary pull-back.

So the movement of a stock index would look like someone taking two steps forward and one step backward. In a market trending up, the market rises then falls a bit, then rises once again and reaches a point higher than the previous high.

In a down-trending market, the whole movement is reversed. The market falls then rises a bit, then falls once again to reach