Effect of Crude Oil Price on Oil-Related Stocks [India]

Crude oil prices play a pivotal role in determining the performance of oil-related stocks. Since crude oil is the primary input for the entire oil industry, its price directly affects revenue and profitability across different segments. For upstream companies like ONGC and Oil India, benefit from higher crude prices as they sell oil at higher market rates. Conversely, a price decline reduces their earnings, impacting cash flows and investment in exploration activities.In contrast, Downstream companies such as BPCL and RIL loose due to higher crude oil price, as their input cost for refining and marketing operations increases. These companies see declining refining margins during periods of higher crude prices, decreasing their profitability.Oilfield service providers, which support exploration and production activities, also gets affected. Their business depends on the CAPEX of upstream companies. When crude oil prices are rising, CAPEX of upstream companies also rise and vise versa.In this article, we’ll see how fluctuations in crude oil prices affect different segments of the oil industry. By analyzing how each segment reacts to price changes, we’ll use this insight to frame our take on oil-related stocks when crude oil prices are changing.1. Crude Oil Price Movement OverviewOver the past 30-35 years, crude oil prices have experienced significant fluctuations. It was driven by a mix of geopolitical, economic, and supply-demand factors. In the late 1990s, prices were as low as $14 per barrel due to oversupply and the Asian financial crisis. However, from 1999 onwards, production cuts by OPEC and rising global demand, particularly from China and India, pushed prices upward. By 2008, crude reached nearly $100 per barrel. It was all driven by the booming demand and geopolitical tensions in oil-producing regions.Post-2008, the financial crisis caused a sharp decline, with prices dropping to around $62 by 2009. Prices surged again by 2014 due to geopolitical instability in the Middle East but fell dramatically in 2016, hitting $43 per barrel. It was due to a global supply glut caused by US shale production & start of Brexit.The COVID-19 pandemic in 2020 led to an unprecedented collapse in demand, further dropping prices to around $39 per barrel.The oil prices again peaked to $94 per barrel in 2022, due to the Russia-Ukrain war.Main factor that drive the fluctuations in oil prices during these 35 years were mainly geopolitical tensions (war like situation). Exception was in 2008 and 2020, caused by the subprime mortgage crisis of US and COVID-19 respectively.Such price movements directly affect oil-related stocks. It impacts their profitability and operational costs.2. Impact on Upstream Companies (Exploration & Production of Crude)Upstream companies like ONGC, Oil India, and Vedanta (Cairn Oil & Gas) are heavily influenced by crude oil price changes. Their revenue and profitability are directly tied to the price at which they sell the crude they extract.When crude oil prices rise, these companies benefit from increased revenue, improved profit margins, and higher operating cash flow. For example, a $10 increase in crude oil prices can lead to a substantial boost in revenue, directly impacting profitability and free cash flow. Conversely, a drop in prices reduces these metrics, constraining profitability and limiting reinvestment potential.Crude price fluctuations also impact CAPEX decisions. During periods of high prices, upstream companies are more likely to invest in exploration and production (E&P) activities. During these times, as higher revenues provide them the financial flexibility to do so. However, during price downturns, CAPEX is often scaled back. Companies focus on cost-cutting measures to preserve cash flows during such times.Price swings create volatility in earnings. A sharp price drop can severely impact quarterly revenues and profits. However, in the long term, companies may adjust by diversifying their asset base or adopting hedging strategies to stabilize revenue. Asset base can be diversified by investing in different energy sources, such as natural gas or renewable energy, reducing dependency on crude oil prices alone. They also adopt hedging strategies, using financial instruments like futures contracts to lock in prices, which helps stabilize their revenue during periods of price volatility.During volatile times, metrics such as operating cash flow and net profit margins serve as key indicators of the health of these companies. Sustained high crude prices leads to sustained or improving margins and strong cash flow.2.1 Long-Term Investor’s Strategy (Upstream Companies)It can be wise for long-term investors to consider investing in upstream companies during periods of falling crude oil prices. When crude prices decline, stock prices of upstream companies tend to drop. During such times, it potentially offers better value for investors. If the investor believes crude prices will rise in the future, this presents an opportunity to buy shares at a lower price and benefit from the eventual recovery.However, this strategy requires confidence in the long-term rebound of oil prices and the financial stability of the company during downturns.3. Impact on Downstream Companies (Refining & Marketing)Downstream companies like Reliance Industries (RIL), HPCL, and BPCL engage in refining crude oil and marketing petroleum products. Crude oil price fluctuations have a direct impact on their refining margins, which is the difference between the cost of crude oil and the selling price of petrol and diesel (refined products) are sold.When crude prices fall, downstream companies benefit from lower input costs. It leads to improved refining margins. This increase in profitability helps boost their revenue and cash flow. The cost to produce each barrel of refined product decreases on one side and selling price remains relatively same.This positive effect is crucial, especially when market conditions favor sustained demand for refined products like gasoline and diesel.On the marketing side, companies like BPCL, HPCL, and RIL face the challenge of deciding whether to pass on crude price fluctuations to consumers. Earlier, when petrol, and diesel prices were regulated, price fluctuations were not generally passed on to the consumers. The companies used to absorb the higher cost or used to benefit from the falling crude oil prices.These days, the pricing is more liberalized. The marketing companies can pass on price changes to end consumers, for example rise in crude oil prices. This allows them to maintain profitability even when crude prices are high. In case, when crude oil price is falling, downstream companies can opt to keep the price at fuel stations unchanged, thereby increasing their profits.3.1 Long-Term Investor’s Strategy (Downstream Companies)In a typical value investing strategy, the goal is to buy stocks when they are undervalued or when market sentiment is overly negative. It creates a buying opportunity for such investors.For downstream companies, if crude oil prices are rising, it might lead to higher input costs and squeezed margins, causing negative sentiment in the market. This could lead to lower stock prices for these companies as investors react to potential profit pressures.Value investors might view this as an opportunity to buy shares of downstream companies at lower prices. Here the assumption is that the share price fall caused due to rising oil prices is temporary. Moreover, the the company has strong fundamentals to weather the storm.Value investors might find it advantageous to buy stocks of OMCs during periods of rising crude oil prices. This is the time when others are selling due to concerns over higher costs and lower margins.ConclusionCrude oil price fluctuations significantly impact the profitability and stock prices of oil-related companies across segments.For upstream companies, rising crude prices boost revenues and margins, making them more attractive to investors during price hikes. Conversely, when crude prices fall, these companies face declining revenues, making their stocks appealing to long-term investors who anticipate a future price rebound.Downstream companies face a different dynamic. When crude prices rise, their input costs increase, leading to squeezed refining margins and potential stock price declines. However, the liberalization of fuel prices allows them to pass these cost changes to consumers, mitigating some of the pressure on margins. Falling crude prices benefit downstream companies by lowering input costs and increasing refining margins, but buoyant market sentiment might cause overvaluation, reducing value opportunities for investors.For long-term value investors, the ideal time to buy upstream stocks is when crude prices are falling and market sentiment is pessimistic. For downstream companies, rising crude prices may present better buying opportunities as short-term profitability pressures lead to undervaluation.Have a happy investing.Suggested Reading: