The Coal Churn

The prices of coal and crude oil, the backbone of India’s energy sector, have risen sharply in the recent past on the back of rising global energy prices. Brent crude is hovering around $80 per barrel, up by almost 10 per cent in a month, while coal prices have increased by around 15 per cent since August, according to a BofAML (Bank of America-Merrill Lynch) research report, dated September 29, 2021. Coal and crude constitute the bulk of India’s raw material for transportation and power inputs.

The Effect Of Rising Prices

Rising oil prices represent an inflationary risk for India, and they put pressure on trade deficit as the country is a big importer of the commodity. This comes at the wrong time. On the one hand, the dollar is appreciating against the Indian rupee and on the other, India is running low on coal reserves which may force the country to increase the imports.

The Indian economy has, however, grown to a size where the incremental impact of rising crude is expected to be moderate. “Sustained high crude levels of possibly $100-plus can, however, dampen the prospects of the macro economy,” explains Rahul Bhuskute, chief investment officer, Bharti AXA Life Insurance.

Surging energy prices could lead to a rise in consumer price inflation with increase in input costs. This poses a threat to the revival of corporate earnings and could even stall the path of economic recovery.

How Will Investors Get Affected?

Rising coal and fuel prices affect you in two ways—as a consumer and as an investor.

Consumers felt the after-effects of rising coal prices for most of October as the country was gripped by a power crisis, while fuel prices led to shrinking of budgets for most households.

Higher crude prices will have a more direct impact on most of the businesses in India as transportation cost goes through the roof. This, in turn, will lead to a rise in the prices of essentials. This may not bode well for equity investors. As valuations are stretched, and commodity prices are rising, there may be some let-up in the market levels as corporate profits may be hit temporarily.

“In terms of the market outlook, over-stretched valuations coupled with rising commodity prices call for a pullback of around 10-15 per cent in domestic equities,” says Sugandha Sachdeva, vice-president, commodity and currency research, Religare Broking Ltd.

There is an inverse linkage in energy prices and corporate profitability, says Amit Jain, chief strategist, global asset class, and co-founder, Ashika Wealth, a brokerage firm. But the impact on corporate earnings may be short-lived. “The impact on earnings can be transitory depending on the timing of cost pass-through but most sectors will eventually be able to pass on the increase in raw material cost to the end consumer. Therefore, we expect the impact on domestic equities to be temporary and modest,” says Bhuskute.

Investors may see a possible churn in the stock prices of companies that are directly affected by these commodities. Cement companies, for example, have 75 per cent of their power and fuel costs exposed to coal, 40 per cent of road freight costs (70 per cent of total costs) exposed to diesel, according to the BofAML report.

“Considering the fact that we are witnessing a post-pandemic boom, and the market is tightening, the outlook for the energy sector, an engine for global growth, looks quite promising and it does make sense to invest at this point in time from a medium-term perspective,” says Sachdeva.

What Should You Do?

“Investors will do well to invest in a diversified portfolio, with focus on quality companies which have pricing power and can pass on the effects of higher crude prices,” says Bhuskute. You can also consider investment in upstream companies (those involved in the production and sale of crude), which will benefit from higher crude prices.

Investors can pick stocks of companies with sound fundamentals within the energy and power sector after thorough analysis or expert guidance. “India’s coal and oil sectors are dominated by PSUs (public sector undertakings) and investors will benefit if they remain long in this sector,” says Kishor P. Ostwal, chief managing director, CNI Research, a brokerage firm.

There are options within mutual funds too. “There are some dedicated PSU thematic funds, which can serve as an alternative route for investments,” says Jain of Ashika Wealth.

However, remember that commodities are subject to cycles and, hence, are riskier than other avenues.

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The Sectors That’ll Get Affected

Crude has an impact on a variety of sectors, including fast-moving consumer goods, cement, auto, and chemicals, as crude derivatives are inputs to these sectors. “However, most of these sectors will eventually be able to pass on the increase in raw material cost (to consumers),” says Rahul Bhuskute, chief investment officer, Bharti AXA Life Insurance.

“Cement companies have 75 per cent of their power and fuel costs exposed to coal, and 40 per cent of road freight costs (70 per cent of total costs) exposed to diesel.  It is estimated that a 5 per cent rise in both coal and diesel costs could impact the earnings before interest, tax, depreciation and amortisation (Ebitda) of cement companies in approximately the same proportion,” says N.S. Ramaswamy, head of commodities, Ventura Securities.

About the aviation sector, Ramaswamy says turbine fuel forms a huge chunk of the operating costs of airlines and, therefore, stronger crude prices hurt profitability. Passenger load factors wouldn’t be enough to compensate for the jump in costs.

“In the paints sector, higher crude prices are not desirable as a large share of their input costs are linked to crude,” says Ramaswamy.

For the automobile sector, he says, crude price hike poses an inflationary risk to consumer demand. On the commercial vehicle front, consumer demand has an impact as fuel accounts for 50 per cent of costs for truck operators. It could also hit non-banking financial companies in
the sector.

“The FMCG sector would face increase in raw material and transportation costs,” says Ramaswamy.

The sector which will primarily benefit is upstream energy (companies involved in the production and sale of crude) as its profitability is directly linked to the movement in crude prices.

“Most of oil exploration companies will benefit in the short term,” says Amit Jain, chief strategist, global asset class, and co-founder of Ashika Wealth.

In the last few weeks, stock prices of most companies in the energy space have already gone up 15-30 per cent.

The author is a financial journalist