Crude test of India Inc.'s profitability

India’s very heavy reliance on energy imports has once again put it under the pump as the ongoing conflict in the Middle East underscored the fragility of global supply chains.

With oil and gas contributing over a third of its energy mix, the country is vulnerable to sharp price swings and, critically, physical supply disruptions.

The Middle East channels ~30 per cent of the world’s crude oil and ~20 per cent of liquefied natural gas (LNG). A substantial portion traverses the Strait of Hormuz, one of the maritime arteries—and chokepoints—of the world. 

Given that India imports ~88 per cent of its crude oil and half of its LNG requirements, disruptions swiftly pose energy security challenges. That’s because 40-50 per cent of the country’s crude and 50-60 per cent of LNG cargoes sail through this narrow, 21-mile-wide passage.

Brent crude prices recently flamed past $100 per barrel, compared with the January average of ~$67. Similarly, Asian spot LNG has more than doubled to $24-25 per million metric British thermal units (MMBtu) from nearly $10.

If the movement of oil and gas tankers normalises and supply improves, crude oil prices could average $75-80 per barrel next fiscal, with high near-term price volatility. For the first quarter of next fiscal, we are pencilling in an average of $85-90.

LNG prices are seen elevated as well, potentially averaging $13-15 next fiscal due to tighter inventories and persisting geopolitical-risk premium.

There are upside risks to our calls if the conflict prolongs and intensifies.

Rising energy bills impact India’s fiscal math and corporate cost structures and will show up in the upcoming first quarter.

Downstream oil marketers and refiners face margin pressure if higher costs are not fully passed on to consumers. Their average gross refining margin of ~$12 in the third quarter of this fiscal year would crimp.

Manufacturing segments such as paints, tyres, speciality chemicals, fertilisers, synthetic fibres and plastics, which depend heavily on hydrocarbons and derivatives, face rising input costs as well.

Tyre makers are particularly vulnerable, as nearly half of their raw material expenses are tied to crude-based inputs, rendering profitability highly sensitive to sustained increases in crude oil prices.

Similarly, paint manufacturers face a significant constraint, with about 30 per cent of their production costs stemming from crude-linked derivatives such as solvents, resins and monomers. Although paint manufacturers have historically passed on higher costs with a lag, competitive pressure and softer demand in real estate and discretionary home improvement can limit pricing power, compressing margins across the sector.

Trade-linked sectors such as pharmaceuticals and allied industries face indirect exposure to the Middle East crisis through logistics. Disruptions in shipping routes and a recent doubling of freight costs are increasing the landed cost of inputs such as active pharmaceutical ingredients and petrochemical-based solvents. This could squeeze margins for domestic producers and, if tensions persist, lead to higher drug prices where regulations allow for cost pass-through.

Natural gas is another key transmission channel. Imported LNG meets about 40 per cent of gas demand in areas such as city gas distribution for industrial and commercial users.

The fertiliser sector is particularly vulnerable because gas is the main feedstock for urea production. India imports ~23 per cent of its fertiliser requirement, with more than 40 per cent sourced from the Middle East last fiscal. The country also relies on the region for intermediates such as rock phosphate and phosphoric acid.

Thus, prolonged high LNG prices would raise domestic production costs, potentially pushing the fertiliser subsidy bill above the budgeted Rs 1.7 lakh crore next fiscal.

Gas-intensive industries such as ceramics are starting to face production curbs as the availability of LNG and liquefied petroleum gas (LPG) tightens, since many kilns depend on these fuels.

Exports constitute ~40 per cent of the ceramics sector’s revenue, with the Middle East accounting for over 20 per cent. Weaker demand or logistical hurdles in that region could dampen shipments, hurting both revenue and profitability.

For corporate India, a sustained increase in energy prices is likely to exacerbate cost pressures. Even brief disruptions could erode 40-60 basis points from India Inc’s earnings before interest, taxes, depreciation and amortisation (Ebitda) margin next fiscal.

To its credit, India has made efforts to diversify its energy sources and suppliers, building some buffers into its system. However, prolonged geopolitical uncertainties that keep oil and gas prices elevated would permeate through corporate costs and, ultimately, the broader economy.

PRITI ARORA

(The writer is the president and business Head, Crisil Intelligence)