OIL AT AROUND $40 LEVELS – THE NEW NORM?

By Ruma Dubey

Really, there is nothing which will make us humans happy, more so those in the capital market. Till a few months ago, we were ruing our fortune when oil prices were scaling above $100/barrel. We felt that we were about to lose it all and oil prices would cripple our limping economy.  Ok, so then we had falling oil prices.  Oil prices are back to hovering at $40/barrel levels – around $42/barrel. OPEC has decided to not cut back on supplies any more as it is scared of losing its market shares even though it is ready to take a hit on its earnings. In fact there are predictions abound that the oil market is headed towards an oversupply by 2018 and most oil pundits expect oil price to stabilize at $40/barrel in the second half of 2017. And it is only when price drops below $40 that oil producers will once again think or rather, be forced to cut supplies.

In India, we are already living in times of decontrolled price of petrol – from last week, prices change every day. Sadly, we never came across any airline company announcing a price cut – they are so prompt to hike fares when oil price surges; why not the same speed to reduce fares? Will taxi companies bring down their minimum fare because of the low prices? No way!  What once goes up, never comes down; defying all forces of gravity.

Yet, the markets and analysts are worried about the impact of falling crude prices. Instead of feeling good about it, most are worried and wondering when the prices will start climbing up again so that one could feel that all is well with the world economy.  But then, in the same breath, when oil was above $100/barrel, shouldn’t we have celebrated because by the same logic it meant that world economies were booming? At that time, the worry was the impact of high oil prices on the economy. So basically, we are never really happy!

Why are we not able to enjoy the low crude oil prices? What is this underlying worry that comes along with a low oil price? Well, earlier, it was construed to be on account of a slowing Chinese economy. But today, the world has adjusted to the new dimension, of Brexit and the new Europe and America.

The advantages of lower oil prices are far too many. Yes, the upstream and offshore oil companies like ONGC, Oil India, Cairn, RIL, Aban Offshore, Dolphin, Deep Inds will have to deal with this but most have adjusted to the new levels of oil prices; they all know that windfall gains of over $100/barrel are long gone.

But the straight gainers of low oil prices are quite a lot. For us Indians, naturally this is good news as we import two third of our oil needs. This means shrinkage in trade deficit and current account deficit too. The benefit which we get directly is that it reduces the subsidy burden on oil marketing companies, which in turn could mean lower fuel prices for us. With petrol and diesel prices now decontrolled, if crude continues to fall, we will have lower prices. And lower fuel prices would mean lower inflation, only to some extent.

Apart from the oil companies, which are the most obvious, other big gainer would be paint companies like Asian Paints, Kansai, Berger and Shalimar as 25% of their raw material cost is from a crude derivative and when that price reduces, margins will improve. Analysts say that a 10% fall in crude oil price will boost margins by at least 200 bps. Another gainer will be tyre companies which also use crude derivatives in its raw material - in fact it has the double advantage of falling rubber prices too. Sintex is also listed as a big beneficiary as cost of its crude oil polymer, to make plastics will come down. Packaging costs will come down as it also uses petroleum derivative and that means better margins for Essel Propack and even FMCG companies. Airline stocks will also do well as falling crude will help better their balance sheets – a 10% fall in crude will lead to a 300 bps rise in EBITDA margins.  Diesel genset companies would also stand to gain but companies like L&T and Voltas which have considerable exposure to the oil producing Middle East and Gulf regions, may face some trouble because projects could get stalled and payments could get delayed.

Well, we all are so busy watching out for what's just ahead of us that we don't take time to enjoy where we are. So let’s enjoy this moment of low crude oil and yes, it’s a good thing!