As Crude Oil Prices Surge, India Inc. Has Many Reasons To Worry
The world’s third-largest importer of oil has a lot to lose with Brent crude, the Asian benchmark, surging to a near four-year high in September.
The price rise will adversely impact the world’s seventh-largest economy as it will not only widen its fiscal and current account deficits but also lead to higher inflation and interest rates—thereby affecting consumption and investments.
A $10 per barrel rise in crude prices can increase inflation by nearly 30 basis points and stunt growth by 10 bps (more on this here).
This has a direct impact on many industries that use either crude oil or its derivatives as raw material. Usually, some of the impact gets passed on to consumers, stoking inflation.
Here’s a look at the impact of rising crude oil prices on the various sectors of industry.
Oil producers generally tend to benefit with rising crude oil prices, but not so in India. Though crude is expected to be 30 percent more expensive this fiscal over the previous, the subsidy for petroleum has seen a less than 2 percent increase.
If the government falls short of its budgeted estimates, explorers Oil and Natural Gas Corporation Ltd. and Oil India Ltd., can be called upon to fill the gap—a practice that was in vogue till the quarter ended September 2015. Things may not be the same anymore.
A shortfall in subsidy increases the earning risk for the upstream companies if they were to share the burden, Morgan Stanley said in a recent report.
Prices of crude oil have a direct impact on industrial sectors—from refiners to marketers, aviation companies and manufacturers, among others—as they account for one of its major input costs. If the companies don’t pass the impact, their profitability could be badly hit.
Oil marketers pass on the impact of higher crude prices to consumers by hiking prices. However, the upcoming election season poses a threat to their marketing margins, if the recent past is an indicator.
The margins fell in the run up to the assembly elections in Gujarat and Karnataka early this year as they were restricted from effecting hikes even as Brent crude prices surged in the international market.
However, the margins have stabilized so far in the ongoing quarter as the oil marketers have hiked prices by at least 10 percent.
Fuel expenses, on average, account for a third of the operating costs of aviation companies.
Higher fuel prices dented the margins of the aviation companies India as they were unable to pass on its impact to consumers. This hit their profitability in the quarter ended June and is expected to turn worse in the ongoing quarter due to higher costs and no improvement in the environment for ticket pricing.
Fuel costs for the three listed airlines—Jet Airways Ltd. SpiceJet Ltd. and InterGlobe Aviation Ltd.—rose by over 30 percent in the quarter ended June compared over the previous year and the fuel cost per available seat kilometre stood at a three-year high.
The gross margins of lubricant manufacturers—for whom crude oil is a key raw material—were impacted in the quarter ended June. The companies passed on some of the impact to consumers through hikes. The high prices of oil, however, pose a risk to their margins.
The principal raw material for the industry is a variety of plastic polymers that are derivatives of crude oil. Higher oil prices led to a corresponding rise in the derivatives, albeit with a time lag. Due to this, margins could be impacted temporarily.
Tyre manufacturers source the crude oil derivatives synthetic rubber and carbon black—the prices of which rise at a lag corresponding to that of oil. However, tyre manufacturers have been able to pass on the rising input costs to consumers.
Rising prices of crude oil—which accounts for nearly 50 percent of the total expenses of a paint company—are expected to put pressure on raw material costs, but the same has, in the past, been passed on to consumers by a series of price hikes.
Construction activities in the Middle-East are directly linked to crude oil prices. A dip in oil prices push the Gulf Cooperation Council nations to restrict state spending, hampering the growth of the construction industry which is materially dependent on government funding and vice versa.
The current uptrend in oil prices are expected to boost construction activities in the Middle-East thereby benefitting companies like Larsen & Toubro Ltd., Kalpataru Power Transmission Ltd., KEC International Ltd. and NCC Ltd. L&T benefits the most as the company generates nearly 69 percent of its international business from the region.