Widely read:
There is a reason why companies that are involved in the production of commodities (think metals, crude oil etc.) are classified as "cyclical" companies. Since these companies have revenues that are largely dependent on the prices of the primary commodities that they produce (which in turn undergo cyclical changes that are largely in sync with the general economic cycle), and high fixed costs which enhance both operational and financial synergies, their profits are very cyclical.
But these businesses are inherently riskier than those operating in sectors that exhibit secular growth. So, what explains the willingness of investors to shoulder additional risk?
The short answer: the lure of extraordinary profits during the upmarket cycles. In effect, these additional profits are powerful incentives as they are expected to compensate for the lower profits (or even losses) during the downmarket cycles and provide a little more as a reward for tolerating excess risk.
It is in this context that the decision of the Indian government on July 1, 2022 took the market by surprise. Since the price of crude oil had spiked up since the Russian invasion in February 2022, the central government decided to tax the so-called "windfall" profits accruing to domestic producers of crude oil to the extent of Rs 23,250 per tonne. This would effectively reduce the net realisation of these companies to the lower pre-war prices and thereby reduce their chances of enjoying additional profits. So it was unsurprising that share prices of companies in the exploration and production of crude oil such as Oil India Limited and Oil and Natural Gas Corporation Limited (ONGC) started declining immediately.
Looming uncertainty
Though this tax is meant to be reviewed every fortnight, the uncertainty of how long it may continue is a risk that the markets have not taken too lightly. In fact, the more pertinent risk facing investors in such sectors is the lack of any reasonable belief, let alone a guarantee, that further instances of sudden/unexpected taxes will not recur in the future. This explains the Rs 2.6 lakh crore (approx.) worth fall in the market cap of oil stocks since the announcement despite the Government's tax earning potential estimated to be only around Rs 1.3 lakh crore (if this tax is levied until March, 2023).
For, if after taking on all the risk, investors in any particular sector don't have the faith that they will be able to reap the future benefits, it begs the question of the utility (or lack thereof) in making investments in the first place.
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