Who wins, who loses from the oil price spike

The recent surge in the price of crude oil (Brent is now around $114 a barrel) has set the cat among the pigeons. Could there soon be a repeat (or worse) of July 2008, when prices touched $145 a barrel or is this just a temporary imbalance? What lies ahead if Saudi Arabia, the largest among the Middle-Eastern oil exporters, goes the Libya way? Will the current spike derail the nascent recovery in the developed nations? How does the tragedy in Japan fit into the evolving jigsaw? Closer home, what does ‘oil on a boil' mean for India, which imports more than three-fourths of its crude requirement?

Amidst all these imponderables, it is reasonably clear that the surging oil price will keep high inflation simmering, dilute India's economic growth prospects and throw the recently budgeted deficit numbers into disarray. At a more micro level, the impact will be more pronounced in sectors which produce, process, or use crude oil or its derivatives as raw material or fuel.

This sector set would encompass, among others, oil and allied segments (explorers, refiners, service-providers), airlines, tyres, fertilisers, paints, textiles, and lubricants. In a scenario of rising input costs, companies with strong pricing power will be better equipped to deal with the fallout than those that cannot pass on costs.

We ran a screener on sample companies in the above sectors to check the impact of a cost increase in raw materials, and power, oil and fuel, on financials and margins during previous periods of spiralling oil prices. Analysing data for the first three quarters in calendar 2008 and the last quarter in calendar 2010 — which saw sharp rallies in crude oil — we also compared the performance of these companies in these two periods.

Our analysis suggests that public sector oil marketing companies, airlines and tyre-makers have historically borne the brunt of rising input prices. On the other hand, sectors such as pure play refiners, lubricants, paints and textiles may be relatively better positioned to tide over the crude oil surge. Fertiliser companies have shown mixed trends. Here's the lowdown:

Airlines hit a fuel air-pocket

Airlines, which were on the recovery path with strong demand and calibrated supply, may find themselves in a tight spot, not being able to pass on the increasing cost of aviation turbine fuel (ATF) to passengers. In 2008, saddled with huge capacity and falling demand, many airlines had curtailed flights to avoid burgeoning losses from rising fuel cost.

Power, oil and fuel costs had then shot up to 55-65 per cent of sales from the usual 35-50 per cent, and most airlines, including Jet Airways, sank into the red. Fuel cost pressure has again returned in the recent period, with ATF prices up around 43 per cent over the past six months.

Though strong demand conditions have helped cushion the impact to some extent, going forward, airlines may not be able to pass on the entire cost increase, without fear of losing customers. This may result in margin pressure.

Tyres: Slippery margins

If the past is anything to go by, tyre companies usually face heavy margin pressure when confronted with increasing cost of synthetic rubber and carbon black — raw materials derived from crude oil. For tyre manufacturers such as Apollo Tyres, CEAT, JK Tyre, and MRF, raw material as a percentage of sales shot up sharply (by as much as 15 percentage points in some cases) in 2008, and exerted significant pressure on margins.

High pressure on raw material cost and margins have been seen in the case of most tyre companies in the recent quarter, due to surge in price of both natural rubber and crude oil. The difference from 2008 is the strong growth in sales registered by most tyre companies on the back of buoyancy in the auto sector. The buoyancy, coupled with supply constraints, have endowed tyre companies with some pricing power over the past couple of years, though product price increases may lag those on inputs.

Lubricants: smooth RIDE

To a good extent, lubricant companies such as Castrol, Gulf Oil Corporation and Tide Water Oil have been able to pass on the increasing cost of base oil — a key raw material. For instance, in the first two quarters of 2008 (when crude oil peaked), raw material as a percentage of sales remained more or less at usual levels, helping cushion margins.

Though margins witnessed some pressure later that calendar, this was more than made up for in 2009. In the recent December quarter, market leader Castrol saw some margin pressure (on sequential basis). However, this is attributable mainly to the spike in advertising costs, while raw material as a percentage of sales has remained the same at around 52 per cent.

In addition, the sharp increase in margins over 2009 and 2010 and continued year-on-year growth in sales and profits provides good buffer, suggesting these players may withstand pressure from rising raw material cost.

Paints: Volume Hedge

The recent December quarter has seen paint manufacturers such as Asian Paints, Akzo Nobel, Berger Paints and Kansai Nerolac show some margin pressure due to increase in price of raw materials, chiefly crude oil-based inputs. However, with demand conditions being robust, volumes were strong and overall financial growth was healthy.

Many players, including market leader Asian Paints, resorted to price hikes to deal with rising costs, though not to the full extent. The possibility of further price increases to deal with increasing costs has also been indicated. This, combined with expected volume growth, should position paint makers comfortably to handle further cost increases. Margins, though under pressure, should be at reasonable levels.

Even during the crude oil price spike in 2008, most of the major paint companies put up a good show overall.

Textiles: Strong Fabric

Many textile players such as Indo Rama Synthetics, Century Enka, Garden Silk Mills, JBF Industries and Nakoda Ltd, who use petrochemical based inputs, seem to have recorded good pricing power in the recent December period.

Raw material as a percentage of sales has remained around the same, or increased marginally for most of these players. Margins have also been steady or even improved. Among other factors, prevailing high price of cotton seems to have aided pricing power of petrochemical based textile manufacturers.

The situation is better than in 2008, when margin pressure was felt by many of these players.

Fertilisers: Mixed formulation

The fertiliser sector, another major user of crude oil-based inputs such as naphtha, exhibits mixed trends because this is another sector where subsidy from the government plays a big role. Since all fertilisers in India are sold below their cost of production, the government pays a product-wise subsidy based on the prevailing input costs for each year.

Therefore, yes, an upward price spiral of nitrogenous inputs such as naphtha, ammonia and LNG will escalate costs for players. However, how much of the brunt players bear depends on the extent to which the government compensates costs through subsidy.

For this year, urea manufacturers such as Chambal Fertilisers and Nagarjuna Fertilisers may get compensated to a significant extent as they remain on a cost-linked subsidy regime.

On the other hand, the subsidy levels have already been set at a flat import parity-based price for complex fertiliser makers, ahead of the recent crude oil surge.

Unless the subsidy is revised or they are able to hike prices, players such as Coromandel International, Zuari Industries and RCF may face margin pressures from spiralling inputs.

Fertiliser companies may chart their individual paths based on relative business models and strengths, rather than follow specific sector trends.

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