One of the top commentators on crude oil and a top oil trader had predicted a level of $100/bbl for crude way back at the beginning of 2018. His contention was that the US would impose sanctions on Iran at the first chance it got, as a result of which the latter’s oil supply would be cut off from the market.
While nobody gave too much credence to this view, it is gradually turning out to be true. The US has imposed sanctions on Iran and crude is closer to $80/bbl. With the OPEC (Organization of Petroleum Exporting Countries) supply likely to be in check due to the pressure of the sanctions on Iranian oil supply, further hikes in oil prices cannot be ruled out.
Check out the year-to-date crude oil price chart as of Friday, September 07, 2018, below:
Why the sharp spike in crude oil prices this year?
Many factors are responsible for the sharp spike in the prices of crude oil this year. To begin with, the OPEC supply cut had a gradual impact as the organization was able to put in countermeasures and maintain discipline. Political and economic crisis in countries like Venezuela, Brazil, Nigeria, and Libya negatively impacted output in these nations, which accounted for a significant portion of the OPEC output. But the real spike in crude came due to two different sets of reasons altogether.
With economies like the US growing their GDP at closer to 4% and growth reviving in the European Union (EU), China, Japan, and India, the focus shifted to the demand side. There are expectations of a spurt in demand in line with growth. Crude prices were a tad subdued due to the worry that trade wars may slow down the pace of global trade. However, what is apparent from the recent data is that the trade war has hardly managed to significantly alter the course of the trade flows. This has also been a boost for oil prices.
How should one approach oil stocks if crude gets closer to $100/bbl?
There are a few positives and also negatives of the rising crude prices. If crude gets back to $100/bbl, then it could create a fairly piquant situation. Here is how.
· What happens to oil stocks? In terms of upstream companies like ONGC and OIL, the benefit of higher crude prices should be visible. However, one needs to be cautious as they might be called upon to share part of the subsidy burden. Being an election year, full pass-on to customers may not be a politically wise decision and hence, some subsidy appears to be inevitable. Downstream companies may also face a problem of subsidy loading. However, these stocks may be protected by the diesel regulation mechanism. One can be positive on the upstream oil sector although some caution is warranted on the subsidy sharing front.
· We are going to see consumer goods companies benefit again. Higher crude is going to automatically lead to higher inflation. Higher inflation normally means higher pricing power for the likes of Hindustan Unilever, Marico, and Britannia, among others. These consumer stocks could be the big beneficiaries of the higher crude oil levels. In fact, these stocks can be bought as a hedge against higher inflation.
· Auto could be the surprise package. You may wonder that higher oil prices may dampen the demand for petrol and diesel and auto sales may take a hit. Our view is slightly different. You need to focus on companies that are looking ahead and shifting predominantly to electric cars in the coming years. Companies like Mahindra & Mahindra and Tata Motors, which have aggressive plans to get out of diesel and shift to electric cars, could be the stocks to watch out for. Tata Motors and M&M are already using the higher crude prices as an opportunity to make their big foray into the electric vehicles segment.
· Finally, don’t forget the inter-relationships. It is easy to say that higher crude prices will be negative for paints because oil is a critical input in paint manufacturing. But the reality is more complex. For example, crude at $100/bbl will lead to a sharply higher trade deficit and the CAD perhaps rising. That will weaken the rupee and create higher inflation. When we take a call, we will have to look at these interrelations.