Plunge in crude oil prices to put pressure on IT firms’ margins

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NEW DELHI: Indian IT services companies, which offer software and hardware solutions to oil producers and marketing companies, may become an unwitting victim to the plummeting crude oil prices.

Companies like Wipro, Infosys, TCS, Infotech and L&T have significant exposure to the oil, gas and energy segment and analysts say, the steadily falling crude prices is likely to put pressure on their profit margins in the quarters to come.

“Low prices will impact the capex of oil exploration and production companies such as British Petroleum and Exxon. As a result, their IT spend will fall. Notwithstanding the long-term contracts, there could be a possibile pressure on IT firms to revise their pricing as well,” pointed out Harit Shah, an IT analyst at Reliance Securities.

From a high of USD 100 a barrel in 2014, crude prices have been on a free fall for some time now. On March 16, 2019, oil prices touched a new bottom – USD 30.35 a barrel. Analysts fear the crude price war can send oil crashing to as low as USD 20 this year.

“With oil demand already plummeting due to the economic impact of the coronavirus, traders forecast that prices will go even lower. Forthcoming flood of supply, overwhelming inventories and coronavirus-led demand shock can see prices tumbling to nadir of USD 20 a barrel, lowest oil prices of the last 20 years,” said Shweta Shah, analyst-energy, Motilal Oswal Financial Services.

Large parts of the US shale industry operates at a high cost of production, estimated to be more than USD 40-50 per barrel. In other words, lower prices leave the US shale unprofitable, making the latter unattractive for US producers. In fact, the current prices are lower than the break-even costs for many.

“If prices continue to tumble, US shale companies may decide to shut production. As a result, demand for IT services from oil dependent economies, especially from the Middle East, will take a hit on the back of cost pressures,” said Sony Mathews, senior market strategist, Geojit Financial Services.

Companies are also bracing for a tough time as they continue to struggle through the rough sea of coronavirus crisis by way of restricting travel and allowing its employees to work from home. Shares of most IT firms have slipped amid rapid spread of the infectious virus. Tata Elxsi, Mindtree, HCL Technologies, and Wipro have plunged in the range of 6-8 per cent in the past one week.

Analysts also say that the impact of revenue headwind may be cushioned by a weak rupee in the short term, but the continuing volatility may affect business sentiment with clients looking at re-negotiating the existing billing rates.

It’s no brainer that any fluctuation in the rupee is negative for the IT and ITes exporters who earn their revenue mostly in dollars, even though it aids their revenue in rupee terms. According to industry body Nasscom, the IT sector is projected to grow at 7.7 per cent in FY20, with exports being the major growth driver. It expects exports to touch USD 147 billion during the same period.

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