Oil, Black Gold, is a key source of energy in the economy and is often measured as an indicator of economic stability due to the global societies’ high dependence on petroleum and oil products. Several studies have commented on the changes in oil prices as a key driver of economic ups and downs. In recent times a lot of focus has been thrust upon studying the links between stock market prices and oil share prices. The objective being to be able to successfully predict economic growth or decline in short, mid and long terms, thereby enabling the making of advantageous business decisions. But is that truly possible? Let us examine more in the subsequent sections.
The demand for oil and petroleum products has been consistently increasing as all economies globally are heavily dependent on it. In countries like China and India, due massive population and continuous rapid development, this demand is incredibly high. While there has been a huge amount of focus on finding alternative and cleaner modes of energy, the present demand is at an all time high in both developed and developing countries. Hence, one can safely comment that oil is extremely likely to remain an imperative factor for the global economy for some time to come. And the oil producing / exporting countries are bound to continue having a pivotal role in determining the oil prices and its pricing strategies.
Oil prices, as is often the case, usually remain at an all-time high across the world. However, these prices had taken a significant dip during the current global pandemic and actually went negative for the first time ever in the US due to the fall in demand and other economic uncertainties. But, by early this year, they had recovered their position and even managed a 15-20 % surge. Recently, talks between the Organization of the Petroleum Exporting Countries (OPEC) and allied oil producers have been postponed after they failed to reach a consensus on the oil production policy.
How Oil Prices Affect the Stock Market
The common factors that affect the stock market are:
- Profitability of oil companies
- Consumer Demand
- Profitability of other industries
- Impact on Inflation
- Effect on Imports
A recent study has suggested that oil prices and stock prices actually do not show as much proportionate climb or decline as was earlier thought to be.
The increase or decrease in crude oil does have an impact on the global stock markets. Volatility in oil prices clearly impacts the economies of all countries in a positive or negative manner. This is further dependent on how self-sustainable the country is in terms of oil production and whether it is an overall importer or exporter of crude oil. Increase in oil prices typically has a domino effect on several other aspects of the economy which then combine together to lead to a possible economic deceleration.
The Indian Context
Apart from the above mentioned factors, in India, the oil prices are also dependent on the taxation policies, tax rates and prevailing Rupee vs Dollar exchange rates. The traditional belief has been that a dip in crude oil prices leads to a fall in petrol prices India and the other way round as well. However, an analogy to this belief has been consistently on display over the last few months wherein even during a dip in international crude rates there has been a steady increase in petrol prices in India. This has led to huge furore and protests making it an important political topic of contention presently. The heavy excise duty levied by the Government of India is a significant reason for this hike. Furthermore, there are Value Added Taxes imposed by the state governments which vary from state to state. Hence, one can see different oil prices in different states of India. One of the main reasons given by the central government regarding the consistent addition and increase in petroleum taxes is to facilitate the various social schemes like the Ujjwala LPG schemes which aims to make clean LPG accessible to the rural and needy population. Another significant scheme presently in action is the CoWin vaccination drive. Hence, it is reported that the gains made due to high fuel prices are put to use in such socially benefiting schemes.
It has been typically observed that the increase in oil prices usually tends to lower the expected rate of economic growth and increases inflation in the short term. Decreased economic growth rate, in turn, lowers companies’ revenue expectations thereby resulting in a dip in stock price due to this perceived lower earnings.
Oil prices are majorly determined by supply and demand. Higher demand typically leads to higher oil prices. In such a scenario, stocks and oil share prices might rise together. On the other hand, oil prices could also rise due to some challenges along the supply chain, which may not necessarily be an advantage for the economy. In reality, rightly predicting the future of oil prices may not necessarily tell you where stock prices will go. Usually, these two have very different catalysts and while some of the drivers may conjoin, others may not and be mutually exclusive of one another. In this rather complex global economy and financial ecosystem it is inadvisable to base your investing strategy and decisions on oversimplified rules and unverified studies, reports and such.
Standard market fundamentals of supply and demand are usually the main factors affecting crude oil prices. However, government policies and the prevalent financial markets also play an impacting role. One cannot ignore the correlation between oil prices and international stock market indices.
Lot of focus and funding has been spent on conducting several studies to concretely prove or disprove the correlation between oil prices and the stock market and the impact of oil share prices at an overall level. However, no conclusive verdict has been achieved thus far. In fact, all that these studies have actually been able to convey is that analysts cannot truly and definitely predict the way stocks react to changing oil prices. There is one sector, however, that is heavily and consistently impacted by the changes in oil prices and that is the transportation sector. This is largely because it relies significantly on oil and petroleum products as a major commodity for movement.