NOC hikes petroleum prices again in just 10 days, How International Fuel Prices Influences prices in Nepal

According to various News Handles, NOC has again decided to hike the price of petroleum products by Rs. 1. Now you can buy 1 Liter petrol for 102, diesel for Rs. 88 and Kerosene for Rs. 88 (Inside KTM Valley pricing). There has been no change in the price of LPG and Aviation Turbine Fuel.

Although newspapers nationwide have claimed that the price has been increased, there isn’t any Official Notice the Nepal Oil Corporation Website. The prices were updated on the website on 11^th, July 2020 and they may still be in the process to upload the new press release. The last press release they have updated is from 1st July 2020, the last time they decided to update the petroleum prices in Nepal. Even the Current Retail Selling Price in Nepal still shows the price as updated on 1^st July 2020. They have claimed the increase in oil prices in international markets to be the reason for the increase in petroleum prices here in Nepal. Although it has been felt that NOC is a bit slow to react to the fall in prices in the International Market, the increase in prices is implemented more frequently and actively.

Source: NOC, Investing.com

When we look at the trend between the change in the price of petroleum products in Nepal and the change in the price of the Brent Crude futures, we can see that they are moving in the same direction. We can also see that the domestic prices for petroleum are less volatile compared to the Brent Crude and Nepal Oil. While the standard deviation of change in the price of petroleum products is in the range of 5, the change in prices of Brent in the same timeline has a standard deviation of 13.6. Nepal Oil Corporation seems to have protected the consumers from frequent price changes and have adjusted the price gap over a period of time in a streamlined manner. The domestic prices of fuel and the Brent Crude prices are strongly correlated with a correlation of over 0.86(very strong correlation), this shows that they are moving in the same direction, but the domestic market is less reactive, which has its own pros and cons.

The International Oil Market

After a few months which were worth forgetting, it looks like oil markets have finally stabilized, at least for the time being. After the May expiry Futures dipping down to negative, WTI futures look like they are slowly bouncing back and have stabilized in the last month with price deviation limited to almost 5$ (in the range of 35$ to 40$). With the Lockdown slowly lifting worldwide, the demand and consumption for fuel slowly started increasing, which ramped up the WTI prices. The Worldwide lockdown also affected the price of Brent Crude, which saw a decline of 70% in a period of 4 months, but WTI were the bigger losers among the two because of the geographical differences and storage difficulties between the two.

What are Brent Crude and WTI?

When we talk about fuel, we generally think about petrol, diesel, and LPG but they are not actually traded as commodities but are products generated after the processing of Crude Oil. The major benchmarks used for crude oil pricing are Brent Crude and WTI. Brent crude is produced near the sea areas whereas WTI, which stands for West Texas Intermediate which is extracted or produced in North America. More than 65% of oil prices worldwide are based on Brent crude prices while the remaining are based on WTI prices. Brent crude prices are based on the Brent crude futures trading in the Commodity market and the same happens with the WTI. Like any other commodities, their prices are based on the theory of Demand and Supply; When demand increases and supply stays the same, prices go up and vice versa.

While the utility of the two classes is almost identical, they are traded differently in the commodity and derivatives market. Before the start of this global pandemic, Brent crude was trading around $68.43 per barrel. The implication of Covid-19 was seen in the prices immediately as the demand had a direct impact as many parts of China went into lockdown and worldwide movement started to decline.

Source: Investing.com

With this, the prices started to plummet and in 4 months’ time, it reached a low of $20.72. During this time, almost two-thirds of the World population was in lockdown and the demand for fuel was very low and the already available supply was more than adequate for the fuel requirement almost all around the world. Brent crude prices made a W recovery with the low volume supported growth in early April and then an immediate plummet to almost the same time duration, reaching a low of $20.72. Slowly with the lockdown being lifted, the demand went up, pushing the prices around $41, a 100% rise in 2 months but still a third less than what their prices were in January of the same year.

Source: Investing.com

When we look at the price fluctuation in WTI futures, it was trading around $63.47 in early January and like what happened to the Brent Crude prices, with the decline in demand, the prices started to go down in an increasing rate. In Mid-April, The May Expiry WTI Futures had a freefall taking them to a double-digit negative value as contract holders were shying away from taking physical delivery with their storage facility already operating at maximum capacity. But this only lasted for a short period of time and the prices started rallying slowly and have now reached $38.64, very positive pricing considering just a few months ago it was trading at almost identical value but in negative. It is questionable if the prices can sustain this rally because of the uncertainty surrounding the pandemic and still no vaccine near.

Why WTI prices became negative but not Brent Crude?

The oil prices became negative; so can we get money to purchase oil from the seller? The simple answer is No. It was the future contract of WTI that became negative and not the actual physical product. A futures contract is a contract in which the buyer agrees to buy a commodity (in this case) at a pre-determined rate in a future date. So, if the price of the commodity goes up, the contract buyer is at profit and when it actually comes down, the seller is at profit. Many use future contracts as a hedge for price risk.

WTI futures prices became negative as the storage capacity was already full and were unable to store any more quantity.  Since WTI is produced in a landlocked area, the transportation cost is also high. Since the contract buyers of the May expiry futures had nowhere to store the new stock. WTI futures are settled by physical delivery in which the contract buyer has to take the physical delivery of oil as per the contract. The other option that they have is either to sell the contract, which would also fetch them loss or buy a futures contract for the next month (rollover).

But in case of Brent Crude, at expiry, the settlement is done using cash settlement method and the buyer doesn’t have the obligation to take physical delivery but he/she will pay/receive the difference amount based on the expiry price and the price in which the contract was done. The other reason why Brent crude price didn’t reach negative numbers is due to the OPEC influence.

OPEC is a group of Oil Producing Nations that controls the prices and supply of Oil. In early April, OPEC decided to control the supply of oil by decreasing production, which in some ways acted as an anchor to hold the prices above the zero level. Since OPEC uses Brent crude prices as its benchmark, they have some influence over the price of Brent Crude.

Price Influencers in Nepal

India is the sole exporter of petroleum products in Nepal. Since Nepal doesn’t have its own oil processing plant, we import mostly finished products in the form of petrol, diesel, LPG, airplane fuel, etc. from India. The import price mostly depends upon the selling price as denoted by India. Previously, the price adjustment was done manually and the petroleum product prices in Nepal didn’t correlate with the Global prices. But after 2014, a new pricing methodology was brought in which India gives us a new price in every two weeks’ time. So, price changes occur accordingly. But it is evident that the price decrease is done very slowly compared to the price increase even in the condition of profit when the price adjustment is done. This may have been done to offset the losses NOC faces while selling LPG gas at a subsidized rate to the consumers.

Source: Nepal Oil Corporation

Nepal Oil Corporation also established a Price Stabilization Fund, which would shield Nepali general consumers from a sudden price shock. So when the petroleum prices went up, this fund was utilized to lower the impact and when the prices went down, the surplus amount (Old Selling price- New Price) would be added to this price stabilization fund.

Although the Indian side updates the price change fortnightly for Nepal, the prices change daily in the Indian Domestic market. The prices are set every morning at 6:00 am based on the international price of Brent Crude. So, the International prices are better reflected in the Indian Market rather than in our domestic market. Changing prices fortnightly has its own benefits and drawbacks. This system will make sure that there are no sudden price shocks for petroleum products but the consumer would not be able to have a short term gain considering how volatile the global oil market actually is. Since India’s import basket consists of Dubai and Oman Crude oil and Brent crude, the change in the prices of WTI has very less impact on the prices as it takes Brent Crude as the pricing benchmark. So, in Nepal too the same thing applies. On top of the purchase price, taxes, cost of transportation, and dealer’s margin add up to make the retail petroleum prices in our country. The government of Nepal has recently hiked the Infrastructure Development Tax in fuel from Rs. 5 to Rs. 10 and this increase in tax also gets incorporated into the final price the consumer has to pay.

But although Nepal Imports fuel from India, the prices for petroleum oil in Nepal are Cheaper than in India.

Source: https://www.globalpetrolprices.com/

When we compare Nepal’s fuel prices with those other countries around us, the prices here are still cheaper than most of the countries, including our big neighbors India and China. Nepal’s prices for both petrol and diesel are below the World Average price. When we look at the Global Scenario, we have little to complain, but a better pricing strategy and methodology would definitely benefit the consumers as well as NOC. The demand for petroleum products went down up to 80% in April and is now on the rise as the government decided to ease lockdown from 15^th June 2020. The low consumption prompted a decrease in import of petroleum products that may complement the narrowing down the trade deficit in our Country, at least for the short run.

Prashant Ghimire