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Thursday, Sep 30, 2004

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Oil on a high

IN A MARKET already stretched, very little adverse news is necessary to make it snap. Literally hit by a hurricane last fortnight, global oil prices were swept up to $50 a barrel. Hurricane Ivan that ravaged the Gulf of Mexico shut down production in one of the most important oilfields in the world that fuels the US. This and the renewed civil strife in Nigeria that threatens to take more supplies off the stretched global oil market were enough for prices to breach new barriers and the current momentum looks set to take them to newer levels in the days ahead.

About 2 per cent of the annual production from the Gulf of Mexico is reported to have been lost the last fortnight alone and the shutdown of the wells has taken almost half-a-million barrels a day of oil out of the system. This shortfall will alter the global demand-supply situation as the US seeks to replenish its drawn-down inventory ahead of the approaching winter. Not helping matters is the continued problem with Iraqi supplies, struggling to reach normal levels. The basic point is that with the global oil demand averaging 82 million barrels a day and production barely above that, the margin of safety is rather thin, and such events as Hurricane Ivan and the Nigerian strife tend to send the market into a tailspin. Assertions by the Organisation of Petroleum Exporting Countries that it has at least another 1.5 million barrels a day of spare capacity notwithstanding, it appears prices are not going to retreat in a hurry. The problems in Nigeria and Iraq do not bode well for the near-term prospects and the burgeoning appetite of China for oil will keep prices buoyant. Besides, soon it will be time for countries in the Western Hemisphere to start stocking up for winter heating requirements which will be another additional factor weighing on the market. Therefore, there appears little prospect of soft oil prices in the near term.

The Government must be watching the latest developments in alarm as the benign effect on domestic prices of the last tranche of adjustments in taxes and duties has been overwhelmed by the latest spike in global prices. It is decision time yet again for the Government confronted with the choice of either further tinkering with taxes and duties, with the resultant adverse impact on revenues, or allowing domestic prices to rise with the baneful impact on inflation. There is already talk of the Government thinking of adjusting the duty structure and shifting from ad valorem rates to specific duties for products. While this is a good idea, the Government may also have to revisit the proposal to reduce the import duty on crude oil, which is 10 per cent now. Even a 3-5 percentage point reduction in this can have a big impact on retail product prices. If necessary, State governments should also be persuaded to have a re-look at their own levies that add sizeably to the final retail price. From a larger perspective, now is the right time to put in place a dynamic taxation system wherein levies move antithetically with global oil prices so as to keep retail prices within a comfortable price band. Besides being transparent and efficient, such a system would also lend the sorely needed stability to energy prices.

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