Crude oil on the boil again: What it means for the stock market and economy - EntornoInteligente /

Crude oil prices are soaring and an expected trade deal between the US and China is the immediate trigger. Tensions between US and Iran is the other factor. The Brent variety has surged by around $6 or 10% during December. The increase has been around 18% for the October-December quarter. With crude oil getting costlier, there might be some short-term profit booking. However, experts say the global crude oil market will remain firm in the coming months as well. Opec’s decision to keep oil production low till March 2020 is the main reason for it. “The downside in oil market will be restricted due to supply cut by Opec and the US-China trade deal. So, Brent is expected to consolidate in the $63-68 range during the first half,” says Manoj Kumar Jain, Director, IndiaNivesh Commodities. After remaining range-bound in the first half, crude oil is expected to firm up again in the second half of 2020, mostly because of the expected global economic recovery. “After months of slowdown in 2019, global economic activity is expected to pick up in second half of 2020 and this will increase the crude oil demand by another 1 million bpd. So, Brent is expected to top the $70-72 range by end-2020,” says Kishore Narne, Associate Director, Motilal Oswal Financial Services. Mbpd stands for million barrels per day. Jain is more bullish. “Brent could go to $75 dollar in 2020,” he says. Brent prices likely to remain high As India is an oil dependent country, a price hike will impact the economy negatively. Source: Bloomberg Impact on the economy Since India is dependent on imported oil, any flare up in prices can have serious repercussions for our economy. Increasing domestic inflation is the main worry and this may stop RBI from cutting rates further. While oil exploration companies will benefit, all other sectors that use crude derivatives as inputs will suffer. Since oil price increase will impact energy products like coal, natural gas, etc, this will negatively impact almost all manufacturing companies. “Crude going up will be a headwind for the economy. It is going to be negative at the aggregate level,” says Harsha Upadhyaya, CIO-Equity, Kotak Mutual Fund. Since domestic uncertainties about growth already exists and tax collection is already low, increasing crude prices may create problems for the country’s fiscal situation too. Impact on broader market However, the news may not be all that bad for the markets. “Since crude oil prices have not yet reached the point of concern, we can treat it as a positive. It is also a sign of confidence about global macroeconomic growth,” says Sandeep Nanda, CIO, Bharti Axa Life Insurance. For example, the immediate trigger—the US-China trade deal that could signal an end to the trade war— is good news for everyone. Oil and gas sector Though the broader market will be agnostic to the flare up, it won’t be same at the sectoral level and the main impact will be on stocks from the oil and gas sector. Since this sector has several sub-sections, let us deal with one at a time. There will be no impact on independent oil refineries like Mangalore Refinery and Petrochemicals, because they take crude, refine and then sell the finished products to oil marketing companies. What concerns them is just their ‘refining margin’. The situation is similar for Reliance Industries, which operates the biggest oil refinery in India. Though Reliance and Essar are also into oil marketing, public sector oil marketing companies like IOC, BPCL, HPCL, etc still control the market. These PSU oil marketing companies may get into trouble if the government does not allow them to increase rates as per market rates. They may also be asked to bear the subsidy burden. For instance, the government had asked the oil marketing PSUs to take a hit on their marketing margins a few years back. Experts, however, say this is not an immediate worry. “Right now, the government is allowing oil marketing companies to pass on crude oil price increases. This is a positive signal, and this may continue because the government is planning to divest some of them,” says Nanda. BPCL is the first big company on the divestment list now. Since most other PSU oil marketing companies also rallied in sympathy, (BPCL rallied based on divestment news and others also rallied because their relative valuation compared to BPCL became cheap), there is not much investment opportunity right now. The subsidy fear is on upstream oil companies as well, because the government may not allow them to hike prices based on international crude oil rates. Since Cairn is part of Vedanta and not a separate company, the upstream oil space is also occupied by PSU giants like ONGC, Oil India , etc. Here again, subsidy burden may not be imposed this time because that will reduce the attractiveness of the divestment process. More and more industries are shifting from dirty fuels (coal, pet coke and fuel oil) to natural gas due to environmental concerns and this should increase natural gas demand in India. To boost natural gas production in India, the government may also remove price restrictions on domestic natural gas. If this happens, it will be a boon for upstream oil companies. ONGC Oil India Despite the weak second quarter numbers, analysts continue to be bullish on ONGC due to various reasons. First, its weak second quarter performance was mostly because of the fall in crude oil prices, which fell by 17% y-o-y. In other words, ONGC will start reporting good numbers in the coming quarters due to the spurt in crude oil prices in the third quarter. Though domestic production continues to be weak, its overseas production is expected to increase in coming years. Subsidiary ONGC Videsh has joint ventures in several countries like Russia, Vietnam, Norway, Egypt, Tunisia, Iran and Australia and contributed 23% of ONGC group production during 2018-19. In addition to giving fabulous dividends (dividend yield ratio is now placed at 5.47%), ONGC is also reducing its debt obligations regularly. For instance, ONGC reduced its borrowing from Rs 21,600 crore in March 2019 to Rs 10,400 by September 2019. Realisations should increase for Oil India also in the coming quarters compared to the second quarter of 2019-20, when its net realisation was only $61.3 per barrel. With a dividend yield of 7.24% at current prices, Oil India is also attractively priced now and its attractiveness is expected to increase in coming years. “Oil India’s dividend yield is attractive at 7.6% and 8.1% respectively if one considers the dividend expected for 2019-20 and 2020-21,” says a recent Motilal Oswal report. Aviation Since aviation fuel is deregulated, aviation sector companies will be on the firing line. “The biggest worry for the aviation sector now is the availability of planes to fly and how companies are managing them,” says Nanda. Since several Indian companies have placed orders for 737 Max planes, their problem got aggravated when Boeing decided to suspend its production. Since multiple woes are hounding this sector now, investors should avoid it. FMCG A crude oil flare-up will also impact FMCG companies that use crude derivatives as their raw material. Though input costs of lubricants companies like Castrol will go up, this may not impact them much because of their pricing power—the ability to pass on additional costs to the consumers. Due to strong brand loyalty, the situation is similar for paint companies like Asian Paints. Consumption of crude derivative is low for other FMCG companies like HUL. Cement Manufacturing companies, which consume a large amount of energy, is another segment that will be impacted negatively. “Prices of other energy products will also move up with crude oil and therefore, this will impact most manufacturing companies even if they use any other fuel,” says Upadhyaya. For instance, fuel grade petcoke has very high heating value and produces virtually no ash when burned and therefore, is used as a substitute for furnace oil. This means the price of petcoke will also go up, impacting cement companies that use them in their kilns. Since construction activity is weak now, cement manufacturers may not be able to pass on the full cost increases to the consumers. Among the cement stocks, ACC is still favourably valued and is also doing well despite the ongoing weakness in the cement sector. For instance, ACC was able to report a 3% y-o-y net sales growth despite a small fall in sales volume. A 3.5% y-o-y increase in realisation, due to 9% y-o-y growth in premium products volume and price hikes initiated in March, is the main reason for this. Despite the fuel cost increase, ACC should be able to maintain margin due to its cost saving measures and product mix optimising strategies. Since tax rate applicable for ACC is now at 32%, the recent reduction in corporate tax should also benefit it in coming years. ACC Tyres Though direct consumption of crude oil derivatives is less, input cost of tyre companies will also go up because of its linkage with natural rubber prices. This is because synthetic rubber, a substitute for natural rubber, is manufactured by combining naphtha and natural gas. Since the auto sector is on a slowdown mode, tyre companies may not be able to pass on the full cost increases to the consumers, especially to automobile manufacturers who buy tyres as OEM. However, the replacement market is still robust and companies like Apollo Tyres that are active in the space should continue to do well. Due to the expected improvement in volume and product mix, Apollo’s domestic performance should improve in coming years. Apollo Tyres Apollo’s overseas production, especially its hub Europe, should also improve due to the anti-dumping duty imposed by EU. After the recent price correction, its valuation has also become reasonable. “We expect Apollo’s earnings to grow at a CAGR of 24% between 2018-19 and 2021-22. Its current valuation of around 8.3 times its expected earnings in 2021-22 appears attractive,” says a recent Reliance Securities report. Follow and connect with us on Twitter , Facebook , Linkedin
LINK ORIGINAL: Energy.economictimes.indiatimes

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