OIL PRICES VOLATILITY: CAUSES, BENEFITS AND DETRIMENTS

MULAZIM ALI KHOKHAR
Jan 19 - 25, 2009

2008 has been the best and the worst for both oil driven & industrial economies. During the year the crude oil prices touched skies at US $147/barrel and went down to their 4 years low of US $ 40/barrel. What are the causes of this volatility in the prices?

WORLD CRUDE PRICES 2008 2007 CHANGE
WTI US $/bbl 33 95.9 -65.59%
Arab Light US $/bbl 33 90.6 -63.58%

Definitely the world economic collapse is the root-cause of all evils, which has slashed oil demand and snatched buying powers of economies and eventually reduced oil price world over.

STORY OF OIL SLUMP

During the first quarter 2008, developed economies were in the recessionary period and fund managers pulled trillions of dollars from hedge funds and parked them in energy ETFs. This was the period when banking industry of the developed countries was still strong & quite liquid. The gradual increase in oil prices was offering promising profits on energy ETFs.

But as the banking industry collapsed, the funds in energy ETFs were deleveraged. Along with that almost every economy on the earth slowed their pace (world oil consumption slashed by almost 10%). All these resulted in oil prices diving down to their lowest and the oil prices slashed by about 75% from their peak.

THE BENEFICIARIES OF THE VOLATILITY

The increasing oil prices had created unbearable problems for underdeveloped and developing economies like Pakistan but the recovery and further breakdown in the prices have released the pressures from their economic reserves. The most of the benefits of declining oil prices are being materialized by China that is converting its "world's greatest $ reserves into oil reserves."

Today the oil prices are lower than exploration cost. OPEC has already slashed their production and cancelled new projects, but to finance Government programs and prevent political chaos they need to continue selling at lower than cost prices to earn enough money to carry out their business.

In short, today, most of oil slump benefits are materialized by China while most of the losses are borne by oil producing countries realizing billions of US $ losses.

World oil reserves have started depleting and rate of depletion has been measured at 9% per annum. This is really a bad news for the world. But will the oil prices fall in 2009 and will the supply discipline control the situation, are the questions to be answered.

Oil cartels have failed to bring up the declining prices to their levels. They have cut oil productions to no avail. Supply control factors have failed due to declining oil demand and global financial crisis. Some of the oil giants like IRAN and Russia cannot bear strains of lowering revenues on their economies and thus cannot cut their production further.

Given the problems, if there are no new conflicts inflicted on Iran then analysts are expecting the price to touch US $ 20/barrel; but during the year 2009 they may hover around 50 to 70 US $ per barrel.

BAD NEWS AND GOOD NEWS

Bad news for oil producing countries is that lower oil prices will mean higher risk premiums on their sovereign bonds, weak currencies and reduced development in the sector. The stock market profits for the sectors will also decline and will depress stock market performances world over.

Good news for consumers is that main costs of productions and transportation will decline, which will result in lower consumer prices of goods and reduce inflationary pressures world over.

THE CHANGING SCENARIOS AND PAKISTAN

Pakistan is the net importer of the major oil products consumed by the country. This has major impacts on country's exchange rates and local oil prices.

During the year, the local oil prices had increased on initial hike in global crude prices. This resulted in almost hyper inflation (more than 30%) in local commodities. But when the time came to reverse the trend, it turned out to be impossible.

The Government was short of funds due to huge subsidies on oil products in the wake of increasing oil price; and this time it is bound to withdraw subsidies on diesel under IMF program. On the other hand sharp decline in exchange rate also proved to be a hurdle in the price reversal as the imported oil was costlier than actual. That's why petrol and HSD didn't revert and the prices witnessed 7% and 52% increase in their prices as compared to last year.

Overall, the benefits of sharp decline in global oil prices have never passed on to local consumer in Pakistan. There were very few and minimal drop in local oil prices (when compared to price hikes) and those did never help to reduce inflating commodities prices. Today inflation still hovers over 20%. The Government officials are at loggers' heads to pass the declining oil price benefits to consumers but have failed yet.

What we expect from the Government.... 'Hope for the best!!!'

YEAR END PRICES 2008 2007 %CHANGE
GLOBAL CRUDE PRICES
WTI (USS/ bbl) 33 95.9 -66%
Arab Light )USS/bbl) 33 90.6 -64%
LOCAL EX-REFINERY PRICES
Prtrol (Rs/liter) 18.8 40.8 -54%
HSD (Rs/liter 32 43.7 -26%
Jetfuel (Rs/ liter) 31.4 41.6 -25%
Fumace oli (Rs/ton) 18,650 29,461 -37%
LOCAL RETAIL PRICES
petrol (Rs/liter) 57.7 53.7 7%
HSD (Rs/liter) 57.7 53.7 7%
Jetfuel (Rs/ liter) 36.4 47.9 -24%
Fumace oli (Rs/ton) 23,068 34,985 -34%