Vedanta Ltd: Buy

CMP: Rs.87.35

"There may be light at the end of what has been a long, dark tunnel" for oil, says the International Energy Agency (IEA).

In its latest monthly market update, the global watchdog speculates prices may indeed have bottomed when international benchmark Brent crude fell to $27 a barrel early last month.

Since then, there have been signs of a natural attrition on supply and, crucially, a deal to freeze production at January levels, which could eventually rebalance a heavily oversupplied market.

It pointed to outages in Iraq, Nigeria and the United Arab Emirates that took 350,000 barrels a day off the market in February alone, reports the Financial Times. Iranian production post-sanctions is also rising more gradually than expected, adding 220,000 barrels last month compared to claims it would boost output by 500,000 immediately.

Overall, global supplies eased 180,000 barrels last month – and exports from high-cost exploration areas such as the US and South America could fall more sharply than expected this year. But the IEA also noted that stockpiles are at record levels and that it would take the remainder of this year for supply and demand, currently out of kilter to the tune of two million barrels a day, to reach equilibrium.

In short, prices will be more stable at current levels around $40 a barrel and will not plough depths of $20 or below as some analysts once predicted. But neither will they rise substantially until next year.

Meanwhile, Goldman Sachs said on Friday that crude oil prices will rise by an average of $5 per barrel in the second quarter; priices are expected to increase to between $25 to $45 per barrel, up from the $20 to $40 per barrel range in the present quarter.

"As we do not expect growth from OPEC and Russia after 2Q16, and given our expectation for resilient demand growth, our confidence that stocks will draw in 2016 if prices remain low is rising," it said in a report.

Oversupply has been a major contributor to the worst price slump since 2008.

A supply glut has increased and caused a build up in inventories that has placed greater downward pressure on oil prices in the past 18 months.

Prices fell around 75 percent from June 2014 when they were around $115 per barrel, to around $27 a barrel in January.

Goldman Sachs pointed to three significant factors for the anticipated price recovery, including low oil prices that would increase global demand that has been low with economic slowdowns in Asia and Europe and would eventually trim crude inventories.

But low oil prices need to be sustained in order to allow a rebalancing of supply and demand in the global oil market, it said.

Bottom line: A rise in crude oil prices is likely to trigger a rally in the commodity market, leading to a price recovery in Metals and Gold. Moreover, the US Fed is expected to keep the interest rate hike on hold, triggering speculative rally in Gold and Crude oil.

Besides, the union budget document said that the import duty on aluminium will be raised to 7.5% from 5% while the export duty on low-quality iron ore fines would be scrapped. This Duty Revision on iron ore and aluminium is expected to benefit Vedanta Ltd, the most as it is a big producer of both commodities.

The iron ore duty cuts will help miners liquidate stocks at a time when international prices are low," Mines Secretary Balvinder Kumar, who proposed the revisions, told Reuters.

Iron ore fines and lumps, with ferrous content of less than 58%, were earlier charged 10% and 30% export duty respectively. The move will help Vedanta compete in the world market which is undergoing one of the worst commodity meltdowns in recent history. 

The low grade iron ore, exported by Vedanta from Goa, has few takers in the country, which still relies of high quality to iron ore to produce steel. The steel industry in India still lacks technology to extract iron from low grade iron ore. 

Therefore, buy the shares of Vedanta Ltd (whose valuation will increase corresponding to the rise in the valuation of Cairns India Ltd, following the rise in crude oil prices) at Rs.87.35 for short term targets of Rs.95--104. SL--Rs.83.