The crudeness of oil on the stock market
The stock market and crude oil have an
uncanny relationship, however, a wide understanding of this interdependence has
not been established. The two markets are so important in understanding the
global economy because of their massive usage and value all over the world.
Factoring various happenings in the current scenario, a detailed analysis upon
this relationship and its effects on the world economy becomes imperative.
By Sirjan Kaur 7 min read
It has been a common understanding that
high prices of crude oil may have a direct and negative impact on the world
economy and the stock market.
Overtime, it has become quite usual to
correlate the changes in major factor prices, such as oil, with the performance
and conditions of major stock market indices. Putting logic to this thought,
the idea becomes that a rise in oil prices possibly raises input costs for most
businesses and hence increases consumer expenditure on gasoline, also leasing
to a reduction in the corporate earnings of other businesses.
The standard idea that exists is that the
price of oil has a major influence on
the cost price of various production and manufacturing units across the
world. For example, it is assumed that there exists a direct relation amongst change in fuel
prices and transportation costs. Lower oil prices might have a positive effect
on maximum Industries as the input costs for their production reduces.
Similarly, rice in oil prices adds to the costs of production which results in
a negative impact on the Industries.
The major factors that establish a relation
between the two are:
1 Current Account Deficit (CAD) and Rupee
depreciation:
Every U$10/bbl increase in oil price
results in a 0.55% or 55 bps increase in the current account deficit. Crude oil
being amongst the most important commodities in recent time, India is one of
the largest importers of oil in the world. It imports close to 3/4th of its
regular oil requirements. Other countries also import large quantities of oil
to meet their needs. Therefore, a dip in the price of crude oil has a positive
effect on the importing country's current account deficit situation. Lower CAD
reduces the country's burden with respect to foreign currency outflows. This,
then might result in currency appreciation. As the value of currency
appreciates, the imports for the company become cheaper, hence bringing a
positive impact. This, then in turn impacts companies that depend on
imported crude oil and other raw
materials, for the functioning of their business activities. Therefore, due to
comfort and ease in production, the price of stocks of these companies might
experience an increase.
2 A rise in the cost of production:
Companies dealing in tyres, lubricants, logistics, footwear,
refinery, and airlines massively depend
on crude oil and hence are majorly affected by its prices. A decrease in
crude-oil prices results in reduced input cost of production of these goods.
Thus, reduction in crude oil prices
usually have a positive impact on the stocks of these companies as well.
3 Rise in the transportation cost:
An increment or decrement in crude oil
prices affects the transportation cost of goods. Prices of crude oil have a
due impact on the prices of consumer
durable products as well. These goods are usually produced in industrial units
and then sent for sale in various cities. A decrease in the logistics cost of
these products brings down their ultimate price. A decrease in prices of consumer goods raises its demand
since they are widely used and thus there lies a propensity that its stock
price also Increases. .
4 Inflation:
Every US $10/bbl rise in the price of oil
will lead to a 0.3% or 30 bps rise in
CPI. Crude oil has a major impact on the
prices of all goods and services. When the prices of goods and services
considerably decrease, it helps in easing
inflation to some extent. Thus, a lower inflation level will
comparitively be more beneficial for the stock market.
Talking about the Indian scenario, India is
extremely dependent on import of oil, an increase in prices usually has serious
repercussions on the economy. Increasing domestic inflation becomes a worry due
to this and this might act as a reason for RBI to cut the rates further.
Recently, Crude oil prices are soaring
beyond expectations triggered by the US-China situation. The rising tensions
amongst US and Iran has also contributed as the secondary factor. With crude
oil getting costly, there might be room for some short-term profit booking in
the near future. However, experts strongly believe that the global crude oil
market shall remain the same for upcoming months too. Opec’s decision to
control oil production and keep the numbers low till March 2020 has been
accredited as the main reason for it.
Now, finally considering the current
situation in the market. Vladimir Putin recently ignited what could end up becoming
one of the worst oil price wars in
history, and the victims of this move could be American oil and gas Companies facing the
brunt of the actions. Saudi Arabia recently dropped the oil bomb. Firstly, it
slashed its crude oil price to its chinese customers by as much as $6 or $7 per
barrel, secondly it is also reportedly looking to increase its daily crude oil
production by over 2 million barrels per day at a point in time when the global
market is already oversupplied.
OPEC
members also proposed to further cut down oil output quotas by around 1.5
million barrels per day. This recent development in the global crude oil market
had or may have its share of impacts on other sectors. This move has an effect
on the entire stock market, the harshest brunt being placed on energy
companies.
The volatility in the stock market gets
further ignited due to problems in other sectors of major importance. The
established importance of oil all over the world makes it quite clear, how this
recent alteration in the sector may result in a massive hit to the stock
market.