What does ‘oil on a boil' mean for India?

Who wins, who loses from the oil price spike
By..........ANAND KALYANARAMAN ....from the pages of HINDU BUSINESS
LINE newspaper.

With rising price of crude oil, companies with strong pricing power
will cope better than those that cannot pass on costs.
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