How the crude oil price collapse will impact India. 5 Points…

Co-head of Research at Equitymaster Rahul Shah did an editorial yesterday explaining why the Sensex can hit an all-time high in August 2022.

Now, the one important factor behind the short recovery is falling crude oil prices.

Crude oil prices are falling amid fears of a recession, demand-supply dynamics, among other reasons.

Nowadays it’s almost like another day and another fall in crude oil prices.

At present, they are trading near multi-month lows.

WTI Crude Oil – 1 Year Performance 

Data Source: Investing.com

Yesterday, oil prices dropped as recession fears hurt the demand outlook and data pointed to a slow recovery in China's crude imports last month.

China, the world's top crude importer, imported 8.79 m barrels per day (bpd) of crude in July 2022, up from a four-year low in June 2022. But this is still 9.5% lower than a year ago.

Without signs of a big demand recovery, it’s important for you to know the after effects of falling crude prices and how they impact India.

Here are five points to take note of.

#1 Inflation

The markets don't like high crude oil prices. It raises the prospects of higher inflation and interest rates, as well as lower consumer spending and corporate profits.

A fall in the oil price is helping to ease inflationary pressures. Therefore crude oil is negatively correlated with equity markets. This is an established fact. Lower oil prices tend to push equity markets higher.

The recent fall in oil is already addressing the depreciating rupee problem but we’ll come to that later.

Rising oil prices lead to higher inflation as prices of majority of products increase. Petrol and diesel prices rise and food prices follow.

The situation is reversed when there’s a fall in crude prices.

#2 Rupee

Falling oil prices are good for the Indian rupee.

You’re already seeing the effect. From touching a record high of 80 against the US dollar last month, the USDINR currently trades at 79.57. It touched 78.58 earlier this month on 2 August.

When crude oil prices were rising, the big concern was the cost of India’s imports. The cost of India's big imports - crude oil, natural gas, minerals of all kinds, machinery, electrical equipment, appliances, and chemicals - all went up significantly. 

This made inflation in India, which was already high, harder to control.

At present, the situation is reversing now that crude oil is falling.

Here's some number crunching by The Hindu...

We ran a correlation analysis to see the linkage between the crude oil prices and the rupee and Nifty50 over the last 25 years. 

We found that when crude oil prices move sharply in either direction in a short period (say one month), then the rupee and the Nifty50 move in the opposite direction in many instances.

But when the period of extended crude price shocks are considered (spanning several months), the relationship is very weak during crude price decline. When crude oil prices keep rising over several months, the inverse relation proves right on 2 out of 3 occasions.

#3 Trade deficit

Trade deficit is the excess of imports over exports. India’s trade deficit swelled to a record US$ 31 bn in July 2022. It was US$ 10 bn in the same period last year.

India is the third largest consumer of crude oil behind US and China. But we import nearly 85% of our total crude oil consumption every year.

Thus a fall in oil prices helps India’s trade balance. 

This is because imports moderate as crude oil prices decline. This helps bridge the gap between imports and exports.

The narrowing trade gap, in turn, supports the currency.

Here’s an interesting data point from an Economic Times report…

If crude oil prices are at US$ 100, India's oil trade deficit would be about US$ 140 bn. For every US$ 10 rise in crude oil from US$ 100, India's oil trade deficit will rise by about US$ 15 bn.

#4 Sectoral Effect

Any sector that uses oil or its derivatives, will be a direct beneficiary of falling crude oil prices. This is because companies will see their raw material prices come down over time.

Which sectors are these?

Any company that makes adhesives are heavily dependent on petrochemicals. Their raw material prices will fall very sharply.

The second sector that is likely to gain is plastics and polymer. This is a sector that uses petrochemicals and oil-based derivatives as its raw materials. Their raw material prices will also fall sharply.

The third sector is oil based paint and dye companies.

There are some companies which are diversified from oil-based paints to water-based colors. We’re purely talking about oil-based paints here. The dye that makes the paint is a petrochemical derivative.

Companies in these sectors will directly benefit and their bottomline will increase. The selling price is fixed but the raw material prices are falling. Therefore these sectors will start making above-average profits.

There are other sectors too that get affected but these are the three prime sectors affected from rising and falling crude oil prices as they share a tight co-relation.

Other sectors include the paint industry, automotive lubricants sector, and airlines that use crude as fuel. Fast-moving consumer goods (FMCG) stocks will also benefit from the fall in crude oil.

#5 Impact on Green Energy Demand

Renewable energy is the future of the energy industry. India’s top renewable energy stocks have delivered multibagger gains recently.

Whether it's harnessed from the sun or wind, renewable energy is becoming the power of choice as countries across the globe strive to tackle climate change.

But falling crude oil price is bad news for the green energy sector. At least for the short term.

As crude gets cheaper, automobiles and airlines will prefer to keep using oil which will dampen the green energy demand.

Electric vehicle stocks may get affected as falling oil prices may push consumers away from such vehicles.

As energy demand will be lower, it may put pressure on solar prices which are already the lowest in the world. The top solar companies in India will be impacted.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. 

This article is syndicated from Equitymaster.com