Implications of the Crude Oil Crash

Fri, 22 Jan Pre-Open

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As an investor you would agree that one of the most talked about affairs today is the plunge in crude oil prices. Why wouldn't it be. The sharp fall in oil prices have created mayhem. And the effects of this are felt right, center and left. However, while this has brought in a great deal of relief for consumers of products derived from oil, the reality, as always, is not so straight forward.

Crude oil prices have affected the Indian Indices. It has also created some woes for the economy's growth. Let's note some facts and understand why...

Going by basics, the reason why oil prices are so low is because there is so much of it. The crude oil glut has sparked the downward rally in prices. If one has to note, in June 2014, global oil prices were trading at nearly US$108 a barrel. This week, oil prices crashed to below US$30 a barrel. This was the lowest price since the height of the global financial crisis in February in 2009. And the fall is getting prolonged as global producers haven't cut back production. Furthermore, the lifting of sanctions against Iran has meant more oil flowing into markets.

The concerns are mounting as the demand that seems to be steady at present, might not last longer. This can be said by looking at the ill health of China, one of the world's top energy consumers. China is already slowing down and a combination of falling demand and rising supply has taken its toll on overall oil prices.

Profits of oil companies can take a hit on the back of this subdued demand. Also, the falling demand can take a toll on companies exposed to the oil industry. Banks that have lent enormous amounts to oil related companies could also be affected if debts begin to go sour. Further, oil companies into exploration and production are likely to face a tough time. Low prices can exert considerable pressure on their overall financials and impact viability of fresh investments. All of the above concerns have led to a sell-off in the stocks of these companies. And in broader terms, contributed to the overall fall in the benchmark indices. Few days back, Richa Agarwal, our in house energy-analyst, wrote an article explaining what this oil crash say us about the markets and economists. You can read it here.

On the other hand, it is not necessarily all bad. As oil makes up a large share of the import pie for India, low prices mean a lower oil import bill and less pressure on the country's fiscal and trade balances.

Indian companies using crude derivate will also benefit. Lower crude prices translate into lower input costs for them.

At the end of the day, oil prices are highly volatile. While they have nosedived in recent times, history proves that they can rise just as quickly. Given that there are way too many variables involved, other than just demand for the commodity, we believe in not taking a long term call on oil prices. And in the longer run, factors such as our reliance on oil, finite supply and rising cost of exploration could mean that oil may very well see higher prices in future.

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