Thursday, 16 October 2014

Pakistan Stock Market: Impact of declining global oil prices

Oil futures have collapsed into bear markets as shale supplies boost U.S. output to the highest level in almost 30 years amid signs of weakening global demand. The biggest producers in the Organization of Petroleum Exporting Countries (OPEC) are responding by cutting prices, sparking speculation that they will compete for market share rather than reduce supply. It is up to OPEC to do something because the U.S. isn’t going to slow down production. Therefore, it may be of some interest to explore the impact of declining crude oil prices of Pakistan, which usually buys Arab light.

Arab light, which averaged at US$107.7/barrel last year, has now come down by 14% to US$92.3, similar trend was evident in Brent also down by 16%. This is primarily due to 1) supply boost coming in from countries that were previously facing some internal tensions and 2) diminishing demand from developed countries amid global economic slow-down. Amongst different countries, production boost coming from Iraq, especially post ISIS invasion as the militant outfit strives for self-sufficiency. If this was not enough, fading demand from developed countries such as China and Germany due to economic slow-down is further pushing the price of the commodity downhill.                    .

With OPEC countries scheduled to meet in November this year, the biggest question on everyone's mind is what will be the direction of oil prices in the future. It is believed that countries like Iran, Ecuador, Nigeria and Algeria amongst others with relatively higher respective break-even prices are of an opinion that OPEC countries should scale down their production to bring the prices up. Conversely, countries with relatively lower break-even price are likely to oppose this move.

Pakistan imported oil (crude + refined products) worth US$14.7 billion in FY14 when Arab Light averaged US$108/bbl. Keeping all other factors constant, this could lead to up to a US$1.5 billion reduction in the overall import bill which would be beneficial for the current account deficit (2MFY15 deficit: US$1.37 billion). Resultant comfort on the external account coupled with on-target foreign exchange mobilization through privatization transactions/sukuk issuance could convince the SBP to cut the discount rate which would be beneficial for leveraged plays such as ENGRO, EFOODS, EFERT, GATM and MLCF. At the same time, any Pak Rupee appreciation due to Balance of Payment strength would benefit importers such as Autos (HCAR, INDU & PSMC).

On the KSE-100 front, decline in International oil prices is likely to weaken E&P Sector’s FY15E earnings growth as 45% of the sector’s (ex-Mari) revenues are oil based. Analysts estimate every 5% decline in International oil prices is likely to dampen POL, OGDC and PPL projected FY15 earnings by 3.0%, 2.4% and 1.7%, respectively. Reduction in crude oil is likely to be negative for the OMC sector as it would lead to decline in product prices in the local market and will result in inventory losses also.


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