Impact of Strait of Hormuz Closure on Crude Prices and Potential Benefits for Indian Upstream Oil Companies

Wars and geopolitical conflicts can have profound effects on economies, and the ongoing conflict in the Middle East is no exception. As energy supplies tighten, companies in the Gulf are reevaluating their production strategies. For Indian firms, the situation presents a mixed bag: while many retailers are grappling with losses due to supply concerns, upstream oil companies like ONGC and Oil India stand to gain significantly from rising crude oil prices. Since the conflict escalated on February 28, crude oil prices have surged past the $100 per barrel mark, potentially boosting India’s average crude realization from approximately $65 to nearly $90 per barrel, which could enhance the earnings of these state-run oil producers.

Upstream Indian Oil Giants to Bag Big Gains

Recent reports indicate that the financial outlook for ONGC and Oil India could improve dramatically with rising crude prices. For ONGC, every $10 increase in crude prices translates to an additional Rs13,000 crore in earnings before interest, taxes, depreciation, and amortization (Ebitda). Similarly, Oil India stands to gain around Rs2,200 crore for the same price increase. If crude prices stabilize at $90 per barrel, both companies could collectively see an increase of Rs30,000 crore to Rs35,000 crore in Ebitda for the fiscal year 2027 compared to the previous year, even if their production levels remain unchanged.

The Indian finance ministry’s budget is based on crude prices around $65 per barrel. A rise to $90 would represent a 35% to 40% increase in realizations. Since production costs for these upstream firms do not rise as sharply, a significant portion of this increase would directly enhance profits. ONGC has disclosed that a $1 change in crude price affects its Ebitda by approximately Rs1,200 crore to Rs1,300 crore, while Oil India estimates a $1 change impacts its Ebitda by about Rs200 crore to Rs220 crore. Analysts suggest that the earnings of these companies are now closely tied to crude prices, making them well-positioned for profit growth if prices remain high.

Challenges to Windfall

Despite the potential for increased profits, both ONGC and Oil India face long-term challenges related to production decline. ONGC’s crude production peaked at around 32 million metric tonnes in 1990 but has since decreased to nearly half that amount. Oil India has experienced a slower but steady decline, with both companies losing approximately 15 million metric tonnes of annual output over the past three decades. Their major oil fields are aging, with ONGC’s Mumbai High asset being over 50 years old and Oil India’s main fields in Assam even older. As oilfields mature, production becomes increasingly difficult and costly due to rising water content and declining pressure.

ONGC has acknowledged in its annual reports that many of its major producing fields are mature and face high water cut, which negatively impacts production levels. Oil India has also noted the natural decline in older fields. While new projects like ONGC’s KG-98/2 deepwater block and the redevelopment of Mumbai High could offer some hope for future production, analysts caution that it is premature to rely on these initiatives fully. Some experts believe that the recent stabilization in production is a positive sign, but whether this indicates a genuine turnaround remains uncertain.

Not Every Oil Giant Wins

While upstream oil companies are poised for significant gains, oil retailers are experiencing mounting losses. State-run fuel retailers, including IOC, BPCL, and HPCL, are facing deeper financial challenges as they continue to sell petrol and diesel at unchanged prices despite rising global crude costs. Reports indicate that these companies are currently losing around Rs18 per litre on petrol and Rs35 per litre on diesel while maintaining retail prices since April 2022, despite the deregulation of fuel prices over a decade ago.

The volatility in crude prices has been stark, with prices soaring above $100 per barrel following the Russia-Ukraine conflict, dropping to nearly $70 earlier this year, and then spiking to around $120 last month due to renewed supply fears following US-Israel attacks on Iran. This situation has created a challenging environment for oil marketing companies, which are struggling to balance their operational costs with retail pricing.

Government Also Stands to Gain

The rise in crude prices is not only beneficial for oil companies but also for the Indian government, which holds majority stakes in both ONGC and Oil India. Higher crude prices are expected to increase government earnings through dividends. In the fiscal year 2024, ONGC paid approximately Rs7,224 crore in dividends, while Oil India contributed around Rs700 crore to Rs750 crore. If crude prices remain elevated and profits rise, dividend payouts could see a significant increase, especially given that central public sector rules mandate that at least 30% of profits be distributed as dividends.

However, the benefits of higher crude prices come with a caveat. India’s import bill is likely to rise, as the country is heavily dependent on crude imports. Analysts estimate that every $1 increase in crude prices adds between $1.5 billion and $2 billion to the import bill. A $25 increase in crude prices could result in an annualized hit of $37 billion to $50 billion. Furthermore, every $10 rise in crude prices could widen the current account deficit by 0.35% to 0.5% of GDP and push inflation up by 20 basis points. Thus, while the windfall for ONGC and Oil India is significant, it also poses challenges for the broader Indian economy through increased imports and inflationary pressures.

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