Brent hits $100. What are the implications of higher oil prices?

Brent hits $100. What are the implications of higher oil prices?

Brent crude oil prices surpassed $100 per barrel on Thursday, the first time since 2014. This is after the Russian president Vladimir Putin ordered troops into eastern Ukraine.

Unsurprisingly, following escalating geopolitical tensions, the Indian stock markets nosedived. In early trade on Thursday, BSE Sensex and Nifty50 indices fell by more than 3%.

Higher oil prices are bad news for the India economy as it imports a lion’s share of its fuel requirements. With this, over the past one year, the benchmark crude prices have now risen by more than 50%. In the near future, oil prices can be expected to remain firm. “We expect crude oil prices to remain volatile and rise from current levels if geopolitical concerns do not materially ease,” pointed out a report from Kotak Institutional Equities on 23 February. The brokerage added, “We maintain our current oil price estimate of $80 per barrel in FY2023 for the time being, while noting upside risks if ongoing geopolitical concerns persist over the coming months.”

 For India, higher prices have a negative influence on inflation and the country’s current account deficit (CAD). Even so, in a higher oil price environment, upstream oil companies such as Oil and Natural Gas Corp. Ltd (ONGC) and Oil India Ltd stand to benefit. Already, both companies have seen a meaningful jump in their price realisations during the December quarter results (Q3FY22). For instance, ONGC’s crude realization rose 75% year-on-year (y-o-y) and 9% sequentially to $75.7 per barrel. To that extent, higher crude prices offset the muted production outlook for these companies. ONGC’s shares have appreciated over 40% in the last one year, suggesting investors are factoring in the optimism adequately.

For the state-run oil marketing companies (OMCs), marketing margins come under pressure if retail pump prices are not increased sufficiently when crude prices rise. Currently, retail prices are below market prices. “Post elections, retail prices are expected to rise and from an inflation point of view, it would be negative,” said an analyst requesting anonymity. He further added, “November excise duty cut was helpful and it remains to be seen if further cuts happen, which would soften the blow to the consumer,” he added.

 It must be noted that higher oil prices are detrimental to most companies. Plus, this comes at a time when companies are already battling cost inflation at various levels. For instance, while higher oil prices increase packaging costs for fast-moving consumer goods (FMCG) companies, individual companies are also dealing with a rise in other input costs. Add to this, demand in the rural market has slowed down. Companies have taken price hikes and investors will watch the extent to which this helps gross margins.

Moreover, some analysts think if consumers end up spending more on fuel, demand for consumer discretionary products may get hurt.

Further, for cement companies, higher oil prices lead to an increase in petcoke prices. Plus, freight costs typically increase, weighing on margins. Note that power and fuel expenses account for 25-30% of the sector’s total operating cost.

 For paint companies, however, there may be some respite as paint makers have taken significant price hikes in the decorative coating business over the course of this financial year. Paint companies use crude-based derivatives such as monomers. Analysts expect the March quarter results (Q4FY22) to reflect the full impact of price hikes taken, thus supporting margin recovery.

For airlines, aviation turbine fuel accounts for a big share of operating costs therefore higher oil prices are unwelcome. In Q3, InterGlobe Aviation Ltd’s fuel CASK grew by around 90% y-o-y and 13% sequentially. CASK is cost per available seat kilometres and is a unit measure. Brent crude prices have averaged at $79 per barrel in Q3 and so far in Q4, they stand at about $90 per barrel. It helps that domestic traffic data is showing a recovery in February after a dismal January. How traffic recovery pans out ahead is key and so is the strength in yields, a measure of pricing for airlines. Shares of InterGlobe and SpiceJet Ltd were down around 5% in Thursday’s morning trade.

 To be sure, high oil prices pose a risk to global recovery as well. “If prices hold at current levels or rise further, cost pressures would further increase for a host of industries and household purchasing power would diminish, dampening the pace of the global recovery,” said a Moody’s Global Macro Outlook report published on 23 February. The report added, “We expect oil prices to gradually decline in the second half of 2022 and to fall further in 2023.”

Meanwhile, crude oil is not the only worry for India. In a note on 21 February, Jefferies India said, “India is seeing the prospect of ‘twin’ deficit – fiscal and CAD – simultaneously over the next 12 months.” The brokerage further added, “The imports surge is quite broad based (non-oil, non-gold rising at 20% 2-year cagr now) and recovering local demand, along with high commodity/oil prices, could keep current account under pressure. We estimate CAD at 2.5% of GDP in FY23 (US$80/bbl assumption), 10 year high.”

Published: 24-02-2022