If you look at oil in the post-2006 period and up to 2014, it has typically traded above $100/bbl except for the period of the global recession post the Lehman implosion. However, for the price to go up to $100/bbl from current levels would entail a rally of almost 50%. But oil markets today are different from the past. Here is how.
- OPEC’s market share has fallen from above 50% in the 1990s to around 33% currently due to the rapid increase in capacities across US and Russia
- Saudi Arabia, which used to be the swing producer of oil and also the world’s largest producer, has ceded that position to the US
- Oil demand is largely a function of economic growth and that has been faltering in the largest oil market i.e. China
What happens if oil touches $100/bbl?
At a macro level, there would be a lot of pressure on the macros. Trade deficit would widen and the current account deficit could widen by another 2% as a percentage of GDP. The rate of inflation could also be higher by 50-60 basis points. Apart from these factors, sharply higher oil prices would also mean a weaker rupee, as we have seen in the past. So, how would this impact stocks and who would be the gainers if oil touches $100/bbl?
Upstream oil companies
These are the oil extractors and include the likes of ONGC, OIL, Reliance and Vedanta. Globally, oil extractors and producers tend to benefit from higher oil prices. Of course, in the Indian context, oil is still tightly regulated and as a result oil extractors are not able to get the full benefit of higher crude prices. The positive side of the story is that extractors tend to get better valuations in the M&A market when the prices of oil are higher. Normally, since crude prices tend to benefit gas prices also, we also see transporters like GAIL benefiting from higher realizations.
Downstream oil companies
These include the oil refiners like IOCL, BPCL and Reliance Industries as well as the oil marketing companies like HPCL, BPCL and IOCL. In this case, the impact of $100/bbl oil can be quite mixed. For example, refiners tend to benefit from a sharp spike in crude prices. That is because, this spike allows them to value their inventories at a much higher valuation and that helps to improve their profits. Downstream oil has a different problem. Normally, governments allow oil marketers to pass on the crude prices up to a point. Beyond that point, any rise in petrol and diesel tends to become unpopular and that is when the oil marketing companies are forced to share part of the burden in their books. Also, as we have seen in the past, the subsidy burden tends to get passed on to oil marketing companies. As a result, oil marketing companies have not benefited as much as the refiners. Since refining and marketing happens under a common banner in most cases, you need to exercise caution here.
Would companies like Hindustan Unilever and Britannia benefit from higher oil prices? Actually, there are two sides to this argument. Some FMCG companies like Hindustan Unilever and Asian Paints require crude oil as a key input in the manufacture of paints and hygiene products respectively. However, there is also a positive side to it. Higher oil prices of around $100/bbl would mean higher inflation. Inflation has been typically positive for FMCG companies. So while the segments like detergents and paints will face some margin pressure, the segments like body care products and food products tend to enjoy better pricing. Depending on their product mix, higher oil prices can benefit FMCG companies.
IT and Pharma companies
What do IT and pharma have to do with oil? The relationship here is indirect. For example, both IT and pharma are export oriented businesses, and hence, tend to benefit from a weaker rupee as it inflates their earnings in rupee terms. Oil at $100/bbl is a clear recipe for the trade deficit to widen, the CAD to sharpen and the rupee to weaken. In October 2018, when Brent Crude had touched $84/bbl, the rupee had fallen as low as Rs75/$. So oil at $100/bbl would surely mean a weaker rupee. That would clearly benefit the service oriented exporters.
Apart from the above, there are companies that provide engineering and support services to oil extraction companies which benefit from the higher investments in oil. Companies like Engineers India, Dolphin Offshore have benefited in such conditions. Also, companies like L&T get over 25% of their revenues from erection and maintenance of hydrocarbons plants and they also tend to benefit from higher crude prices.
Of course, oil at $100 is still some time away unless global growth picks up in a big way. But, even in that condition, there are interesting stocks to look at.