Steady Oil Prices Key To Stabilising Equity Markets In Near Future

The Sudden Decline In Oil Prices Has Set A Shock Wave Across Asset Class. Unless Oil Prices Stabalise, Equity Markets Will Remain Volatile.

Crude oil prices have fallen by over 40 percent from the four-year high it reached in October 2018. Brent crude is at present below $50 a barrel, a price last seen in July 2017.

Under normal circumstances, falling oil prices would have been taken as a big positive for the economy, with analysts tripping over each other to upgrade companies, in particular, those that will benefit from low oil prices.

But this time around things seem different. The decline in oil prices is a mixed blessing.

One reason is the speed at which prices have fallen. A drop of 40 percent in just two months has shocked oil-producing economies. Apart from OPEC, Russia and the US are also reeling under pressure of the sudden drop.

The US Federal Reserve added fuel to fire by increasing interest rates to prevent the economy from overheating. With concerns prevailing over US-China trade relations, markets are discounting a slowing global economy.

Another reason is that the fall in oil prices itself indicates a slowdown.

To make matter worse, there is a chance the fall in oil prices may directly impact the banking sector, especially in the US which has seen a bank financed shale oil boom. Despite average oil prices pegged at $73 a barrel, only 15 of the 50 shale oil companies operating in the US have had positive free cash flow. According to Dealogic, US oil companies have borrowed $300 billion from bond sales, $780 billion in bank loans and raised $140 billion from the equity markets in the last decade.

However, analysts in the US are saying that oil companies have locked in their profit by hedging their position. Energy economist Philip Verleger has pointed out that hedging has only accentuated the problem by pushing oil prices lower as oil companies have either sold futures or bought puts to hedge their position.

The fall in oil prices has already rubbed on to the equity markets globally. Oil companies in the US have fallen by nearly 25 percent from their peak in two months. In India, oil refiners who are dependent on imported oil have benefited and are up by nearly 40 percent from the lows of October.

This difference between respective oil sectors sums up the movement in indices of Indian and US markets. The divergence between Indian indices and the US is at the widest range in the last five years. US markets have fallen by nearly 19 percent from their peak of October 2018, while Indian markets are down by less than 10 percent from their peak in September 2018.

After the sharp fall in tech giants Facebook, Apple, Microsoft, Google, and Amazon, US markets were hit by a fall in energy stocks. Indian markets, on the other hand, had to largely worry about their domestic problems which are reflected in the fall in banking stocks plus the looming political risk.

A global sell-off will impact the Indian stock markets too. But as long as the benefits of lower oil prices persist, Indian stocks should outperform.

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