US-Iran conflict: Oil rally has a crude impact on India Inc's key sectors

The rising tension between the United States and Iran and its consequent impact on Brent crude oil, which surged further on Monday to around $70 per barrel, has only added to the woes of India Inc. Companies, which are already grappling with the sagging economic situation, now also face the potential threat of higher costs, and therefore, a fall in margins.

The Street’s concern was also palpable. Stocks pertaining to the sectors with relatively higher co-relation with crude oil prices, such as oil marketing (OMCs), aviation, paints and adhesives, cement, and tyres were down up to 7 per cent, as against a close to 2 per cent fall in the S&P BSE Sensex.

What holds key at this point, when the overall demand scenario is muted, is companies’ ability to pass on the incremental cost because of higher crude oil prices. This is because the escalation in the US-Iran tensions cannot be ignored, even as many experts are of the view that oil prices would retreat as soon as normalcy is restored.

According to Devendra Pant, chief economist at India Ratings, “If there is disruption to crude oil supplies and if oil prices stay high for a long time, it will be of great concern.” Some other experts predict Brent crude to hover around  $70 per barrel or 8-9 per cent higher than FY19 average prices if the situation worsens.

In this scenario, OMCs like Indian Oil Corporation may see a significant impact as their refining and marketing margins get directly affected. Though OMCs have shown their ability to pass on higher benchmark prices recently, Swarnendu Bhushan, analyst at Motilal Oswal Financial Services, believes that a sharp rally may challenge OMCs’ ability to hike auto fuel prices. 
 

If they are unable to do so, it will then put the upcoming Bharat Petroleum Corporation (BPCL) divestment in question. Additional pressure for OMCs will be in the form of higher interest costs, as their working capital requirement will likely increase with higher oil prices.

Sunil Jain, head of research at Nirmal Bang, however, has a different opinion. He believes that OMCs can increase fuel prices to pass on the cost burden and given the planned divestment of BPCL, government intervention to control fuel prices because of demand worries looks unlikely. The jury, however, is out on this.

Aviation companies, however, may find it tough to increase prices as it may hurt passenger traffic, says Jain. In the case of aviation, crude oil prices account for about 40 per cent of the operating cost. Further, with the rupee sliding past 72 to the dollar, it will not only increase the oil bill but also lease and maintenance costs, which are denominated in dollars. Thus, with costs moving up and competitive pressure keeping a tab on ticket fares, their margins which will take a beating.

Among other sectors staring at a negative impact from higher crude oil prices are tyres and cement. Crude derivatives, such as synthetic rubber, tyre cord fabric, steel cord, and carbon black are used in tyres, while fuels, such as diesel and petroleum coke, are among key cost elements for cement companies. Both these sectors are reeling from poor demand.

Paints and adhesives, for which crude oil-derived inputs account for 20-35 per cent of their respective raw material cost, will also feel the heat. But, since they enjoy relatively better pricing power, maintaining margin may not be a major concern. Yet, some impact can be seen in the short-term.

The only sector, which will benefit from higher crude oil prices, is upstream oil & gas, as it will get higher realisations on their sales. However, because of issues related to PSU divestment, the stocks of ONGC and Oil India were down about 1-2 per cent on Monday.

In this backdrop, while the pressure is clearly mounting, how India Inc tackles the high crude oil price scenario in terms of margins and volume growth would be interesting to see.