Vijay Kumar Gaba: Crude Oil

Showing posts with label Crude Oil. Show all posts

Wednesday, December 14, 2022

Commodities – more uncertainty than equities

The global markets behaviour in the year 2022 would remain subject matter of analysis for many decades. Almost all markets – equity, bonds, commodities, crypto, housing, arts etc. - have shown a classical pattern in the current year, despite several unconventional factors impacting the global economy.

If we observe from the averages the behaviour of commodity markets in particular has been very archetypal in a market still enduring a war, inclement weather and supply chain dislocations. S&P Goldman Sachs Commodities Index, has gained ~17% YTD 2022.

Evidently, the first half of 2022 saw a sharp surge in commodity prices led by energy and food prices, ostensibly due to the Russia-Ukraine conflict and severe drought in many parts of the world. However, easing of post Covid logistic constraints and monetary tightening by most central bankers led to an improvement in supplies; demand destruction and unwinding of speculative positions; resulting in lower commodity prices.

However, if we analyze the internals of commodities markets we find huge variation in price performances of various commodities within the same category. For example-

· Energy: crude oil is literally unchanged for the year; Ethanol, Naptha, Propane etc. have lost 15% to 35% for the year; whereas Coal (+147%) and Natural Gas (+84%) recorded huge gains. Wind Energy and Solar Energy prices are down over 10% YTD2022; whereas electricity prices in European nations are higher by 37% (UK) ti 105% (France).

· Precious metals: Gold is unchanged for the year; while silver(+5%), platinum (+10%), and Titanium (+27%) are ending the year with decent gains.

· Other metals: Steel (-59%), Tin (-39%), and Copper (-11%) are major losers in the metal universe. Aluminum, Lead, Zinc are also ending the year with some losses; whereas Lithium (+157%), Bitumen (+20%) and Nickel (+46%) have bucked the trend. LME Index fell ~6% YTD2022.

· Chemicals: PVC (-28%), Soda Ash (-13%), DAP (-13%), Urea (-41%), were some major losers during the year. Polypropylene and Polyethylene etc. are mostly unchanged for the year.

· Agriculture produce: Coffee (-33%), Cotton (-25%), Rubber (-20%), Palm Oil (-20%), Wheat (-9%), etc. are ending the year with strong losses; Sugar, Cocoa, Tea are little changed; while Rice (+20%), Soy (+17%), Corn (+10%) are some notable gainers. US Lumber prices are lower YTD2022 by over 60%.

As of this morning, the uncertainty in the commodity markets appears much higher than the equities. The following uncertainties, for example, could continue to impact commodities markets in 2023 also:

· Covid situation in China and growth trajectory post opening. A sharper recovery than presently estimated may again lead to a strong rally in many commodities.

· A ceasefire in Russia-Ukraine conflict with easing of sanctions on Russia could impact energy and food markets materially.

· A deeper recession triggered by persistent monetary tightening could result in sharper demand destruction and further inventory unwinding, resulting in further cuts in commodity prices. On the other hand a softer slow down followed by a guided recovery (monetary easing) could result in accelerated inventory rebuilding and sharper price inflation.

· Extension of La Nina conditions beyond 1Q2023, as presently estimated, could further worsen food supply leading to sharp inflation in prices.

· Further deterioration in international relations and persistent Sino-US trade war could accelerate central bank demand for gold.

Thursday, December 1, 2022

Need to think beyond obvious

I had a chance to meet a small group of seasoned market participants yesterday. The group included a couple of brokers, some investors, a banker and a few analysts and advisors. After exchanging pleasantries and going through the mundanity of “kya lagta hai?” (what’s happening in the market?), the discussion veered around “what could go wrong to make Nifty fall 20% from the present level”.

Not surprisingly, only one broker participant outrightly rejected the idea of a potential 20% correction in Nifty. He felt that the worst is over and it is going to be a blue sky scenario in 2023, with India continuing to lead the charge. None of the other participants was so sanguine, though.

The surprising part however was to note the participants’ arguments to support their “expectation” of a major correction in Nifty, sometime in the next 6 months. The usual suspects like global slowdown, inflation, geopolitics, valuation and technically overbought were cited by everyone. In fact I have also cited these obvious reasons in a few of my recent posts.

Some who are more active on social media reiterated the complicated Armageddon jargon; the doomsayers are spitting on their timelines. However, no participant appeared to be having their “own view” about the current market conditions and the direction it may take in the next 12 months.

To be honest, I was more focused on the snacks being served than the discussions. I did not want to be rude to the host by telling them that discussing media reports and sensational headlines does not make much sense. I would rather like to hear the personal views and opinions of the participants based on their experience, research, observations or their interactions with their other participants.

It is a common saying in the market parlance that the outcomes which are widely expected or spoken about, do seldom occur. I however did not want to use this maxim this time, since I also feel that we may see a material correction in the market in early part of 2023; even though I am not sure if the correction will happen because of the reasons most obvious to everyone. Since everyone is expecting fall of Swiss bank Credit Suisse, an actual failure may not bother the market beyond a few hours, I guess.

In my view, the correction in Indian markets may be triggered by the disappointment and accentuated by global problems. The disappoint may be driven by the factors like (i) the wide divergence in promise vs performance of the government; (ii) much less than expected gains from trends like China+1, Production Linked Incentives (PLI), capex; (iii) worsening of external account; and (iv) poor earnings growth; etc.

It is pertinent to note that Russian and Canadian oils are selling at US$52/bbl. Reportedly, in the current year we have bought huge quantities of crude oil from Russia at a steep discount to market rates. So far the savings have not reflected anywhere – current account, fiscal deficit, profitability of OMCs, pump price of fuel, or LPG price. Don’t you find it disappointing?

The most worrisome thing for markets (domestic as well as global) presently, in my view, is that the policymakers’ appear clueless about the solutions to the pressing problems of mistrust in political & financial systems; worsening demographics; and worsening climatic conditions.

Wednesday, March 23, 2022

Does the audience concur with Governor Das?

The RBI governor reportedly assured the country that “there was no prospect of the economy falling into a stagflation vortex and retail inflation was expected to moderate going forward, notwithstanding fears of imported inflation given the massive spike in commodity prices, especially crude oil, after Russia invaded Ukraine last month.” Speaking to the elite group of industrialists and bankers, Governor Das emphasized that “We are comfortably placed to deal with any challenges with regard to financing the current account deficit, and the RBI stands committed to deal with any challenges on this front.”

In this context, I consider it pertinent to note what the industry and markets are saying about the current state of affairs of the Indian economy, particularly the inflation and demand outlook.

The rating agency CRISIL notes that “Inflation based on the Consumer Price Index (CPI), or retail inflation, rose to 6.1% on-year in February compared with 6.0% in January and 5.0% a year ago. This marks the fifth consecutive month of rising inflation, and the second month of it staying above the Reserve Bank of India’s (RBI) upper target of 6%. Food has been driving the rise, as the benefit from a favourable base is wearing off. Core retail inflation remains sticky around the 6% mark, while fuel inflation softened as domestic fuel prices did not change.”

(Note: Beginning 21 March 2022, the oil marketing companies have started to raise the fuel and cooking gas prices, after a gap of almost five months.)

The brokerage firm Motilal Oswal Financial Services (MOFSL), highlighted a business update released by the FMCG major Hindustan Unilever (HUVR). Speaking about the demand environment, the management reportedly emphasized that “Sharp inflation is affecting consumption. Cumulative growth, for categories in which HUVR is present, was flat with a high single-digit volume decline in Jan-Feb '21. High inflation is affecting volume growth. Down trading is being witnessed towards lower unit packs (LUPs), but not yet towards lower-end brands. The mix is deteriorating both YoY and QoQ in a quarter where relatively higher mobility should have brought back demand for high margin beauty products. Instead, the customer is tightening their purse strings on premium purchases.” The management had warned about persisting pressure on margins due to raw material inflation. It now believes that “The Ukraine crisis has further exacerbated cost inflation, particularly in palm oil and crude-related RMs like LAB, soda ash, and packaging costs, all of which have seen a sharp sequential inflation. A greater impact of the Ukraine crisis will result in higher inflation in coming months.”

Kotak Securities, highlighted the challenges being faced by the steel industry. In a recent note, it noted that “Prices of coking coal, iron ore and steel have surged sharply amid the ongoing war, as Russia and Ukraine are large exporters of these commodities. Domestic steel price hikes, so far, are insufficient to cover cost inflation, however, the consumption lag suggests higher margins in 4QFY22E. We expect steel prices to rise further, leading to demand destruction partly offset by higher export opportunities.” In the meantime, the European Union has increased duties on stainless steel imported from India.

JM Financial note also warned about likely demand destruction for steel. In a recent note the brokerage emphasized that “Rising raw material cost pressures driven by geopolitical factors – NMDC iron ore price hike (INR900/t CYTD for fines) and US$303/ton CYTD increase in coking coal price to US$660/ton spot, has driven a sharp steel price increase in Indian domestic markets. Dealer price for HRC and Rebar recorded a jump of INR10.2k/19.3k per ton respectively CYTD – some of it driven in anticipation of impending mill price hike. Gross margins for flat products are likely to witness a drop of INR8.1k/t QoQ despite the steep steel price hike. While, on the one hand Ukraine-Russia (~10% of global steel exports) situation has thrown open the European steel market to India, the record high domestic steel price may dampen domestic demand in rural/construction sectors in our view.”

In a separate note, Kotak Securities highlighted the downside risks to the growth forecasts. It said, “With the ongoing Russia-Ukraine conflict’s impact on commodity prices, especially crude prices, we see downside risks to our growth estimates of 8.1% (with crude at US$80/bbl). Under various scenarios of average crude prices (US$120-80/bbl), we estimate FY2023E real GDP growth between 7.0-8.1%. Given the volatility in commodity prices and probable outcomes of the geopolitical tensions, the adverse risks to India’s inflation and growth outturns remain high.”

In a sector note, Edelweiss Securities highlighted the sluggishness creeping in the road construction sector. The note reads, “Overall road award from NHAI and the Ministry of Road Transport and Highways (MoRTH) remained sluggish in Feb-22, with only ~735km of road projects awarded during the month. YTD project award stands at ~7,618km (with NHAI’s share at 2,988 km), down 10% YoY. Road construction in Feb-22 stood at ~1,361km. YTD road construction stands at ~8,045km, down 28% YoY. The 2022 Union Budget (refer to, Union Budget – A mixed bag) witnessed a mere 1% YoY increase in outlay for roads space. This has raised concerns about the trajectory of road capex going ahead.”

Edelweiss also noted, in a separate note, that “The paint industry has never seen such sharp cost inflation in at least the past four decades. Price hikes for the end-consumer has been at record levels too. Hence, we do not have a precedent to see how demand behaves with such sharp price hikes. But, we do expect some adverse impact on demand in the near-term (especially at the lower-end)”

The higher oil prices shall also reflect on current account deficit and INR exchange rates. As MOFSL notes, “Due to higher commodity prices (including fuel), we have almost doubled our FY23 CAD forecasts to 1.5% of GDP, with slight downward revision in FY22E. Further, while India’s inflation is likely to remain broadly intact, higher US inflation could lead to some appreciation bias in INR against USD, which is reflected in our INR forecasts. We have revised our USD:INR expectations to average 75.6/76.8 in FY23/FY24 vis-à-vis earlier forecasts of 76.4/78.3, respectively.”

Notwithstanding the assurance of Governor Das to maintain adequate liquidity in the system to support growth, the banking system liquidity surplus has been narrowing. For the week ended 17 March 2022, the average banking system liquidity surplus at Rs 5.78 lakh crore was Rs 1.46 lakh crore less than that in the previous week (Rs 7.24 lakh crore). Some of this liquidity outflow could be attributed to advance tax payments. But the present net surplus liquidity is more than 40% lower than the peak surplus in 2021.

Friday, April 24, 2020

Cheaper is not always better

The elementary principle of economics is that the price of a thing that has any economic value is determined by the forces of demand and supply. Often in the short term a state of inequilibrium may exist leading to higher volatility in prices. However, the equilibrium is usually restored by operation of a variety of factors.

There is no denial that economics is youngest amongst the scientific discipline and pure scientists hesitate in admitting it as a discipline of science. Nonetheless it is evolving fast and becoming popular. Not getting into this academic debate, what I have understood is that in popular economics theory is that:

(a) Price of currency is usually a function of demand and supply of that currency at any given point in time. Higher supply should normally lead to lower exchange value and vice versa. The demand of the currency is determined by the relative real rate of return (interest) and structure of economic activity (e.g., current account balance and inflation) in the parent jurisdiction.

(b) Price for a particular commodity is determined by the demand and supply conditions of that commodity at any given point in time. The demand of commodities fluctuates as per the level of economic activity in the consuming jurisdiction, export demand and outlook for the foreseeable future. The supply of commodities may fluctuate due to a variety of reason - local to the producing jurisdiction as well global. Cost of production, weather conditions, civil and geopolitical disruptions, inventory levels & cost of carrying inventory, etc are some of the key factors that may influence the supply of commodities in the short term.

(c) Interest rates are usually function of demand and supply of the money in the monetary system. Demand for money is again impacted by the level of economic activity and outlook in foreseeable future; whereas supply of money is mostly a function of risk perception and relative returns.

The traits of human behavior like "greed", "fear", "complacence", "renunciation", and "aspirations" are usually accounted for as the balancing factors for demand and supply and not considered as determinates of price as such. This in my view is the cause of most problems facing global economy in the present times. Consequently, the business of forecasting and trading in currencies, money and commodities has become extremely difficult and fraught with risk. The huge volatility and irrationality in crude oil market in past 6 months is just an example of this.

In past three months I have seen hundreds of reports forecasting prices of commodities, currencies, and interest rates. Most of these forecasts appear mere extrapolation of the current price trend and hence do not inspire any confidence.

In Indian context, exchange value of INR, 10yr benchmark yield and crude oil prices evoke much interest. Interestingly most economic growth forecasts appear predicated on these, whereas logically it should be the other way round.

INR depreciation is beyond economics

In the summer of 2007, I had just moved to the financial capital Mumbai from the political capital Delhi. The mood was as buoyant as it could be. Everyday plane loads of foreign investors and NRIs would alight at Mumbai airport with bagful of Dollars. They would spend two hours in sweltering heat to reach the then CBD Nariman point (Worli Sea link was not there and BKC was still underdeveloped), and virtually stand in queue to get a deal where they can burn those greenbacks.

Mumbai properties were selling like hot cakes. Every day one used to hear some mega property deal. NRIs from middle east, Europe and US were buying properties without even bothering to have a look at them.

Bank were hiring jokers for USD 100 to 500k salary for doing nothing. I was of course one of these jokers!

That was the time, when sub-prime crisis has just started to grab headlines. Indian economic cycle started turning down in spring of 2007, with inflation raising its head. RBI had already started tightening. Bubble was already blown and waiting for the pin that would burst it.

INR appreciated more than 10% vs. USD in first six months of 2007.

Then INR depreciated over 75% during period from January 2008 to August 2013. This was the time when Fed was printing USD at an unprecedented rate. There was no shortage of EUR, GBP and JPY either.

The point I am making is that in the present times when most globally relevant central bankers are using unconventional policy measures with impunity to stabilize their respective economies, the value of currency is seldom a function of demand and supply alone.

Regardless of the economic theory, it is the faith of people in a particular currency that is primary determinate of its relative exchange value.

2005-2007 was the time when the Indians had developed good faith in their currency. Local people were happy retaining their wealth in INR assets, despite liberal remittance regulations and NRIs were eager to convert a part of their USD holding in INR assets. The situation changed 2010 onwards. There is no sign of reversal yet. Despite huge popularity of Narendra Modi amongst overseas Indians, we have not seen any material change in remittance pattern in past six years. Despite tighter regulations, local people appear keen to diversify their INR assets. Most of the USD inflows have come from "professional investors" who invest others' money to earn their salaries and bonuses. These flows are bound to chase the flavor of the day, not necessarily the best investment. Whereas the outflows are mostly personal, or by corporates with material promoters' stakes.

In my view, no amount of FII/FDI money can strengthen INR if Indians do not have faith in their own currency. Yield and inflation have become secondary considerations.

...so are interest rates

Yesterday, RBI auctioned 91 days and 182 days treasuries bills at far below the policy repo rate and lower than the recently reduced reverse repo rate. Even at ~3.6%, it accepted only one fifth of the bids received. SBI has reduced the rates on whole sale fixed deposits to 2.5%.

Obviously, the supply of money at this point in time is overwhelming higher than the demand. Like crude, banks have no place to park their deposits.

However, interpreting these lower rates as supportive for growth would be a huge mistake; just as it was with lower crude prices (see here). In fact in the present circumstances, low interest rates are likely to do more harm to the economy than help it. In next 12months, there is going to be hardly nay growth in investment demand irrespective of the interest rates. However, lower interest rates may damage the consumption demand as it may lead to lower interest and rental income for consumers, negative real return for savers, worsening income inequality.

Remember, lower interest rates because demand for money is less is as bad a thing as in case of anything else.

Friday, February 28, 2020

Lower crude prices not necessarily good for economy and markets

In past few days many market experts have highlighted that the recent fall in crude prices is a major positive for Indian economy. Through my interactions with some investors I learned that many investors do take the publically expressed random opinions of these experts quite seriously and actually base their decisions on these.

Besides, small investors are also usually seen following the actions large celebrity investors. Even in recent past, there have been many instances where small investors have emulated the actions of large investor buying a meaningful stake in a stressed asset.

From the regulatory standpoint there is no violation in both these cases. The market experts are free to publically express their opinions and views about the market trends and events. The companies, stock exchanges and investors are in fact obligated to make public disclosure of large secondary market deals. But there could be an ethical lacuna in these practices.

For example, one reputed fund manager, who presently runs an investment management and advisory firm and had been CIO of one of the top AMCs in the country, recently tweeted "$40 for crude in 2020 coming soon. Big positive for India!"

Obviously he made this assertion in zest and may not have any particular design in mind while writing this tweet at midnight. However, his numerous followers may find it an "advice" and accordingly act upon it.

It would therefore be better if the "experts" had also highlight that crude prices usually have positive correlation with India's GDP growth. In past 20yrs, all three episodes of sharp rise in crude prices have resulted in rising trend in India's GDP growth rate, and vice versa.

2004-2007: Brent Crude prices jumped from under $30/bbl to over $140/bbl. In this period India's GDP growth accelerated from about 3% (FY03) to 9.5% (FY08).
2010-2012: Brent crude prices again jumped from $40/bbl to $$120/bbl. In this period, India's GDP growth improved from 5.5% in FY13 to 8.25% in FY12.
2016-2017: Brent crude prices jumped from below $30/bbl to over $80/bbl. In this period also India's GDP growth improved from 7.5% in FY15 to 7.75% in FY17.

It would be pertinent to note that crude prices fall in response to demand slowdown. A fall in crude prices has not particularly shown to be pushing the growth higher. Besides, the Indian markets have not shown any significant correlation with the rude prices in the past.

Lower crude prices hurt many businesses like oil & gas producers and oil marketing companies.

Lower crude prices hurt state revenues (excise and customs) which are ad valorem to crude prices. Since the fuel pricing is not market driven and subsidies have been virtually eliminated, the offsetting positive impact on fiscal in form of lower subsidies is no longer available.

Moreover, if the crude prices are falling due to demand slowdown, the benefit to the consumer industries is limited as they are not able to increase production at lower cost. So lower crude prices may help in protecting margins to some extent during the demand slowdown period, but may not necessarily result in higher profits.

It may be noted that sharp fall in crude prices in 2008-09 and 2014-16 did not result in any major gains for Indian stock markets.