Oilnomics & its impact on stocks

Oil.jpeg

Oil prices have taken the attention of investors & analysts over last week. It has been rising and impacting Indian rupee. At the time of writing this article, it has touched $75 per barrel mark. It is not showing any signs of slowing down and can be perfect recipe for opposition just before election. Seems like deja-vu to current ruling party as they came into power by raising similar issues.

Anyways let’s leave politics to the politicians and focus back on oil for this article. Media looks for such incidents and with souring oil prices-falling rupee, they keep flashing various charts but they don’t tell you much about Oilnomics. Oilnomics is a metophor used to describe the economics of oil. Today on AI Post, we are not going to talk much on oil charts but the factors which guide oil prices and what possibly lies ahead. Ultimately, we will come down to list of small cap stocks which may benefit or sink from it.

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The Middle-East

Oil is a very important commodity in our daily lives, it signifies power & energy. More so for India with billion people wanting to move from one place to another. However it comes at a cost which pinches our economy as we are a net oil importing country. Most oil reserves are in Middle East and they are carefully controlling its supply to support prices. OPEC is a cartel (group) of middle eastern oil-producing countries who collectively decide how much oil should be supplied to the world to keep prices sustainable at higher levels. Thankfully, we have got Shale oil producers in USA who are threatening their monopoly. Middle Eastern countries like Saudi Arabia are heavily dependent on oil prices to support their economy. Saudi Arabia has second largest proven crude oil reserves in the world. Their dependence on oil was evident from the fact that Saudi Arabia prepared their 2014 budget on the assumptions that oil prices will remain above $100 per barrel. Shale oil discovery jolted them out of sleep and now they are looking to diversify economy by 2030.

As some of you may be aware, Saudi Arabia sells petroleum under government-owned Saudi Aramco. Saudi Aramco sells oil to the world and in trade receives billions of dollars every year. This has been ongoing since many decades. A real cash cow for the kingdom. Since it is not a public company, Saudi government has kept its revenue confidential to the world. Bloomberg estimates that it can be world’s most profitable company which can be valued around $2 trillions.

Saudi government has been milking Aramco for nation’s benefit for decades but guess what, they have announced to make it a public company. Yes, Saudi government is planning a mega IPO of Aramco somewhere down the line. No one is sure of at what price this IPO will be released and when this IPO will open. While Saudi government wants to launch this mega IPO, they certainly don’t want to launch it when oil prices are $40 per barrel. Imagine the valuation it will get at oil prices above $100 per barrel. If Aramco gets valued at $2 trillion, that will be almost 60 times valuation of our own oil giant ONGC. Kingdoms seldom share their cash cows with general public. This signifies future changes in oilnomics. It means Saudi Arabia itself don’t see a very bright future for oil and wants to en-cash it while it is still at peak.

What can possibly threaten oil?Cost per Unit.PNG

Thanks to rapid advancement in electric vehicles and green sources of energy (Solar & Wind), there is an increasing threat on oil as main source of energy. Cost of producing solar energy per unit has fallen the most in the last decade. Almost 72% fall in per unit cost for solar energy!! At the same time, conventional form of energy from oil or coal has remained same or risen a little. This catching up is ringing alarm bells for all oil dependent countries.

Onslaught on petroleum does not stop here, there is rapid development in producing safe nuclear energy using uranium. All these factors are pushing conventional sources of energy closer to the door. Solar energy hogs the main limelight as alternate form of energy apart from oil because it is very environment friendly. Many governments are silently pushing big time on nuclear energy but not with so much propaganda. Uranium is also catching fast as an alternate form of energy. Enriched Uranium is a highly sought after stockpile which every country is trying to hoard on. China is aggressively looking to curtail dependence on petroleum and produce most of the electricity from nuclear power by year 2025. India is also pushing ahead and aims to multiply uranium generated electricity by 11 times from now until 2030.

Apart from alternate energy sources of energy getting cheaper, alarming pollution levels are also closing the doors for fossil fuels. For example, China which has some of the highly polluted cities in the world is now pushing back big time on petrol & diesel cars and promoting electric vehicles. It is directly impacting car manufacturers who rely on China for their sales. Our own Tata Motors’s JLR sales has nose-dived in China after these changes and forcing company to invest heavily into all-electric variants of JLR.

Tussle to control oil

There was open tussle between Shale Oil producers and OPEC for last three years as they increased their production in a bid to grab larger market share. It resulted in dramatic drop in oil prices as it touched $33 per barrel. Simply unsustainable for both. Soon Shale oil producers had to cut production as they could not afford to sell at these prices. OPEC & Middle east countries won this battle as they had lots of money in store to outlast shale oil producers. However, the monopoly of OPEC is gone and very soon we may see oil prices softening a bit as shale once again kicks in at these levels ($75 per barrel)

Recently, there is another interesting development happening in Iran. Donald Trump announced that US will be withdrawing from Iranian nuclear deal. US has proposed to put sanctions on Iran after November. This is hurting Iran as it supplied oil to mainly Asia & Europe including India. These countries want to avoid friction with USA over Iranian oil and reducing dependence on Iranian oil. This will benefit OPEC nations and sensing this, OPEC has already started adding production to capture Iranian market.

On May 21st, President Donald Trump signed a new executive order prohibiting certain oil-related transactions with Venezuela. The oil output from Venezuela has fallen to a third from the levels of 2011 and it keeps on dropping every year. This will increase market share of nearby oil-producing leaders like US.  So the game is clearly to duopolize oil market in which ultimately two player will govern rules of the game – the OPEC & USA. The ongoing unrest over middle east further hampers countries to effectively utilize their oil reserves and thus giving away market share to nearby regional giants.

Recent oil price surge

Recent surge in oil prices are on account of growing concerns over Iran resulting in shift in demand patterns and closure of oil-producing states in USA due to hurricane Gorden. This hurricane is active in gulf of Mexico which account for nearly 17% of total US crude oil output as per US Energy Information Administration reports. If this hurricane gets strength, crude oil will also get strength. However, needless to say these are temporary trends. The larger trends are managed by demand-supply equation between OPEC & US oil producers.

Conclusion

So now you know what drives the oil prices and what are the major factors impacting oil prices across the world. In our view, oil prices are political in nature as they are more influenced by OPEC’s views of demand supply situation rather than real shortage of crude oil in the world. There is plenty of fossil fuel still left in the world. For countries like India, we need to diversify our energy sources away from oil. With rise in alternate forms of energy, oil prices will have wild swings again in future. However, if we rely on any single source of energy whether it is Crude Oil or something else, it will again create a monopoly problem. Best solution should be a mix of different forms of energy to achieve a balance. In fact, rapid growth in lithium-ion batteries can also drain lithium sources in the world and become a major concern in future. More on this on some other day.

Stocks impacted by hike in oil prices

Enough of Oilnomics, let’s focus back on our favorite topic, stocks 😉

Needless to say, all downstream oil companies like BPCL, ONGC, HPCL are negatively impacted along with aviation stocks like Indigo, Jet Airways & Spicejet. However, all of them are either large or mid cap companies. Below is the list of small cap stocks which can either positively or negatively benefit from hike in oil prices.

  • Negative Impact
    • Lasa Supergeneric (M-Cap ₹66 Cr)
    • Prima Plastics (M-Cap ₹140 Cr)
    • Shalimar Paints (M-Cap ₹268 Cr)
    • Pokarna (M-Cap ₹466 Cr)
    • Shreyas Shipping & Logistics (M-Cap ₹655 Cr)
    • Allcargo Logistics (M-Cap ₹2880 Cr)
  • Positive Impact
    • Deep Industries (M-Cap ₹349 Cr)
    • Jindal Drilling (M-Cap ₹393 Cr)
    • Olectra Greentech (M-Cap ₹1262 Cr)
    • Praj Industries (M-Cap ₹1667 Cr)
    • Hindustan Oil Exploration (M-Cap ₹1945 Cr)

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