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Crude prices: What will be the impact? - Views on News from Equitymaster
 
 
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  • Mar 8, 2004

    Crude prices: What will be the impact?

    The last year has been a memorable one for the equity markets and especially for energy stocks with the major oil companies gaining more than 100% on the bourses. It should be remembered that in the Indian context, being an emerging market and with industrial activity picking up, the demand for oil has been ever-growing as a result of which, even today, we rely heavily on imports (to the extent that 70% of crude requirements is imported). However, wait a minute. Is this just the bubble…. waiting to burst???

    The smart gains recorded by these companies can largely be attributed to the fundamental factors such as higher volumes and better margins, filtering into the numbers. However, what is to be seen is that during most of the previous year, crude prices remained on the higher side leading to better margins for upstream companies such as ONGC (Oil and Natural Gas Corporation). This is because when crude prices increase, ONGC as a major producer of crude in the domestic market benefits from higher prices. At the same time, US dollar slid southwards against all major currencies i.e. Euro, Pound Sterling and the Japanese Yen last year. And the trend has continued in this fiscal as well.

    Crude prices have risen tremendously in the recent past and this is mainly due to the growing demand from the Americas, where oil reserves seem to be on the lower side compared to the normal levels. To make matters worse, OPEC's decision to cut production from April has not helped either.

    The impact on refinery companies...

    Increasing crude prices shall have an adverse impact on the refinery companies, where crude is the major raw material. Although these refineries faced the brunt of high crude prices, higher than normal gross refinery margins (GRM) helped ease out pressure on operating margins in the last quarter. To put things in perspective, IOC witnessed a 43% jump in its GRM (US$ 4/barrel as compared to US$ 2.8/barrel) while another refining and marketing major BPCL saw a 17% improvement in its GRM. However, going forward, oil companies may not be in a position to increase prices due to political and competitive reasons. To make things worse, the oil PSUs have been, for long, sharing the burden of LPG (liquefied petroleum gas) and SKO (superior kerosene oil) subsidies, which in the long run, shall squeeze margins further.

    The impact on upstream companies...

    The only beneficiaries of the increasing crude prices scenario shall be those engaged in upstream activities such as ONGC and Oil India. It therefore, becomes imperative for oil marketing PSUs to enter into the upstream segment to secure crude at reasonable prices and maintain margins. Another beneficiary of this scenario seems to be GAIL India. With increasing crude prices, feedstock such as naphtha and furnace oil becomes an expensive proposition, resulting in higher demand for natural gas. The GOI's decision to deregulate gas prices shall provide a fillip to GAIL's prospects, which already has a vast network of pipelines spanning across the length and breadth of the country. It further plans to set up a national gas grid to expand its reach in the southern markets.

    Overall, barring the subsidy receipts that refining and marketing majors received in the last quarter, the performance of oil stocks is likely to be muted because of the squeeze on margins. So, if you expect another good year of profits like in 2003, investors could be in for a disappointment considering the fact that demand for petro-products like diesel and petrol have remained lackluster in this fiscal.

     

     

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