By Sreekumar Raghavan What is the biggest news hogging the limelight in the media these days? It is crude oil prices. What is intriguing is that nobody has so far come up with an acceptable thesis on why it is defying gravity and going only upwards. All possible explanations have been put forward by pundits and forecasters. One team, led by Arjun Mistry of Morgan Stanley, forecast that crude prices would touch $200 per barrel soon.
Within days, perhaps, because of the psychological effect of this prediction, oil prices did move up. Three explanations have been cited too often one is the 'peak oil' theory which says that after attaining a peak, oil production has started coming down. Others blame the dollar and US Federal Reserve for keeping the interest rates low. So this leads to speculative money flowing into all sorts of hot commodities.
Textbook theory says that demand and supply imbalance will be ironed out after sometime and will reach an equilibrium. But in the case of oil at least the textbook theory isn't working. According to International Energy Agency, global oil demand has increased in each of the last three years, from 84.9 million barrels per day in 2006, to 86mbbl/day in 2007, to this year's rate of 87.2mbbl/day.
The IEA's most recent forecast calls for global demand of 87.8mbpd for the rest of this year. But what has Organisation of Petroleum Exporting Countries (OPEC) done? It has decreased production in February to 32mbpd. In March it declined further by 347kbpd. According to Dan Denning, Daily Reckoning, there are other possibilities to be looked into why oil production is not increasing. OPEC won't increase production because it doesn't want to, OPEC can't increase production.
Non-OPEC countries cannot increase production enough to bring prices down. The first question looks impossible to answer according to Dan Denning. Oil producers, from OPEC to large multi-nationals, plan with long time horizons. They view oil markets as cyclical and do not base capital expenditure plans on pie-in-the-sky price forecasts.
ELLIOT WAVEThen there are the Elliot Wave theorists who said that oil prices are not being driven by ever-fluctuating external news events. The “winning” factor behind the market's trend is mass social mood, as reflected in clear and consistent Elliott Wave patterns unfolding on oil's price chart. Some others, including countries like Iran, are sure who is raising oil prices speculators.
They raise these allegations in all fora. Indeed, it is a mystery why speculators in commodities are not making it to any of the Fortune top billionaire lists. Some theorists have said that up to 60 per cent of the current oil rally is speculation driven. Anyway, the Commodity Futures Trading Commission and New York Mercantile Exchange have taken a series of measures apparently to curb speculation or manipulation in oil futures.
It is quite interesting that hedge fund managers, including billionaire George Soros, recently testified to US Congress that speculation has caused the oil rally. Joining him in this argument was a former commissioner of the Commodity Futures Trading Commission and the president of a company that runs gas stations in the US, both of whom essentially said the same thing at a hearing of the Senate's commerce, science and transportation committee.
Some investment banks, for instance, can trade without any curbs on position limits. This has come in for criticism and CFTC is now considering a proposal to reclassify these banks as speculators, which would subject them to trading limits. Global inflation is rising, inflation in America rose 0.8% last month to an annual rate of 4.2% partly due to oil prices and prices of food commodities.
INDIA-CHINA THEORY What happened to per capita oil consumption during phases of industrialisation in the US between 1900 and 1970? It rose from one barrel per year to around 28 barrels. In the case of Japan's industrialisation between 1950 and 1970 and South-Korea's between 1965 and 1990, per capita oil consumption rose from one barrel to 17 barrels. In the case of China, oil demand per capita is still only 1.7 barrels per year, and for India it has only reached 0.7 barrels.
By comparison, Mexico consumes annually about 7 barrels of oil per capita and the entire Latin American continent around 4.5 barrels. Even if India's demand doubles, it will still be lesser in per capita terms with China which is 1.7 barrels per year.
Again, poor importing countries are blamed for subsidising oil which, according to the US, is distorting the market and not enabling conservation of energy or adoption of alternative technologies. Recently the Union government announced the inevitable a hike in petrol and diesel prices by Rs 5 per litre and Rs 3 per litre respectively. This is the second hike in a span of four months.
The move was necessitated to bail out the public sector oil companies that are suffering huge losses on account of selling fuel below cost. Now Bharat Petroleum has hinted that more hikes may be required as oil bonds-based system cannot go on for ever. The crucial issue to be debated is not whether the government is justified in increasing the price at this stage. The most important issue is whether the nation can meet its fuel requirements at reasonable prices if crude oil prices move to $200 levels per barrel as predicted by some experts. What would be the resultant impact of such a price rise on several other commodities and the economy as a whole?
Speculation apart, demand-supply fundamentals don't support lower prices of crude oil from the present levels. This means that the nation should find an alternative to heavily subsidising the fuel prices that would lead to large budgetary deficits. The high cost of crude should make the policy makers think of other alternatives, for example increasing the content of ethanol by even higher levels rather than depend too much on fossil fuels.
The rising prices of crude is a reminder that the nation should look at investment in research and development (R&D) on alternative fuels or more oil exploration within the country's reserves. Both the industry, research institutions and scientistic community should garner their resources to invest in alternative options of energy. Nothing is more puzzling than the present oil crisis which looks far different from the oil crisis of the 1970s. Indeed, the first person who solves the riddle indeed should get the next Nobel Prize in Economics. Any takers? •
This article published in COMMODITY MARKET, India’s No 1 news magazine on commodities.
