KARACHI: Global oil prices witnessed a significant drop on Monday, sending markets around the world in frenzy.
According to report issued by AKB Securities Limited, the global drop in oil prices will likely benefit Pakistan’s macro-economic indicators even though oil companies will take a hit due to the drop.
The report further stated that fallout of OPEC+ disagreement has reverberated across global oil market with benchmarks Brent and WTI plunging 25%+ to currently stand at USD33.9/bbl and USD30.09/bbl.
Decline in oil prices has worsened already panic stricken global markets reeling from the economic effects of the COVID-19 virus where pace of new cases in Italy, Iran and the US has caused concern.
From Pakistan’s perspective, however, plunging of global oil prices is economic positive where lower oil prices should help alleviate inflationary pressures – CPI for March/April can potentially clock in at 10.83%/10.5% and falling to single digit by June 2020.
With benchmark policy rate at 13.25% and lower CPI at 10.5% for Apr’20, this can potentially provide the SBP an opportunity for reducing rate given potential real interest rates at 275bps.
From a sectoral perspective, lower generation cost consequent to oil price decline should aid GMs across the board while companies with oil derivative costs ala chemicals (EPCL, LOTCHEM) and leveraged plays (cements, steel, consumer durables, cable & electric) should benefit.
Oil – lack of consensus leads to price war! With no OPEC+ deal on the horizon, previous cuts of 1.7mn bpd agreed upon by the 23 country cartel will likely to expire unleashing significant supply upswing. For the month of Feb’20 OPEC produced 27.99mn bpd down 2.9%MoM complying with cuts agreed (90% compliance), where Saudi Arabia (9.69mn bpd production) cut about ~250K bpd.
During the same month, Russian production rested at 11.29mn bpd while US production amounted to 13.1mn bpd for the last week of Feb’20 where exports from the country jumped 500kbpd to 4.15mn bpd. The move by Saudi Aramco to cut crude delivery prices by 10% on Saturday was cited as instigating the current price shock, marking a clear break in Saudi Arabia’s three year alliance with Russia.
To recall, Saudi Arabia has 2.4mn bpd of spare capacity which can be ramped up to further pressure prices.
Question is not if, but by how much will the policy rate be cut! The coronavirus issue has snowballed into a global endemic with Central Banks across the globe coordinating a response to the impending slowdown. The US Fed set the ball rolling in this regard with a substantial 50bps cut in its policy rate while other central banks including Australia, Malaysia, Indonesia and Canada following suit. At home, Pakistan is already in the midst of a slowdown owing to idiosyncratic issues while global quantitative steps will only increase the pressure for rate cuts.
The oil price conundrum has provided a prime opportunity for the SBP to initiate the easing cycle as inflationary pressures will likely continue receding going forward. Already, inflation has declined to 12.6% in Feb’20 and oil product prices have already been cut and will likely be further reduced in the next adjustment. Moreover, CPI is expected to fall to single digit by Jun’20 while at our tentative estimate for March’20/Apr’20, real interest rate clocks in at 275bps, providing ample space for a rate cut.
PSX – Oil to take a hit, others to benefit! While reduction in global crude price will obviously weigh heavy on the Oil sector (E&P: revenue stream; OMC: NRV adjustments), we believe declining costs as a consequence of lower production costs vis-à-vis captive power generation will be positive across the board. At the same time, companies with oil derivative RMs will benefit, particularly Chemicals. Expectations of interest rate easing should also bring leveraged plays / cyclicals into play particularly Cements, Steel, Consumer Durables and Cable & Electric.