There are several factors which affect stock price movements. Among the important ones to look out for are the geopolitics of oil and the valuations of stocks.

In May 2018, the US unilaterally withdrew from the Joint Comprehensive Plan of Action (JCPOA) nuclear deal signed in 2015, to restrict Iran’s ability to obtain nuclear weapons. It then imposed sanctions on Iranian oil sales and threatened countries buying it with sanctions. It egged Saudi Arabia to ramp up its output of crude oil, as a reduction of supply from Iran would make prices shoot up. Iran produces around 5 per cent of global oil.

This suited the Kingdom of Saudi Arabia (KSA). Iran is considered a religious rival and a regional threat. KSA also needed to boost revenues after the proposed sale of part of Saudi Aramco was postponed. The need to keep the US on its side, following the brutal murder of Khashoggi in the Saudi Consulate in Turkey, was another factor. So, KSA ramped up production.

As it transpired, Trump permitted seven friendly countries (including India) a temporary waiver against the sanctions, so both Iranian and Saudi crude flooded the market, and Brent crude dropped sharply to $50/barrel from $80/barrel. It has, since, moved up to $73.

Now, Trump has announced no extension of waiver, which expire on May 2, and is again asking KSA, the largest producer with the highest spare capacity available to ramp up production.

Once bitten, twice shy. KSA is waiting for a clear message on withdrawal of waivers, before ramping up production.

So, it is quite possible that crude prices will go up, before they stabilise. That would mess up India’s current account deficit (CAD) as it imports 80 per cent of its crude requirement. Supply is also curtailed from those countries in financial distress (Venezuela) or turmoil (Libya, Sudan).

Supply is rising from the US, now the world’s largest producer, thanks to shale oil. As this column has pointed out, this is a quandary, because the industry has never produced free cash flow, that is, enough cash to meet its capex. The nature of the industry is such that it continually needs to do capex.

So, the shale industry is reorganising. Bigger (traditional) players are taking over smaller (independent) players. With their larger balance sheets, the bigger players are better positioned to borrow debt/raise equity to fund capex. Chevron made a $33-billion (plus taking over debt) bid to acquire independent shale producer Anadarco. Last week, Occidental Petroleum upped that to $55 billion (excluding debt, but a higher figure).

What is perplexing is why billions are being spent on acquiring assets that do not generate free cash flow, an unviable proposition. Unless the acquirers feel that, in future, because of better productivity or higher prices, the industry can start generating enough free cash flow to justify the acquisition.

If the US shale industry stops getting funded for its capex, the supply of US shale oil will drop 70-80 per cent and crude prices would go stratospheric. Unless, by then, enough has been done to reduce oil demand through electrification of vehicles and additions to renewable energy capacity.

The valuation paradigm has changed.

The stock markets will continue rallying till central banks raise interest rates. Easy money has created, and continues to create, debt bubbles. These will burst, causing mayhem. When, exactly, is the zillion dollar question.

(The writer is India Head — Finance Asia/Haymarket. The views are personal.)

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