Thursday, June 12, 2008

High Oil Prices--some observations

It is really interesting to observe the high prices of oil. Today, oil closed at $136 per barrel, which is $3 less than the peak of $139 that it touched a couple of days ago. Let us first look at recent developments--some points and counter-points.

The CEO of Gazprom, the Russian oil company, had said in January that he expects oil to touch $250 in 2009. And soon thereafter, there was a rebuttal of this price by the Chairman of British oil major, BP.

Then I am sure we have heard of Mr. Arjun Murti who works at Goldman Sachs and he's well known for predicting seemingly impossible oil prices and in the last couple of years, his predictions have been proved right to a number of people, who thought he was being too speculative. I don't know how he is able to work it out. But then I guess he is a specialist in his field and you must allow the specialists that kind of freedom, where they should be worth their word. There is a very interesting link on the website of the Society of Petroleum Engineers Gulf Coast Section, where we have details about a talk by Arjun Murti where he predicted a price of $105 a barrel on March 30, 2005. If you look up this link, you can read that even in March 2005, the prediction had sent shock waves throughout the industry. Then you have a December 19, 2005, piece on $105 oil and Murti at Bloomberg website. This also makes for very interesting reading. If I am correct and if what I deduce from the article is correct, then on December 19, 2005, the price of oil was $58. Let us take it at $60. So, in the last two and a half years, oil has gone up by about 2.5 times. e haven't had such runaway inflation or we haven't had such a great fall in the US$ in the last three years which justifies such a peak in oil prices.

The reason for this latest rise is the news that US supplies have fallen unexpectedly for a fourth week. Here is the Marketwatch story.

The OPEC members have repeatedly said that there is no shortage of oil in the market. The billionaire investor George Soros said recently that he believes oil to be caught up in a speculative bubble. The major oil producing nations have also said that there are other reasons behind the oil spike and that there are no supply-side fears.

One reason for the hike in oil prices is a fall in the US $. Oil prices have always been linked to the dollar. The currencies of the UAE have been pegged to the US$. Most of the world's oil is produced in the Persian Gulf but it is sold in New York in the US dollar, which has kept its prominence as an international currency. It is this lack of sheen in the dollar that is aggravating the crisis. But what is this connection between the fall of the US dollar and the rise in oil prices? Let me explain. The dollar has been the most stable currency in historical terms. Most nations have their foreign currency reserves in dollars or dollars form a major part of their reserves. When the dollar drops, the second most stable thing to buy is oil futures. This is also a hedge against the fall in the dollar. So, the more the dollar falls, the more there are fears in the markets and the more oil would become expensive irrespective of the oil supplies. Also, other commodities would become costly as well. The fall of the dollar also leads to a rise in gold prices for the same reason.

So, how do the Americans rein in the fall in the dollar? That's a tough question. They would need to restore confidence in the stock markets. There are problems galore in the US stock markets--there was the subprime, and there have been too many job losses. It is indeed frightening. I wouldn't like to work in the United States and feel I am quite lucky to be working in India.

I teach this course called English for Media Communications to journalism students at MCRC in my University, which is one of the most premier media institutes around. Last year, I had given an assignment to the students where they were given few articles to read and then write a feature based on those articles or on further reading that they might have done. One set of articles were on Energy. I had culled a number of articles from the Financial Times, London, for their excellent coverage. I remember an article published on November 9, 2007, by Ed Crooks, where he says:

The price of oil is a temperature gauge for the world’s energy system – and at $95 a barrel for US crude, it is showing that the system is seriously overheated...China and India between them have accounted for about 70 per cent of the increase in global oil consumption over the past seven quarters, with oil-producing countries accounting for much of the rest.
On November 14, 2007, I read in the Financial Times that the OPEC had rejected US calls for an increase in production. Let me quote the Opec Secretary General:

Abdulla El-Badri, Opec secretary general, said that there was “no shortage of oil” in the market and deferred any decision on production to the next ministerial meeting of the oil producers’ cartel in Abu Dhabi in December.

Mr El-Badri said, however, that the the “US should help to resolve the problem” and enumerated several factors, among them bottleneck in refining, geopolitical concerns and the weakness of the US dollar, that were affecting the oil price.

“The US has not invested in refining capacity in 30 years. The refineries are operating at 80 per cent. That is not adequate,” Mr El-Badri said. “We have also the problem of the dollar,” the secretary general added.

So, it seems that the Opec is quite genuine about what it says. And despite what a respected investor like George Soros says, I am sure that the oil prices are going to be on the higher side for the whole of 2008. Unless, they come down to $110-$115 levels, I don't foresee any fall. So, even if we are really caught in a speculative bubble, we are there and we need to face it. And there may not be short term, quick fix solutions to the problem. There should be good, long term solutions.

Those would surely help.

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