Crude oil's trajectory looks uncertain; should you invest in oil stocks?

Crude oil prices climbed in international markets on April 15, underpinned by hopes that the demand from major consumers will focus on their strategic stockpiles which will raise the demand for oil.

Crude oil is likely to gain after oil-producing countries agreed for a cut in output to shore up energy markets battered by the coronavirus pandemic and a Saudi-Russia price war.

The OPEC+ alliance have announced a 9.7mb/d total cut in oil output from May 1, for two months. After that, for the next six months till December, cuts would be lowered to 7.7mb/d and thereafter till April 2022-end to 5.8mb/d.

However, oil prices have been wobbly as investors are sceptical that record supply cuts may not be able to help much in markets hammered by the coronavirus pandemic.

Brokerages feel that the two years’ timeline of this deal is long and if it is complied after normalcy returns, there could be an extended rally in oil prices as demand could exceed supply by 4-5mb/d.

A rise in crude oil prices is a matter of concern for India as it will add further pressure on its fiscal books which is already under pressure due to reasons including COVID-19.

Crude oil prices affect the Indian stock market too and stocks react to its movement sharply. Barring the occasional gains, crude oil prices have been subdued this year so far.

Due to the coronavirus pandemic and a significant slump in global demand, crude oil prices have corrected sharply by almost 50 percent this year.

As per brokerage firm Angel Broking, this sharp fall in crude oil prices could result in portfolio churning in energy stocks.

"State-owned oil marketing companies (OMCs) like Bharat Petroleum (BPCL), Hindustan Petroleum Corporations (HPCL) and Indian Oil Corporation (IOC) are likely to be preferred over upstream Oil & Natural Gas Corporation (ONGC) and Oil India (OIL), as the impact of falling crude oil price on the earnings of OMCs is lower than on exploration companies," Angel Broking said.

The state-owned OMCs derive nearly two-thirds of their gross operating profit from marketing margins — the money earned from sales of retail fuel such as petrol and diesel.

"These downstream companies buy oil from producers, and then sell the refined products. The difference means they're less sensitive to oil price volatility, which enables them to generate more free cash flow that they tend to return to investors," Angel pointed out.

"For the upstream companies, it will be a challenge on margins as long as crude prices trade low. Given the anticipated demand destruction in global crude demand, it would be tough for all such companies," Angel Broking added.

Upstream companies can see traction if demand revives, but revival of demand will depend on how soon normalcy returns.

"About the demand, it can be said that its revival is solicited. However, the revival depends upon the reinstatement of normalcy which would only occur once the dread of the virus ends. So, this brings the Indian companies to a complicated standpoint, irrespective of them being upstream (exploration) or downstream (refining)," said Pranjal Kamra, CEO, Finology.

Investing in oil stocks

Kamra of Finology said investing at this point in time with the oil-related businesses would be purely speculative and as a matter of fact, speculation is always risky.

"Nothing can be clearly said as to when would the spread of coronavirus end. And, until this happens, demand revival is a far-fetched dream. So, unless one is interested in risking the capital via speculation, the sector should be avoided overall for investment," he said.

Angel Broking suggests, Bharat Petroleum, the country’s second largest national oil marketer, can be looked at from an investment perspective, with a long-term horizon, as prices have witnessed a significant correction over the last year.

On the other hand, Yogesh Patil, Senior Research Analyst - Oil & Gas at Reliance Securities doe snot see any risk of oil supply issues to Indian Oil refiners.

"Oil marketing companies (BPCL/HPCL/IOCL) are reaping benefits of lower oil prices in terms of net marketing margins on petrol and diesel, but the sales volume of oil products has fallen down to nearly 60 percent on the month-on-month basis in April," said Patil.

Patil has buy recommendations on Gujarat Gas and BPCL.