Fall in crude price: What to buy?
Growing up, we had always heard that the rising crude prices are not good for India. The rationale was quite simple. Higher the fuel prices, higher the inflationary pressures. Unlike developed nations, India struggles more with high inflation rather than with low inflation. Additionally, India relies heavy on imports to meet its fuel requirements. Higher the price of crude, higher the subsidy government has to bear and higher the fiscal deficit. Higher the fiscal deficit, the less government is left to spend on capital investments. The negative correlation was so well established that with every significant increase in price of crude oil, Sensex would go down the next day.
Over the last six months, the crude has gone down from USD 115 per barrel to USD 50 per barrel. Initially, this fall was initially cheered by Indian markets. However, over the last month, the fall is not being viewed as positive for the Indian markets. The relationship has reversed to such an extent that with every dollar rise in crude, the Sensex (or Nifty) goes down. With the fall in crude price, you can expect that stocks of companies involved in crude production/exploration or refining to struggle but the fall in stock prices has been broad based.
Who would have thought that fall in crude oil prices would not be beneficial to Indian markets? Many reasons have been given. Falling crude price is indicative of a shaky global economy and demand scenario, leading to flight of capital from emerging markets to safer havens. Investments from sovereign wealth funds of oil producing nations may dry up or are being liquidated. Major oil producing nations will struggle which may lead to political unrest. Credit to oil producing companies may start turning bad. Some financial institutions are booking profits in emerging markets to provide for such losses on such investments. There are many other reasons being given. Every market commentator has a rationale for this reversal of correlation. However, one thing is for sure, fall in crude prices (perhaps along with other global events) has disturbed equilibrium in financial markets which has resulted in reversal of this old relationship.
As a stock market participant, what should you buy or sell to take advantage of this sharp cut in crude price? In this article, we discuss about the kind of stocks you can look for (or can avoid) to benefit from this crude price fall. Do remember that investment decisions cannot be based solely on this simple assessment. Remember a good company bought at a bad price (too high a price) is likely to turn out to be a bad investment.
The worst hit sector will be oil exploration/production and refining. Costs of production or refining do not change much due to fall in crude prices. Hence, there will be strong downward pressure on margins. Further, with such low prices, investments in further exploration will be severely. Hence, the companies which sell their product or services to such companies (e.g. rig suppliers) will be adversely affected. Demand in economies of major oil producing nations is likely to be severely hit. Hence, companies which derive a substantial portion of their earnings through exports to such economies (or in their currency) will face the brunt too.
On the positive front, the companies which use crude or its derivatives as a raw material are likely to benefit the most. Hence, one can expect FMCG, paints and packaging companies to do well. Even within these companies, the companies with B2C (that sell directly to consumers) business model will reap greater benefits than those with B2B (sell to other businesses) business model since pricing power is much greater in a B2C business. Hence, pure play packaging players (or any other B2B player) will not benefit beyond a point.
Further, if the government lets oil marketing companies pass on the benefit in form of lower retail petrol/diesel prices, lower prices can lead to lower inflation. Low inflationary expectations can allow RBI to cut rates. An interest rate cut will give a huge boost to domestic consumption and investment. This will help cyclical sectors such banking, cement, steel, construction, automobiles and housing. Boom in these sectors will help other secondary sectors too. For instance, a boom in housing will benefit paints industry, in addition to cement and steel industry. Higher automobiles sales benefit auto ancillary and tyre companies.
In short, look out for companies which:
- Use crude/crude derivatives as raw material
- Cater to domestic consumption
- Preferably have a B2C business model
Sounds too much work. You need not worry. You can trust this work (and your money) to a good mutual fund. Such funds are managed by experienced professionals who understand the impact of such price movements on various stocks. Read our article about selecting good mutual funds here.
Deepesh is Founder, PersonalFinancePlan.in
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