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Terrorist attacks and record oil prices threaten the bull run

Rex Mathew*
8 July 2005


The week was quite a dramatic one for the Indian stock markets as they sought new peaks in the early part of the week and came crashing down on Thursday after the London bomb blasts.

On Monday the indices continued their surge from the previous week as operators built up positions in the July derivative series and took both the indices to all time closing highs.

The terrorist attack in Ayodhya shook the markets on Tuesday as they were trading firm in early trades and the Sensex had crossed the 7300 mark for the first time. The indices closed weaker on reports of political protests against the attacks.

Markets chose to forget about Ayodhya by Wednesday as the met department came out with some encouraging news on the monsoon front. The indices managed to close at new all time closing highs.

The London bomb blasts led to a market crash on Thursday. The markets were trading with a negative sentiment when news of the blasts came and led to a decline of around 2 per cent on both the indices. The losses were partly recouped on Friday as traders took heart from the positive closing in the US markets on Thursday after the blasts.

After trailing the large caps for almost 2 weeks, mid-caps had another great week as frenzied buying came back to many of the actively traded stocks. Media and banking stocks were in the forefront as rumours and speculations about big ticket deals spread. Even the large drop on Thursday did not have much of an impact on smaller stocks. CNX Mid-cap 200 index closed the week very close to its life-time highs.

US markets, economy and oil

US markets saw some volatility during the shortened week after the markets remained closed on Monday. The strong manufacturing outlook supported by surging factory orders as per data released last week and improved guidance from Wal-Mart supported the US markets on Tuesday.

Record high crude prices led to a significant decline in the US markets on Wednesday though technology stocks were relatively better off. The London blasts led to a further decline on Thursday morning, but the markets recovered to close with gains.

Crude prices surged during the week to record highs of above $62 to a barrel. The arrival of tropical storms in the coasts of US raised fears of supply disruptions and refinery shut downs. Some of the refineries were in fact shut down temporarily after a storm caused power outages.

Even the terrorist attacks in London did not have much impact on crude prices. After crashing more than 4 per cent as the news spread, crude futures clawed back and closed only a per cent lower on Thursday.

After all the worries about dwindling oil supplies as emerging economies like China and India have started consuming more and more energy, some of the oil bulls have started talking about geopolitical risks which could disrupt supplies in a big way. They believe that a political crisis in one of the Middle East countries is imminent and such an event would cause a huge supply shock.

Most of their fears are about Iran where a new President has recently assumed power. Some of the analysts believe that Iran would pursue a more aggressive policy on nuclear weapon development and this would force the US to launch pre-emptive strikes against their nuclear installations.

Though these fears sound far fetched, the fact remains that crude continues to seek higher ground on these worries. The large presence of hedge funds and speculators in the crude market has made it highly volatile. Self serving statements from investment banks who themselves are large traders are adding more fuel to the fire.

The only way crude markets can cool off is a clear sign of slowing global economic activity. Though there is enough evidence of a slowdown in growth in China, growth in the US continues to remain steady. To make matters worse, record crude prices are not having much of a negative impact on growth as the global economy is less dependent on oil than it was a couple of decades ago.

Industry update

  • The issue of sharing the subsidy on petroleum products between upstream and downstream oil companies caught much attention during the week. The government has reportedly put forward a proposal which would see the share of upstream companies going up.

    As per the new proposal, private and stand alone refiners will also be asked to share the subsidy on retail sales of fuel. The impact on Reliance Industries, the country's largest private refiner, would be around Rs700 crore. The company is reportedly not averse to the idea of sharing subsidies, but the extent to which it is willing to share the burden is not known.

    Stand alone refiners like Kochi Refineries, Chennai Petroleum and MRPL will be required to contribute Rs700 crore between them while GAIL and Oil India will have to bear a bill of Rs400 crore.

    The company which would be worst affected by this new formula will be ONGC, which may have to contribute up to Rs3,500 crore. The decline in the share price of ONGC over the week reflects the market concerns over this move.

    Presently, upstream PSU oil companies like ONGC, GAIL and Oil India are required to share one third of the total subsidy bill on petroleum products. The oil marketing companies are demanding that this share should be raised to 50 per cent as up stream companies enjoy much better profit margins when crude prices are high. Hence they are in a better position to bear the subsidy bill unlike the marketing companies, most of whom are expected to post losses in the first quarter.

    The price paid by domestic refiners to ONGC for the crude produced domestically is lower than international prices. So is the case of natural gas prices paid by GAIL to ONGC. Even after the recent revision in natural gas prices, the realisations by ONGC is almost 40 per cent lower than the landed prices offered by private players like Shell.

    Hence ONGC contends that if it is to share a larger part of subsidy on liquid fuels, the subsidy on natural gas should also be shared on a more equitable basis. The company also argues that higher subsidy burden would seriously affect its plans to acquire energy assets abroad.

    Since the arguments of both upstream and downstream companies are valid, the government would find it tough to arrive at a subsidy sharing formula which will satisfy all. Many in the petroleum ministry would be praying for a downward correction in crude prices in the immediate future.

  • After remaining out of market radar for a couple of months, consolidation among smaller banks has once again caught the attention of investors. While it was mergers between smaller PSU banks which were talked about earlier, now the attention is only on smaller private sector banks. The merger between Centurion Bank and Bank of Punjab has raised expectations about more such deals to follow.

    It does make sense for most of the smaller private banks to look at mergers to increase their geographical reach and achieve critical size. Many of these banks are niche players present only in some parts of the country. Many of them are based in the south with negligible presence in other parts of the country. Some of them rely too much on business from NRI's and hence business risks are relatively high.

    Since many of them have similar profiles in terms of business and geographical presence, it would be difficult to find mutually complementing candidates for merger. Therefore, apart from increasing the balance sheet size not much can be expected from these mergers.

    The more intriguing are the stories of foreign banks and domestic corporate bodies acquiring some of these banks. The present policy framework clearly discourages such deals and still rumours continue to fly around.

    The Reserve Bank has identified some weak banks which may be allowed to be taken over by foreign banks or domestic institutions. Corporate groups are not allowed to buy them as yet. None of the banks in this list by RBI are listed on the exchanges. The rumours about takeovers of listed banks by domestic corporate groups sound incredulous.

    Most retail investors get enticed by such unsubstantiated rumours and speculations. They would do well to remember the frenzy in PSU bank stocks not so long back. Even the merger ratios were discussed and reported by the financial media as if the deals are finalised and everybody was waiting for the signing ceremony. Many months have passed by and still there is no clarity on the government policy despite occasional statements from the finance minister favouring bank consolidation.

Corporate moves

  • The Videocon group has completed 2 major acquisitions in the last 2 weeks which would make it one of the largest consumer electronics and appliances players globally. After the acquisition of the television picture tube manufacturing facilities of Thomson in Italy, Mexico, Poland and China, the group acquired the Indian operations of Swedish giant Electrolux this week.

    The Electrolux deal involves the manufacturing facilities for white goods as well as brands like Kelvinator and Allwyn. These brands were acquired by Electrolux in the nineties when it had large plans for the country. Electrolux will also source appliances from Videocon for its global operations. This is expected to bring in business worth over Rs5,000 crore annually in the next 2 to 3 years.

    Videocon group also announced the merger between group companies Videocon International and Videocon Industries. The former focuses on consumer electronics and appliances and had posted a turnover of over Rs4,000 crore last year. Videocon Industries has been focussing on the energy sector and had acquired working interest in soil and gas fields in Myanmar and Sudan.

    The more interesting part of the deals is that both Thomson and Electrolux will be investing in Videocon Industries, after the merger. While Thomson will hold a 14 per cent stake, Electrolux will be taking a 5 per cent stake. Thomson will also have representation on the Videocon board.

    While the size and nature of the deals are impressive, the group will face considerable challenges in integrating the businesses. The businesses of the 2 companies have very little synergy and the only positive aspect of the merger is to achieve an impressive balance sheet size. The size would help the company while going for more acquisitions in the energy space.

    Appliances and consumer electronics business in the country is highly competitive and offers very low margins. South Korean companies Samsung and LG have a dominant position in the market and it would be difficult for Videocon to break their dominance. On the positive side, the company can expect to become a major supplier to multinational brands given the large capacities it has under its control now.

    The management expects total turnover for the current year to be close to Rs18,000 crore, which is a huge jump from under Rs5,000 crore for the last year. Bulk of this growth will come from overseas operations. The future will depend on how well the company will be able to manage costs as it will become a send this article to a friendpredominantly contract manufacturing operations. Energy business could offer significant upsides provided the company can continue to make large enough investments.

*Disclaimer: The author doesn't have any position in the stocks specifically mentioned above at the time of writing this article. This analysis/report is only for the purpose of information and is not an investment advice. Readers are advised to consult a certified financial advisor before taking any investment decisions. While efforts have been made to ensure the accuracy of the information provided in the content the author or publisher shall not be held responsible for any loss caused to any person whatsoever.

Other articles by Rex Mathew

List of general reports on markets

List of general reports on finance

 

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Terrorist attacks and record oil prices threaten the bull run