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Staring down the barrel

Oct 10, 2008

Stock markets plunge
Stock markets plummeted in the US over fears of more corporate failures as a result of the worsening credit crisis. The Dow plunged more than 7%. The Asian markets are currently echoing the sentiment with Japan trading lower by 11%, followed by Honk Kong (8%) and Korea (7%).

Crude declines to 1 year low, gold marches on...

Crude oil declined to its lowest in a year over concerns that the global credit crisis will push countries into an economic recession. As per Bloomberg, OPEC has signaled that it may cut output at an emergency meeting on Nov. 18 in a bid to stop the plummeting prices. However, OPEC cannot cut output substantially because it would be seen as worsening the economic slowdown, something its western customers will not appreciate. Gold on the other hand, continued its march upwards as panic-stricken investors continued to get lured by its safe-haven status. While crude declined to US$ 86.6 per barrel, gold closed at US$ 913 an ounce.

It may be recalled that the spike in crude oil, along with the credit crisis was held responsible for the decline in stock markets during the first half of 2008. Now, it has joined the equity markets at the receiving end of the financial turmoil. We believe all asset classes- housing, credit, commodities or equities - must eventually obey their fundamentals. If prices get bid up to levels beyond what is justified by their demand and supply, eventually the bubble bursts.

Domestic oil companies squeezed...
As per a leading business daily, India's commercial banks have stopped lending to the public sector oil marketing companies (OMCs) - Indian Oil, Bharat Petroleum Corporation Limited (BPCL) and Hindustan Petroleum Corporation Limited (HPCL). The OMCs have accumulated high levels of debt to finance the under recoveries from the sale of petroleum products. Given the current squeeze on liquidity world wide, the banks have refused to infuse money into them any longer.

We find it ironical, that when the crude price spikes up, OMCs suffer because of higher under recoveries, and when the crude prices fall they still cannot find adequate finance. This confirms our view that the problems plaguing the downstream oil segment is structural which cheap valuations cannot sufficiently compensate.


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