Thursday, 18 June 2009

Get used to oil price in three digits

The price of crude oil has climbed steadily to $70 a barrel. Its of course, way off, from the peak of $147 it touched in July ’08. But its been climbing steadily over the last couple of months. Two major events await us in the near future.

The first is inflation. Its already a big risk because of the massive amounts of money governments, the world over, have been pumping in to ward off the recession. When oil prices shoot again, everything is going to be affected. Inflation will hit the poor most – the price of food will rise. Many governments will be tempted to subsidise the price of oil and public finances will become a further mess than they are, in most countries. Inflation is going to be a killer ; unfortunately there’s not much that we can do.

Governments should have been acting through last year. When the price of crude oil fell to just above $30, they should have been creating a fund to cushion the inevitable rise that was to come. Nobody did this. Governments who control the price of oil in their countries should have been steadily increasing consumer prices in small doses. But that’s not a politically convenient thing to do; so nothing was done. “Cheap Oil” is an oxymoron. We’re in for a killer increase.

The second major event is the greatest transfer of wealth in human history. All of us, the world over, will transfer a huge portion of our income to fatten a small population in the Middle East & Russia. Sure, this is a free trade and not coercion; the price is after all determined in a free market. But oil is not just any other product, Like it or not, in the way we live, oil has become a necessity, like water and air. When the price of something as basic as that shoots up, it has a major impact on the world. In the long run we can adjust, but in the short run the pain will be high. This has profound social and geopolitical consequences. All of us will lose and a small percentage of the world’s population will gain immensely. History has shown us that when a few enjoy at the expense of many, a revolution starts.

This sounds like a doom and gloom post. Unfortunately, that’s how I see the near term future. We better get used to oil price in three digits. Oil, I’m afraid, is going to become a four letter word.


  1. All that is playing in my head is the "We ll overcome/Hum Honge kamyab" I don't know how it fits in what you say but I hope it does, atleast for the poor people's sake. When prices of oil falls or rises, lifestyles of people like us doesn't change too much, but the poor pay a very cruel price and that's what should not happen. :-(

  2. Sorry AJCL - One of those days when it all seems grim !!

    @thoughtful train - Honge kamyaab zaroor. But its not looking rosy.

  3. Same time last summer, gas was $4.00/gal.This year it is $2.89/gal.The giants play the price games (including heavy retirment packages) and the common man cancels his summer outings.We can only hope that things improve.When I landed in the States so many years ago, gas was $.50/gal.Funny to think of those days and wish.......

  4. You are right, Ramesh, about inflation shooting up because of oil. And that being supplemented by the infusion of money by governments to stave off a recession.
    What you were saying about governemnts stocking up when crude was at USD33 is slightly misplaced. No doubt USA did that or rather it happened to them. There were constant build ups (indicating slowing demand) in the weekly US oil inventories data released during Jan-Feb-Mar. Which was a feedback loop - driving the prices further down. But most countries could not have done much to stock up crude. As USD 33 was already an aberration (just like USD 147 high was). The succesive month future contract was already trading at a $7 to $8 premium (which was insane by any standards as it was a clear cut arbitrage - if you buy now, store for 1 month and sell the next month storage costs were less than the spread. Ultimately storage costs also went up because of this). So to stock up crude would mean either have enough storage to take physical delivery now and consume later (which is difficult as world's average demand for 2008 is 86 million barrels per day of which almost 25% is due to US alone - so storage needed would be Huge). Or buy succesive month futures which were already at a premium (although cheaper than the present USD70 a barrel). The M0 future is hovering around USD 70 while M1 is at around 70.5 and M2 already at 71.5.
    Indian government has recently proposed to let petrol prices float freely as per international crude prices as long as crude stays below $75 a barrel. A step in the right direction but alas a little too late - just as crude seems set to break the $75 mark. The opportunity when crude was at USD 33 was well utilised by Indian Govt (although a bit short-sightedly) as they used it to wipe out the losses that all the PSU refineries were making when crude was at super $100 levels and petrol prices still ceilinged at Rs 52 a litre. Petrl has since come down to Rs42 now. But this cut in prices was done after all the initial losses were recovered.
    I don't think it is as much a doomsday scenario. As alternative energy sources should soon reduce dependence on crude. The bankruptcy of GM is also a signal that the era of fuel guzzling SUVs and V8 engines is gone and it's time to welcome the Tata Nano :) Also a rally like the one leading upto $147 last time is not expected anytime soon.

  5. Sorry! But couldn't hold back as it's crude only that I trade. :)

  6. Ramesh, you have been tagged! :-)

  7. @ Ajay - As always a superb comment from you. I didn't know you trade in oil - so obviously I defer to the expert. My thought was not that governments should stockpile or cover massively forward - there's an obvious limit to how much can be done. I was more arguing for dripfeeding consumer price increases and getting consumers used to higher oil prices. Your point about alternative energy sources and the death of the gas guzzlers is also very valid.

  8. Quote: "When the price of crude oil fell to just above $30, they should have been creating a fund to cushion the inevitable rise that was to come."

    How would such a "fund" have worked in practice?

  9. This pertains largely to developing countries, including India and China, where the end consumer price of petroleum products is controlled. When oil prices fell to $30 most of them reduced end consumer prices. I believe they should have actually kept on making small increases and accrued the profit in a pool account which cushions the impact on consumers when oil prices suddenly shoot up. Most countries run such a pool account which unfortunately goes massively negative and results in a taxpayer subsidy for oil which is completely unwarranted.

  10. Makes sense. As far as I'm aware, China didn't lower petrol prices, though, so the Chinese apparently acted more responsibly than other developing countries.


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