Why Analysts Don’t See Costlier Feedstock Worrying Firms
Users of industrial fuels may see a limited impact on their margin as analysts expect a recovery in demand to offset a rise in prices of feedstock.
The prices of natural gas and most petroleum feedstock products such as naphtha, bitumen and gas oil have risen 7-16% in the past three months, according to Bloomberg data. That came as Brent crude price surged more than 23% during the period. Besides, OPEC’s decision to modestly raise output from January 2021, ICICI Securities said in a report, will ensure supply deficit in the first quarter of 2021, supporting oil prices.
Petroleum feedstock is used as inputs by makers of fertilisers, petrochemicals, power, steel and city gas distributors and ships. Usually, a rise in input prices tends to squeeze margin as operating expenses increase. But analysts, including from Kotak Institutional Securities and ICICI Direct, don’t expect any material impact on the financials of the user industries because the increased costs will be easily passed on to the end-consumers.
Upstream and downstream companies work on a “matrix called delta where the end customer pays the price based on the prices of the feedstock”, Deven Choksey, managing director of KRChoksey Shares and Securities Pvt., told BloombergQuint. If feedstock prices change from say 1 to 1.5, the delta will change in the same ratio and therefore, the end customer will pay the changed price, he said. As long as the demand situation remains strong, the increase in prices of feedstock will be easily passed on to the end-consumers, Choksey said.
Aggregate demand for petroleum products, including auto and industrial fuels, rose for the first time in seven months, as India limped out of a pandemic-induced consumption slowdown. The industrial fuel consumption, according to Petroleum Planning & Analysis Cell, rose 5.2% year-on-year in October compared with a 7.5% fall in September.
Here’s how an increase in feedstock prices are expected to impact various sectors…
The petrochemicals sector uses naphtha, gas oil and natural gas as inputs.
An impact of the increase in naphtha prices will depend on the relative movement of petrochemicals prices, according to Prashant Vasisht, vice president and co-head, corporate ratings at ICRA. There could be a moderate decline in the margin of the petrochemicals sector.
Rusmik Oza, executive vice president, head of fundamental research at Kotak Securities, told BloombergQuint that the raw material cost will go up but prices of petrochemicals products, too, will increase. And most of the cost increase will be passed on.
The increase in gas prices will have a negligible impact on the fertiliser sector. “A rise in natural gas prices will increase the working capital of fertiliser companies. But there is always a pass-through of an increase in gas prices to the government for higher subsidies. Therefore, the fertiliser sector may not get impacted due to the increase in prices of natural gas,” ICRA’s Vasisht said.
City Gas Distribution
The city gas distributors may see a short-term impact due to the increase in prices of natural gas. This plays an important role in determining the profitability of city gas distribution companies. With the increase in LNG prices over the past few months, suppliers of piped gas with higher exposure to the industrial segment will have some impact on the margin, Mayur Matani, oil & gas analyst at ICICI Direct, said in an emailed response to BloombergQuint. Over the medium term, however, the impact will be minimal as the companies would be able to pass on higher costs to customers due to relatively strong pricing power, Matani said.