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India imports most of its crude oil requirements, and higher crude prices have a negative influence on the country’s current account deficit (CAD) and inflation. “For every $10 rise in oil prices, the current account deficit widens by roughly 0.4% of India’s gross domestic product (GDP), with the full impact to be partly offset by the slower rebound in consumption this year,” said Radhika Rao, a senior economist at DBS Bank. Exports, though, will come to the rescue here. As Rao points out, “Pick-up in imports in FY22 due to better economic activity post the second wave is expected to swing the current account balance back to modest red, even as stronger exports will limit the extent of deterioration.”

“We are forecasting Brent crude to trade within a narrow band between $70-75 per barrel over the next six months as Opec+ keeps a lid on its oil supply,” said Darren Aw, Asia economist, Capital Economics. Opec is Organization of the Petroleum Exporting Countries.

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Oil on the boil

Higher crude prices are bad news to most companies that are facing a pause in the recovery momentum that was seen after last year’s lockdown had eased. Here are the implications.

Aviation: Aviation turbine fuel forms a huge chunk of the operating costs of airlines and, therefore, stronger crude hurts profitability. In July 2020, Brent crude prices had averaged at $43 per barrel. So far in July this year, prices have averaged at $74 per barrel. However, passenger load factors aren’t enough to compensate for the jump in costs. InterGlobe Aviation Ltd’s investors, though, aren’t perturbed. The stock is 15% above pre-covid highs seen in early 2020 despite InterGlobe’s consolidated net worth decreasing to 111 crore at the end of FY21 from 5,880 crore a year ago. Investors are cognizant of its strong balance sheet and market leadership. On the other hand, smaller peer SpiceJet Ltd’s stock is 33% below its pre-covid highs.

Automobiles: Higher crude prices translate to higher petrol and diesel prices, posing an inflationary risk to consumer demand. As Basudeb Banerjee, an auto analyst at Ambit Capital, said: “Transportation costs increase meaningfully by ~10% considering almost 40-45% of a trucker’s cost is fuel. This means freight rates need to increase as well, which is not easy in the current environment. Against this backdrop, it is quite likely that truckers are incurring losses, and this may not augur well for commercial vehicles’ demand in the near term.”

“On the other hand, passenger cars’ demand won’t be impacted much owing to higher oil prices as the cost inflation gets subsumed under the need for health safety during the pandemic,” Banerjee added. The impact of higher crude prices on two-wheeler demand, though, is small.

Cement: Higher crude prices have an adverse impact on cement firms as petcoke prices rise. Freight costs, too, typically increase and, in turn, hurt margins. Power and fuel expenses account for 25-30% of the sector’s total operating cost.

Paint: Higher crude prices are not desirable for paint companies as a large share of their input costs are crude-linked. Asian Paints Ltd’s June quarter results reflect this. “The margin picture is no longer as rosy,” said analysts at JM Financial Institutional Securities Ltd. In a 20 July report, the broker said, “Price hikes have just been around 4% year-to-date FY22 despite gross margin having fallen 480 basis points from exit-FY21 level. We have toned down our margin forecasts by 70-90 basis points, but more cuts could follow if selling prices do not catch up soon enough (or input costs do not come off).” One basis point is 0.01%. On the brighter side, a strong demand outlook has supported Asian Paints’ high valuations as consumers spend more time indoors during the pandemic.

Consumer: Fast-moving consumer goods (FMCG) firms are likely to bear the brunt of higher crude prices as raw material, and packaging costs increase. Investors should watch the extent of price hikes companies take to protect margins. “While margin gets hit in the short run, this also tends to tilt the balance in favour of bigger organized firms and stronger brands,” said an analyst, requesting anonymity. According to Rao, “Higher fuel outgo does pressure households’ spending math, with an increase in allocations towards essentials and the need to ration other discretionary spends.” Simply put, with incomes not rising enough and consumers spending more on fuel, demand for consumer discretionary products can get adversely impacted.

Oil companies: Producers such as Oil and Natural Gas Corp. Ltd and Oil India Ltd are some of the biggest beneficiaries of higher crude prices as their price realizations improve. However, an unexciting oil production outlook keeps sentiments muted for stocks of these firms. On the other hand, the marketing margins of oil marketing companies get squeezed if retail pump prices are not increased adequately when crude prices rise.

To be sure, experts point out that the scenario is not particularly grim for India’s CAD this time around.

“Our oil price forecasts are consistent with the CAD averaging at around 1.5% of GDP in FY22/23, much smaller than in FY12/13 when India was on the brink of a balance of payments crisis,” said Aw of Capital Economics. Indeed, valuations of shares of many companies in the sectors mentioned above suggest investors have taken the increase in oil prices in their stride. Hereon, as we emerge from the second wave and the pace of vaccinations picks up, all eyes will be glued to the pace of demand recovery.

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(Excerpt) Read more Here | 2021-07-25 12:20:56

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