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  1. Stock market correction not just knee-jerk reaction to spike in crude prices; here are other factors

Stock market correction not just knee-jerk reaction to spike in crude prices; here are other factors

A quick analysis of the impact of spiking crude oil prices on the Indian equity markets shows that there are no immediate concerns between surging oil prices and equities and the recent slide in the markets was more on account of market sentiment surrounding the outcome of the recent held state elections in Karnataka.

Published: June 21, 2018 4:42 PM
In the long- run, rising inflation is bound to affect corporate profits, real wage growth and interest rates.

Nikhil Kamath, Co-founder, Zerodha

Global crude oil prices are on a roll since the start of 2016, after sliding to near decade lows just the year earlier. WTI crude was seen trading around $72 a barrel and Brent oscillating around the $80 per barrel mark, mid-May this year. The rise in crude prices has been phenomenal with Brent crude spiking more than 100 percent in the last two and a half years and WTI rising close to 175 percent during a similar period.

A quick glimpse at the reasons for the sharp rebound in crude prices throws up quite a few stats

Surging demand

According to the International Energy Agency (IEA), global demand for oil rose by 1.6 percent or 1.5 million barrels per day in 2017, more than twice the average annual growth rate in more than a decade. The rise in demand was led by China and India with the Asian region contributing to more than 60 percent of the overall demand.

Rising tensions in the Middle East

Conflicts in the Middle East are nothing new, but the recent decision by the US to pull out of the Iran nuclear deal inked in 2015 not only split the GCC, but the other permanent members of the UN Security Council along with Germany, who were signatories to the deal. While Iran’s oil output has more than doubled following the lifting of sanctions in 2015, the impact of the US withdrawal from the JCPOA is likely to be felt in the months ahead.

Rise in global automobile sales

Most global economies are expanding as business investments scale new peaks, leading to a rise in the
employment rate and thereby consumer spending. The global automobile industry has been one of the largest beneficiaries with total vehicle sales growing at an annual average of 4 percent since 2011, with the exception of 2015 when automobile sales by around 1.5 percent. The growth in the sector is in turn directed by higher demand for petroleum products including gasoline.

Output cuts by OPEC

From January 2017, OPEC, which accounts for about 40 percent of global crude oil supplies and Russia agreed to cut crude oil output by 1.2- 1.8 million barrels per day until the end of 2018. Although other countries like the US and Canada chipped in to maintain supplies, the negative market sentiment was enough to drive prices higher.

Oil- dollar correlation

All crude contracts are priced in US dollars, so rationally, a stronger US currency should have a negative impact on the prices of crude oil and vice- versa, setting aside all other fundamental factors. In 2017, the dollar index; which represents the value of the US dollar to a basket of foreign currencies, slid by about 15 percent and crude likewise surged 20 percent, in line with historical stats.

Market outlook

A quick analysis of the impact of spiking crude oil prices on the Indian equity markets shows that there are no immediate concerns between surging oil prices and equities and the recent slide in the markets was more on account of market sentiment surrounding the outcome of the recent held state elections in Karnataka. However, in the long- run, rising inflation is bound to affect corporate profits, real wage growth and interest rates giving rise to a situation where investors find it more appealing to park funds in fixed income instruments rather than the risky stock markets.

On the economic front, the effects of rising oil prices are already being felt by consumers, especially after the Indian Government regulated the fuel pricing mechanism in June last year. With gasoline prices hitting fresh all-time highs almost every other day, it won’t be long before the increase in input costs are passed on by producers to consumers, giving rise to consumer inflation, which would negatively impact retail spending. An upsurge in output inflation would in turn edge the RBI to raise interest rates, compelling companies to scale down investments due to higher borrowing costs, ultimately affecting job growth and the broader economy.

The opinions expressed in this article are the author’s own.

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