Crude Oil Price Crash – Winners, Losers, Risks and Concerns

Brent crude oil prices have collapsed by nearly 30% from November beginning till date. Even the common man is aware of such a price crash which has made him happy by way of massive reduction in petrol and diesel prices. In the investing community, most analysts are at most bullish with the crude oil price fall as it is supposed to be extraordinarily beneficial to the Indian economy as much of the crude oil requirement is imported by India.

Market Reaction:

But has the all mighty Market taken it positively ?? The answer is a big negative.

1) The precipitous fall in crude oil since November beginning was approximately 30% till date, but NIFTY was trading at 8324.15 in the beginning of November and is currently at 8111 (at the time of writing) which is a LOSS of approximately 2.56% .
2) Indian Rupee versus the US Dollar have weakened by approximately 3.1% since November. If a fall in crude oil price is expected to benefit Indian economy through savings in foreign exchange, Indian rupee is supposed to have strengthened against US dollar.

 still feel with a time lag somewhere down the next few weeks / months markets will follow crude oil prices southwards. Apart from the broader market indices following crude oil prices, there should be winners and losers in few sectors out of crude oil price crash.

Winners (With Caveats):

Oil Marketing Companies (OMC’s) - Needless to mention, the immediate beneficiary has been the Oil Marketing Companies (OMC’s). But in UPA-II regime itself, petrol has been completely deregulated and diesel prices has been partly deregulated with small monthly hikes. The steep price crude oil price crash had enabled BJP government to completely deregulate diesel prices much earlier than anticipated. But still there is Kerosene and LPG prices which has to be decontrolled. Most of the big gains from diesel price decontrol seems to have been already factored in the recent price rally in oil marketing companies. But, these OMC’s also have Refinery operations and the near 30% price crash since the beginning of this quarter will have a substantial inventory write-down in the current quarterly results.

Airline companies - The decline in aviation turbine fuel (ATF) prices will certainly benefit airline companies such as Jet Airways, Indigo and SpiceJet as fuel expenses makes up almost 41-45% of their operational revenues. This already had a knee-jerk reaction on the stock prices of some of the listed airline stocks. But given the weak demand and entry of several new carriers such as Air Asia, Air Pegasus, etc.. who are in the process of expanding routes may trigger a “fare ware” and the sustainability of expected margin improvement beyond one or two quarters is very difficult in my opinion. Any benefits arising out of low ATF costs, may eventually be passed on to the passengers to grab market share. Unless, the present high losses forces some leading Airline company to scale back or shut down their operations which can benefit other players by way of increase in “Load Factor”, there may not be much benefit due to lower ATF costs. But thats a different case altogether.

Interest Rates:

But a prolonged low crude oil price, will definitely have lower inflationary expectations which can support the cause for lower interest rates . This can of course lead to rally in bond markets and to some extent banks and primary dealers in Indian debt market can benefit out of their treasury operations . This can improve business sentiments starting from second half of 2015 and can revive the prospects of much needed investment cycle in the economy .

Losers:

State and Central Governments:

Crude oil price crash lowers the subsidy burden of the government but it also reduces the tax inflow for both State and Central governments which is charged on petroleum products. As per provisional figures, in FY 2014 State and Central governments collected approximately Rs. 230,000 crores together  by way of Excise & Customs and Sales Tax / VAT on Petroleum products. It may be noted that most of these taxes are a percentage of the value of the petroleum products. In the event of (as is the case currently), prolonged lower oil prices will mean lower income for State and Central governments. The lower subsidy burden out of diesel price decontrol is good for Central Government but its not the case with State Governments.To plug such gaps, Governments may hike taxes or by some other means which can only be burdened on its citizens, to raise its income. In my opinion this could largely nullify the expected benefits out of lower crude prices.

Standalone Refineries and Petrochemical Companies:

As mentioned earlier, the steep price crash within a single quarter will result in massive inventory write-down for refineries. Normally refineries maintain 15-18 days of Inventories, but when prices collapse at a rapid pace the high cost of inventory bought few days back becomes less worthy.  The impact on stand-alone refineries such as MRPL or CPCL will be enormous. It is worth stating that Indian oil Corporation Ltd. had reported an inventory loss of around Rs. 4000 crores in Q2 of this fiscal. But the impact will be much higher as the percentage of price fall is much more compared to last quarter.

Similar is the case with various stand-alone petrochemical companies. Given the weak demand in the country, any reduction in raw material feed costs will eventually be passed on to the end users and most petrochemical company margins will clearly be dependent on supply-demand factors rather than fall in crude oil prices.

Risks and Concerns:

Contagion Risk:

The biggest loser out of this oil price crash are some of the leading oil producers including Russia, Iran, Venzuela, Nigeria, Canada, Arab Countries, etc..To be more specific, Russia which is also part of the so called BRIC nations is the most affected. The stock market is crashing heavily, currency have collapsed and interest rates have spiked. There is a risk of contagion spreading to emerging markets including India as foreign investors will try to cut down on the losses by booking profits in other profitable markets such as India. If we remember, a small country called Greece, went into a crisis which caused enormous pain for global markets in late 2011 and mid 2012.

Geopolitical Concerns:

It may also be noted that oil revenues form a considerable chunk of government expenditure in various countries. The recent fall in crude oil will restrict their governments from social spending and other economy boosting expenditures which will only result in slow down of economies.This may also lead to geopolitical risks as in the past wars in Major oil producers have helped Oil Prices to spike. Not necessarily due to oil price hike but investors consider geopolitical fallouts as negative for markets.

Conclusion:

Under a weak global environment with subdued demand for various products , the recent fall in crude oil prices can only result in subdued margins for producers, escalate the weakness in global economic environment further due to lower incomes for governments, disaster for few countries such as Russia resulting in contagious risks spreading to other markets and above all raising the risks of geopolitical fallouts . It is very difficult at this stage to pinpoint which sector can be a major beneficiary out of this crude oil price crash . Some of the sectors like OMC’s and Airlines have already re-rated as a result of crude price crash. But sustainability of such rallies need to be seen in the coming months . Still, the Demand in India for various crude oil derivatives are weak and margins are weak as well due surplus capacities worldover. Until demand improves, lower crude prices will eventually be passed on to the consumers without much impact on margins.