Crude Prices Plunge: Its ‘Wow For Some !

India is one of the biggest beneficiaries whenever the crude oil prices get into the correction mode. And when the crude prices plunge the way they have done now, Indian economy is presented with a huge advantage. Yogesh Supekar and the DSIJ Research Team explain which companies and sectors can benefit the most owing to the slump in crude oil prices.

There is saying in the investment markets: “There is always an investing opportunity in any market condition.” However, if we take a look at the current market situation it really is difficult to convince oneself on identifying any investment opportunities. The global markets are spooked and the panic is widespread even as the US and Indian benchmark indices take a free fall, recording the biggest single downward spiral, in absolute terms as seen in table 1. What is disturbing the markets is known to most market participants but what is not known is the extent of damage this whole motley of factors is going to cause and for how long the ‘risk off’ mode in the investing world will exist.

It does look like the crash in crude oil prices and the economic and political repercussions that it may have on global markets is a bigger concern for investors than the spread of the coronavirus. It is not that the crude oil prices have never crashed before; it’s just that the triggers behind the fall are worrying the markets. In 2008, the crude oil prices touched a low of USD 32.40 per barrel. Ten years ago, the slump was attributed to demand side problems. In 2016, the crude oil prices crashed again and touched a new low of USD 26.05 per barrel with the fall attributed to supply side problems. The recent slump in crude oil prices, however, is attributed to not only the demand and supply hits but also to the unprecedented price war triggered between the oil producers.

Doubts and Fears

No doubt the crude oil prices are important for oil producing nations but global equity investors need to remember that oil economy is of great importance to the US’ economy as well and in fact is one of the major contributors to its GDP. Thus, the negative impact or price war in crude oil is a big negative for the US’ economy which is already feared to be heading into a technical recession with two consecutive negative growths in GDP. Investors in the US’ markets fear that the slowdown in economic activity due to coronavirus and now the slump in crude oil prices may push the markets into bearish territory and head the nation into recession.

❝ If the DOW drops 1,000 points in two days, the president should be impeached immediately ❞

US President Donald J. Trump’s tweet on November 6, 2012. 

Such fears are communicated in the VIX index which crossed 54 levels on Monday, indicating panic. Similar readings were seen during the financial crisis of 2008. One of the biggest concerns for the global equity markets is the inability of the central banks to halt the damage. It is as if the otherwise so powerful central banks have lost their magic touch. The methodologies these central banks, especially US Federal and ECB, use to rescue the global markets with the help of monetary policies are no more considered lethal weapons. This inability of the central banks and policymakers to infuse calm in the markets is worrying market participants. 

The negative impact of the coronavirus outbreak will most likely be big and monetary policy will be of little to no use to counteract it. The coordination between political leaders and central bankers is of utmost importance for a faster and sharper recovery. The market may take cues from the positive announcement by the US government, such as, President Donald Trump announcing this month that his team are looking at measures including cutting payroll taxes and aiding ailing businesses like airline and cruise operators. The incompetence of the US Fed has, however, been the highlight of the current crisis. Only a few months ago US Federal announced that there is no need to cut interest rates and then suddenly decided to cut interest rates, showcasing its reactive way of functioning and not being preventive enough. Commenting on this scenario, Suman Chowdhury, President (Ratings) at Acuite Ratings and Research Limited, said, “The sharp decline in the global oil prices not only reflects the deep underlying concerns on a global economic disruption brought about by the corona virus scare but also a lack of consensus among the OPEC nations regarding production cuts. This will benefit India since it is one of the largest importers of crude oil; we estimate the savings on oil imports to be around USD 30 billion in FY21 if there is no significant uptick in global demand. This will also arrest the rising inflation and facilitate the next round of rate cuts by the RBI.”

Triggering the Price Slump

Oil prices fell almost 30 per cent over the weekend of March 8 owing to Saudi Arabia slashing the official rates of its crude by the most in 30 years. It also announced that the country is planning to raise the output by at least 1 million barrels a day in the coming months. This sent shocks in the crude oil markets and hurt sentiments in other asset classes, which were already trading thin on coronavirus uncertainty. The markets were surprised by the announcement made by Saudi Arabia.

It is perceived that the Crown Prince Mohammed bin Salman, also the de facto leader of the Kingdom of Saudi Arabia, is gearing up to test the oil production capacity to deliver a crushing blow to rival producers. The move appears to be an effort to drive oil prices down so far as to send a message to Russia that it was a mistake to not agree to deepen output costs cuts at Friday's OPEC+ meeting. Some of the major investment banks are betting that the crude oil prices may touch as low as USD 20 per barrel. This price may be seen in the second quarter of 2020 as per some of the leading brokerage houses.

The Beneficial Fallout

While a slump is crude oil price is bad for oil producing countries, it is definitely beneficial for India, at least tactically. The following sectors and stocks may see some positive traction owing to the drop in crude oil prices:

Oil and Gas

The reduction in oil prices should benefit refiners like IOC, HPCL, MRPL, CPCL and BPCL since their fuel expenses will go down which should help in improving refining margins. Similarly, Lubricant companies such as Castrol and Gulf Oil Lubricants India are expected to benefit due to a decline in base oil price. On the other hand, the low price of oil will negatively affect upstream PSUs such as ONGC and Oil India given the impact on oil realisations. There is likely to be an impact on the profitability of petrochemical and LPG segments such as GAIL India as well. The volume growth of city gas distribution companies such as IGL, MGL, Adani Gas and Gujarat Gas may be impacted in the near term as the competitiveness of natural gas diminishes as compared to alternative fuels like fuel oil.

Tyres Companies

Companies such as Apollo Tyres, Goodyear Tyres, MRF, CEAT, TVS Srichakra and Balkrishna Industries should see a reduction in cost as crude-based raw materials account for close to 50 per cent of the cost. Thus, an expansion in margins can be expected for these companies.

Consumer Goods

The fall in crude oil prices will bode well for consumer goods companies in terms of margins as lower crude prices would mean a reduction in packaging cost (15-20 per cent of overall input prices). Moreover, the drop in crude oil prices should also benefit paint companies such as Asian Paints, Berger Paints, Kansai Nerolac Paints and AkzoNobel as 30 per cent of raw materials in these companies are crude oil derivatives and prices of the same are expected to decline with a fall in crude prices.

Agro Chemicals and Speciality Chemicals

The fall in crude oil prices will be positive for PI Industries, UPL, Aarti Industries, SRF, Sudarshan Chemicals, Meghmani Organics, Dhanuka Agritech and Excel Industries, among others. 

Making Headlines 

In the recent crash the following headline caught the investors’ attention: “World's richest 500 people lost USD 203 billion in the first 96 minutes of US’ trading on Monday, March 9.” In December when the markets were not bearish, the following headline impressed the investors: “World’s richest 500 people made USD 1.2 trillion in a single day.”

This is how headlines influence investors’ minds! 

Conclusion

The US markets are struggling because the credit markets have buckled and crude oil has sunk. The US 10-year yield went below 0.50 per cent for the first time ever. The market moods are expected to push the policymakers to reduce interest rates while the zero interest rate scenario in the US is gathering steam. No doubt the current market mood is that of ‘risk off’ and hence we may see some selling pressure in emerging markets, with Indian equities being one of them. However, the ‘risk off’ mood can change if there is a coordinated effort by central banks of the world and some selective fiscal packages are announced to stem the fears of the slag in economic growth.

In the past, good returns have always been preceded with bouts of pain. Long-term investors need to remember that the ride is going to be bumpy and recovery can be painfully slow, testing the patience and conviction of the very best. Such panic situations can be used to build long-term strategic portfolios. The markets are volatile – that is a given as of now. How well the markets recover from here will depend on not only how the global factors interplay but also on how well India manages its balance-sheet and reduces the fiscal deficit with the help of lower crude oil prices. Meanwhile, investors can focus on high dividend yield stocks and those stocks that stand to benefit from lower crude oil prices while setting out to build a portfolio with long-term investment horizon. In fact, such bouts of correction, volatility and panic can be a true friend of longterm investors. One must use it optimally, albeit being cautious.