IN THE WAKE OF ROCKETING OIL PRICES

SHAMSUL GHANI (shams_ghani@hotmail.com)
Dec 03 - 09, 2007

ALARMING SCENARIO

Although high on the political agenda, the Nov-18 OPEC summit was hardly expected to announce any revolutionary measures. The hard hitting rhetoric of the Venezuelan president and a somewhat low key assertions of his Iranian counterpart were summed up in a reconciliatory summit closing statement assuring adequate, timely and sufficient oil supplies." The much talked about change of transaction currency from US $ to either Euro or a basket of currencies was put to the back burner. This was obvious on two accounts: i) few were prepared to meddle with the wounded tiger and ii) most of the OPEC's assets and Chinas reserves are in US $ and any abrupt shift to any other currency would immediately depreciate the value of these assets / reserves.

The current year has seen a steep rise in oil prices an average rise of 64 per cent. Till early September, this year, oil was trading below $70 a barrel in the wake of US sub-prime mortgage fiasco. As a consequence of some half hearted US measures, the sub-prime pressures eased and the oil resumed its upward journey. After September 13, the oil has been trading over US $ 80 a barrel. Since mid November, the prices have managed to move in a bend of $95 - $100. The following table shows the movement of prices during the last two weeks :

DATE

NEW YORK'S MAIN CONTRACT FOR LIGHT SWEET CRUDE (US$)

LONDON'S BRENT NORTH SEA CRUDE (US$)

DELIVERY

16-11-2007

95.13

90.94

December 07

19-11-2007

94.56

92.10

January 07

20-11-2007

95.61

93.26

January 07

21-11-2007

98.19

95.76

January 07

22-11-2007

97.23

94.99

January 07

26-11-2007

96.80

95.10

January 07

27-11-2007

96.41

94.28

January 07

It was in November 1998 when the oil prices hit last decade's lowest at US$ 11 per barrel. Thereafter, for a few years, the prices moved between $28 and $40. It is during the last five years that the prices have more than trebled. Although the situation appears to be eased out a bit with OPEC's resolve to maintain sufficient supply, yet the under production by the countries outside the OPEC, the ever rising consumption level and the war of oil reserves raises a big question mark particularly for the developing countries

THE GRAVITY OF THE ISSUE

The issue of looming energy crisis has found a central place in the economic policy design of world economies. It has assumed some serious political dimensions to threaten the world peace. The implementation of Bush administration's aggressive policies is a reflection on the depth and magnitude of this issue. When George Soros, the well known hedge fund manager says The core of the crisis is the tight supply situation for oil , one shudders to think of the alternatives in case the supply position is not eased to the liking of world bosses.

Alan Greenspan, the former US central bank head admits in his recent book The Iraq war is largely about oil." One can expect a similar statement on "Iran War" from an American writer a few years later. This may sound cynical but a mere glance at the following simple statistics may reveal a lot to the discerning mind.

REMAINING PROVEN OIL RESERVES

PRODUCER

RESERVES TO LAST

Middle East

80 years

Venezuela

78 years

Kazakistan

70 years

Africa

32 years

Russia

22 years

China

12 Years

United States

12 years

The two countries mentioned at the bottom form the nucleus of the problem. China, in the capacity of a major oil consumer of Asia is in a position to influence the output and price levels. Moreover, its annual consumption rate has risen at a very high rate of 7.7 per cent since 2000 as against a constant rate of domestic oil production in the absence of any new recoveries. Its major oil supply comes from Middle East. On the other hand, the depleting reserves of United States and its ever rising rate of oil consumption may end up in an eyeball to eyeball confrontation with China. Other economic and political reasons to fuel this confrontation also carry weight.

The rising rate of consumption in Middle East too is a cause of concern as without a constant increase in production, the level of export to the outside world can not be maintained. United States" relationship with the present Venezuelan government is by itself a flash point. Is the smoke screen of "war on terror" about to vanish in thin air to be replaced by thick dark clouds of "war of oil reserves"?

The soaring oil prices give rise to oil security risks. The geo political situation is a constant threat to the three major oil producers, Saudi Arabia, Iraq and Iran.

OUR OPTIONS

In the given scenario, the options available to our government are :

(A) LONG TERM:

1. Take measures to increase domestic oil production

2. Go for alternate and cheaper sources of energy.

3. Increase exports to pay off the import bill

4. Cut on luxury and non-productive imports

5. Reduce oil consumption by professionaly managing and oeganizing the transport sector. Identifying new mass transit projects and encouraging pool car tarvel habits.

(B) SHORT TERM:

1. Pass on the burden of high oil prices to the end consumer

2. Increase subsidy

3. Reduce the margins of oil marketing companies.

4. Reduce custom duty on import of oil

In the existing political scenario, the present government set up is least likely to exercise options 1 & 2. They are likely to pass the buck to the incoming new set up. What they can do and should do is cutting down on the margins of oil marketing companies both in the public and private sectors. Last year, the government earned Rs.176 billion on energy. It can counter the high oil prices by reducing custom duty as well as tightening the margins of oil marketing companies instead of passing on the burden to the people which in turn will further flare up the inflationary situation. This is exactly what our neighboring country India has been doing to save its people from oil based inflation although its core inflation rate is less than 3 per cent.

Writes Anand Kumar in Daily Dawn:

"All three oil giants are neck deep in debt and their balance sheet awash in red ink; total losses sustained so far this year because of the failure to raise prices adds up to a whopping Rs.700 billion."

For our part, we don't want to make our oil marketing companies" balance sheet awash in red ink. We just want to cut their inventory profits to normal and give relief to our masses. Will the interim set up take lead and write something positive in their short tenure record books?