Oil Spills Ahead

Last week, a reader wrote, asking: “Looking at the way crude oil price is increasing, I was wondering which companies would benefit from this and which ones would suffer.” To my mind, that’s two questions in one—first, will oil prices continue to rise; second, if they do, what will be the impact on the fortunes of different Indian companies?
As for the first question, there must be literally millions of first-rate minds across the world trying to figure whether oil will boil or recede. The emerging consensus seems to be that there are real supply-side issues, regarding oil, chief among them being the state of Russia’s oil infrastructure and the deterioration of Iran and Iraq’s extraction and transportation machinery. To a large extent, this is inevitable when a resource is controlled largely by nationalised companies; they tend not to be the most efficient organisations.
This leaves the big question mark of Saudi Arabia, currently the world’s largest exporter of crude oil. Secrecy shrouds the reserves and oil fields of Saudi Arabia, and no one knows whether it is facing constraints in raising its oil production. In a sense, this question has now become an academic one, and two events over the last six weeks have underlined Saudi Arabia’s intent. The first was the Saudi Arabian ruler’s statement in early April that he would like to hold reserves under the ground for future generations. The second was his tepid response earlier this month to a plea by the US president to increase the pumping of oil. Going by these two statements, one can clearly see no immediate upside to oil production. What about the demand side?
While the ongoing price escalation in the US is leading to some contraction in demand, this is barely one per cent year-on-year. Meanwhile, the India scenario is being played out across Asia, where deepening subsidies have insulated consumers from price rises, and demand continues to boom—nearly 10 per cent annum in India and over 12 per cent in China. Unless these countries take strong measures to compress demand, oil looks like being bullish for a while.
This could be disastrous for our economy, both in terms of our balance of trade, as well as our fiscal deficit. Managing inflation may become increasingly difficult and the government may have to take drastic steps on the monetary side. And, if FIIs take flight, the downward pressure on the rupee could be substantial. One thing is certain—increased volatility is on the cards.
My reader specifically asked me about the impact of rising crude prices on oil marketing companies such as BPCL. In the short- to-medium term, one can’t say, as the government’s response is increasingly likely to be driven by political factors, especially after the Congress party’s election losses in Karnataka. Petrol prices will most likely go up, and some excise and customs duties will be cut. But, under-recoveries on account of diesel, LPG and kerosene will continue, and the going for these companies could be increasingly tough. For a long-term investor, though, these companies represent excellent value, and I remain invested in them.
My reader also asked about Reliance Industries. My current reading is that RIL may continue to eke high refining margins from its refinery—high sulphur heavy crude, especially from Iran, is selling at unprecedented discounts of 11 dollars per barrel to sweet crude at last reckoning. Few refineries are able to process this crude into diesel, which is most in short supply, so the comparative advantage for RIL is likely to continue. Having said that, I don’t follow the stock closely, so I wouldn’t go as far as to call a BUY.
As for the rest of our markets, rising oil is clearly a SELL in the short-term