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Last Updated : Mar 09, 2020 05:39 PM IST | Source: Moneycontrol.com

Oil hits a crash course. What it means for macros and Indian markets


Highlights
- Sharp drop in oil prices sends global markets tumbling
- Russia ends support to OPEC's production cut strategy
- Saudis not willing to do it alone, unveil production ramp-up
- Low crude price is a positive for India, import bill to go down
- Global disruption, expectations of FII outflow pulling down markets

- Short term aberration, investors need to capitalize on valuation comfort 

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It'll certainly rank as one of the sharpest single-day crashes for oil, which has tumbled to almost $32 per barrel, from the earlier $45. The plunge, in turn, has sent shockwaves through global markets, pulling down major stock indices, currencies and commodities.

Close

Currently, the markets are downbeat. Having said that, low crude prices mean good news for India, retail consumers as well as companies that are heavily dependent on oil. However, such a massive fall in the crucial commodity does not augur well globally.

Given sharp movements in currencies and investment flows, many sectors will get impacted negatively. Such steep and sudden drop might have caught many banks on the wrong foot. How long will this current bearish phase sustain is something to watch out for.

Russia ends support to OPEC

Russia made its intention known when it walked out on its 3-year old alliance with the Organization of the Petroleum Exporting Countries (OPEC). Prior to the March 6 meeting with its allies, the oil producing bloc pushed hard for deeper production cuts to support falling prices.

Rubbing salt into the wounds, the spread of Coronavirus has dealt a big blow to demand for crude. However, there has been scepticism in some quarters over support for such deep cuts.

Russia's withdrawal of support is on expected lines, unveiling plans to ramp up production. Its assessment is that US shale stands to benefit hugely from the cartel's production cut. It now intends to drive out the US shale production by taking prices to lower levels.

Saudi’s change of strategy

After Russia’s pullout, Saudi Arabia is rewiring its strategy, unwilling to do it alone for any production cut. Saudi has now announced plans for a full-blown production ramp-up and is expected to pump more than 10 million barrels per day (bpd) from April. It also has announced nearly 20 percent price cut in major markets.

All these proved too hot for oil.

Driving out US shale

The price decline might not be good news for US shale producers. US shale operates at a high cost of production, estimated to be more than $40-50 per barrel. In other words, lower oil prices leave the US shale unprofitable, making the latter unattractive for US producers.

But for the economy as a whole, cheaper crude oil comes as a good piece of news for the US, especially given the fact that President Donald Trump has been pitching hard for the prices to come down.

The global implications

It's no brainer that a decline in crude prices is a positive for those economies which import the commodity, but a negative for the exporters who earn their revenue mostly in dollars. The bruising price war during 2014-16 had left many oil producing nations under a pile of debt, impacting  their growth.

Such a sharp price fall is destabilising for many economies, and this fear is taking over in global markets, which partly explains the current spell of softness. Currencies and investment flows globally are also expected to feel the pinch.

The budgeted cost for most oil exporters is much higher as they have to make way for debt payments and many other added costs. Historically, low crude prices have not helped, leaving many oil exporting countries under huge debt loads. That makes such low levels for oil highly unsustainable.

What it means for India

Nifty – Fundamentally, the low price of crude provides a margin cushion for listed companies in India and should be a positive. But they do not always move in tandem. A marked decline in crude prices has an adverse impact on foreign investment inflows, which becomes counterproductive.

Current account balance – India imports more than 80 percent of its oil requirements. Any slide in the prices brings down the import bill and helps control the current account deficit. Such a plunge could also be a good time to build up on the country's strategic reserves for future.

Inflation – Depressed fuel prices mean lower transportation, packaging and other input costs, which drive down food and commodity prices. All this together leads to easing in retail prices and lower inflation, creating more headroom for a rate cut by the Reserve Bank of India (RBI).

Retail prices – Reduction in global crude prices brings down the rates of petrol and diesel in the domestic market, offering much relief to consumers. With a fortnightly revision, we can expect lower prices of transportation fuels in the upcoming fortnightly revision.

Oil and gas companies – For Indian oil and gas producers and retailers, the impact will be mixed. Take, for example, ONGC, Oil India and HOEC, for whom low prices of their output will yield lower realization, a negative for their earnings.

For oil marketing companies like IOCL, HPCL and BPCL, softer oil means lower input costs and a jump in marketing margins. However, demand slowdown for refining will impact the refinery throughput, keeping its margins under pressure. This, along with the inventory loss on higher cost crude stock, is not a positive for earnings.

Lower LNG prices will be music to ears for gas marketing companies such as IGL, MGL and Gujarat Gas, which will support margins. However, for GAIL, lower spot LNG prices reflect low demand for its unplaced high cost LNG, which can spell trouble.

Company margins – Crude and transportation fuel serves as inputs for many companies. So, crude rates moving down will come as a shot in the arm for margins for these companies. Most major allied sectors like aviation, fertiliser, paints, plastics, polymers and ceramics stand to gain directly from softness in oil.

Outlook

A string of factors such as the changing geopolitics, uncertainty around the Coronavirus epidemic, sluggish demand, economic growth outlook and an expected supply glut are all weighing on the crude prices. With OPEC's renewed production strategy, we remain bearish on oil in the near term.

We believe that very low levels of crude are not sustainable in the longer run as it impacts the number of producers on board the supply ship and this would be something to keenly track. The abnormally low levels might reverse once the impact of the virus fades. Hence, investors should capitalise on emerging pockets of valuation comfort on account of this aberration.

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For more research articles, visit our Moneycontrol Research page
First Published on Mar 9, 2020 04:39 pm
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