The Russia-Ukraine war has had a severe impact on crude oil prices. Amid the standoff between the two countries and the Western countries imposing sanctions on Russia, crude oil prices reached an all-time high of $130 per barrel for the first time on March 7, 2022. The price hike was primarily due to a crude oil shortage in the international market.
Oil is the backbone of the global economy and contributes to economic prosperity. Transporting goods and rendering services in a country depend heavily on oil, while its by-products are used for various industrial purposes. Any impact on crude oil prices directly affects the country’s inflation and its trade deficit.
However, crude oil impact on stock market can also be seen when stocks and market indices fluctuate with movement in crude oil prices. In this blog, we explore the impact of crude oil on stock markets.
Impact of crude oil price fluctuation on the stock market
The stock market generally reacts negatively to rising crude oil prices. The stock market, indices, and stocks are likely to be in the red, while a dip in the crude oil prices may lead to the stock market going through a bull run.
Here are a few ways in which rising crude oil prices may bring the stock market down:
1. Cost of production increases while the company’s profit takes a hit
The goods and services offered by companies have an input cost, which is heavily dependent on various factors. One of the primary factors is oil. Almost all businesses use fuel to transport raw materials and finished goods to their final destination. Many of them use oil and other petroleum products in their manufacturing process.
Any rise in the crude oil prices directly impacts the earnings of these companies since they would have to shell out more money to complete the same work. As a result, the profit of these companies would reduce, which can impact their Earnings Per Share (EPS), bringing the stock price down.
2- Inflation rates go up
The Consumer Price Index (CPI) goes up by 0.3% for every $10 rise per barrel in the price of crude oil. With the CPI inflation going up, the MRP of goods in the market increases, bringing their stock prices down. Rising inflation also dampens investor sentiment in the stocks and the market.
With rising inflation, the prices of commodities and finished goods also increase, squeezing the demand and affecting the net profit a company reports. As a result, their stock may take a hit. A similar trend across the sector can drag the indices and the overall stock market down.
This dip in stocks may be temporary, with reputed stocks having a high chance of recovering from the downturn in the market. This could be a good opportunity to ‘buy the dip’ and get your hands on lucrative stocks. Read more on this strategy in our blog on What does ‘Buy the Dip‘ means in the Stocks.
3- Increase in Current Account Deficit (CAD)
A country’s Current Account Deficit or CAD refers to a situation wherein the total value of goods and services being imported by a country exceeds its exports. A rise in the country’s CAD is an unfavourable situation for any country. Generally, Governments try to keep the CAD in check to prevent economic downturns.
Oil makes for one of India’s heaviest imports. Whenever crude oil prices rise, the cost of importing oil also increases. A rise in crude oil prices by $10 per barrel pushes the county’s CAD up by 0.55%.
The rising current account deficit leads to the Rupee depreciating against the Dollar since more forex moves out of India. Thus, a rise in crude oil prices results in the country spending more dollars to import oil, which increases the country’s current account deficit. With the Rupee depreciating and the cost of importing oil going up, input costs go up for companies, which results in a dip in their profits. This pulls down their stock price.
On the other hand, when the oil prices go down, India has to spend fewer dollars to import the same amount of oil, which strengthens the Rupee and reduces the country’s current account deficit. This translates into the input costs going down and companies making more profits, which reflects in their stock prices going up.
Taking a lesson from history
After Israel won the Yom Kippur War in 1973, supported by Western nations, Arab oil-exporting countries imposed an oil embargo, which reduced the oil trade in the global market. This led to one of the worst oil crises in the world and led to a global stock market downturn. Oil prices rose phenomenally, contributing to global markets taking a beating.
After the global economy came to a temporary halt in March 2020 after the onset of the COVID-19 pandemic, oil-exporting countries had surplus oil but no buyers. This led to another oil crisis where the oil prices dipped to all-time lows, negatively impacting the global markets.
The takeaway
Oil is one of the key drivers of the global economy. Oil and its products are crucial for a country’s growth and development, and an increase in its price can have a negative impact on the stock market. Crude oil prices rising in the global market can also result in global markets taking a hit.
Although companies can transfer the increase in the costs to the end customer, inflation can act as a doubly whammy and dampen the investors’ spirits. However, corrective measures by the Government can help reduce the severity of the impact on the stock market to some extent.
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