Rising crude oil prices to dampen corporate balance sheets

Mumbai: As crude oil prices rise more than 50% so far in 2016 to their highest level in 17 months, along with government finances, corporate balance sheets also may reel under pressure in the near to medium term.

Crude oil prices shot to their highest levels since mid-2015 on Monday after Organization of the Petroleum Exporting Countries (Opec) and other producers reached their first deal since 2001 to jointly reduce output in order to curb the supply glut and drive the market higher.

Brent crude soared to $56.44 barrel on Monday—the highest close since 21 July 2015. It has gained 51.42% for the year to date.

India, Asia’s third-largest economy, is likely to face the brunt, as it imports around 80% of its crude oil requirements.

Going forward, the rising oil prices will exert pressure on margins and hurt the profitability of companies such as oil marketers, airlines, auto manufacturers and consumer goods makers that use crude oil and its derivatives as inputs.

This along with a depreciating rupee, may add to an importers’ woes. The Indian rupee has eroded 1.87% against the US dollar for the year to date, in line with the mayhem in all emerging market currencies, which got hammered due to a stronger greenback.

“The concerns will accentuate if crude prices see a further steep rise,” said Abneesh Roy, senior vice president, research, at Edelweiss Financial Services Ltd.

Around 50% of paint companies’ raw material costs are derived from crude and crude derivatives, according to Roy.

Roy pointed that a rise in crude oil prices will be inflationary for paint companies. They have cut prices by one-year by 3%.

“So, there is a case for price hike now, and they will be able to pass it on to consumers. Post-demonetisation, demand will be a challenge in the near term, but eventually it will catch up,” said Roy.

The fast-moving consumer goods will face the heat too.

“Around 10-20% of packaging costs for FMCG companies will be linked to crude derivatives. So, that will squeeze the margins,” said Roy.

State-owned oil marketing companies (OMCs) Indian Oil Corp. Ltd (IOC), Hindustan Petroleum Corp. Ltd (HPCL) and Bharat Petroleum Corp. Ltd (BPCL), may see a rise in their working capital requirements and consequent interest costs.

“For OMCs—higher crude is slightly negative. In the current situation, petrol and diesel are completely deregulated, while there is a subsidy sharing mechanism in place for LPG and kerosene,” said Sudeep Anand, a research analyst with IDBI Capital Markets Ltd.

Anand said he does not see any pressure in terms of subsidies for these state-run OMCs, until crude rises to $70 per barrel.

“However, their debt burden and working capital needs may rise, and that will eventually result in higher interest costs,” said Anand.

“That said GRMs (gross refining margins) have come in at $6.9 per barrel for this quarter till date, compared to $5.1 per barrel in Q2 of this fiscal year. Also, if crude trades higher, they will also book inventory gains,” added Anand.

Airline companies will see their margins being squeezed as the aviation turbine fuel (ATF) prices will also eventually rise in line with crude oil prices, albeit with a lag.

“In the current environment, around 30-35% of an airlines’ costs emanate from ATF prices. ATF prices usually follow up with a lag as compared to crude oil prices,” said a research analyst at a domestic brokerage firm, who did not wish to be named.

“The fuel costs as a proportion of total costs for airlines will rise as ATF prices go up and the depreciating dollar will accentuate the impact,” he added.