The Hindu Business Line : Will oil prices rise even higher?

For the average citizen, rising crude oil prices mean having to pay more for personal and public transport, as well as rise in inflation. Whether the rise in prices continues will depend on the real state of the supply-demand balance in the world crude market and the perception on the part of stock-players of the way crude prices will behave in the world's financial markets.

LAST WEEK, history was created in the international crude market when the price of a barrel of crude oil touched $60 on two occasions. Admittedly, it was not a total surprise because such an increase had been talked about for quite some time.

Even so, the fact that the psychological $60 had been touched raises important questions for the world oil industry, not to mention the associated problems for those economies which are not strong and which rely heavily on oil imports to keep their wheels turning.

The first question which crosses the mind is whether the price rise will continue unabated which, for an average citizen of this country at least, would mean the prospect of paying even higher prices for personal and public transport, not to speak of the rise in general inflation which is likely follow a jump in transport costs across the board. As of now, the answer depends on two things: First, the real state of the supply-demand balance in the world crude market and, second, the perception on the part of stock-players of the way crude prices will behave on the world's financial markets.

To take the second point first, the hot-money investors have already begun playing their game as far as crude futures are concerned, one point of view holding that the price capers on the crude front over the past few months have all been the handiwork of the futures-market players.

It has in fact been said before that a large amount of hot money has flowed into crude-futures in recent months because of, among other things, a dearth of equally attractive investment opportunities elsewhere. This may be true, but, clearly, it cannot be enough for investments to materialize unless the investors have some reason to expect that crude futures will appreciate in value. It is here that the first factor, namely, the crude supply-demand position, becomes relevant in that any talk of a tightness in the crude market will automatically lend itself to encouraging hot money flows into the futures market.

In fact, there has been a lot of talk about the crude supply-demand position being tight, the most important statement in recent times being made by none other than OPEC. The Oil Minister of Indonesia, Mr Purnomo Yusgiantoro, is reported to have said: "Oil demand will increase when facing summer and winter...We (OPEC) are worrying that the tendency is that (prices) will increase". The Saudi Arabian Oil Minister, Mr Ali al-Naimi, is reported to have said that while Saudi Arabia "is able to lift output...there was no demand for extra crude from the world market due to bottlenecks in the global refining system". Such statements cannot but drive market operators into the bull mode, which in fact is perhaps just what has happened.

Providing strong support to the rising crude price is the fact that till now the demand has not been doused to any extent which, among other things, is indication for market-players that crude futures will in all probability rise in the months ahead. The significance of this point should become clear from the fact that since the beginning of the year, crude prices have risen by around 38 per cent, an increase which should have been able to check demand to an extent; the inference being that there is no slack in the system. In other words, as some analysts have said, the global oil supply chain has little spare capacity to deal with any unexpected disruption which, for a futures-market player, is ideal for making fresh investments.

In statistical terms, what exactly is the nature of the demand-supply (im)balance in the world crude market? According to official US figures on the short-term outlook, the total world demand for crude in million barrels per day (mbd) was 82.5 and the total supply 83.0 in 2004, leaving a positive balance of 500,000 barrels a day. The corresponding projected figures for 2005 are 84.7, 84.9 and 200,000, thus indicating the growing tightness of the market.

For 2006, the estimates are 86.7, 86.7 and zero, the inference being that the world crude market will get even tighter next year. The other interesting fact to emerge from this particular computation is that OPEC's contribution on the supply side is expected to increase marginally from 32.9 mbd in 2004 to 34.1 mbd in 2005 and 35.1 mbd in 2006.

Of further interest is the discrepancy between the US and OPEC figures for total world demand in 2005. While the US's figure is 84.7 mbd, that of OPEC is 83.9 mbd, that is, around 800,000 barrels a day less, As for the supply side statistics, OPEC has provided only the first quarter performance for 2005, which is 83.9 mbd against the corresponding US figure of 84 mbd.

However, all is not bleak on the world oil front, if Cambridge Energy Research Associates is to be believed. In a recent report, the Massachusetts-based body says that "despite current fears that oil will soon `run out', global oil production capacity is actually set to increase dramatically over the rest of this decade" leading to a situation where supply "could exceed demand by as much as 6 to 7.5 mbd later in the decade".

The basis for this increase, according to the study, is an expansion in global production capacity for hydrocarbon liquids by as much as 20 per cent over the period 2004 to 2010. The two authors of the study expect supply to "outpace demand growth in the next few years, which would take the pressure off prices around 2007-2008 or thereafter, and even lead to a period of price weakness".

According to them, "significant new capacity will be coming on stream — much of it launched a few years ago on price assumptions much lower than today's market prices".

If the findings of this study turn out to be accurate, the futures players will still have a couple of years left before they are driven out of business by the economics of crude supply and demand. That should be enough for some people to make their millions. But for a country like India, which is importing around 70 per cent of its crude requirement (a proportion that has been increasing with time), the present surge in the world crude price should be treated as a warning signal.

The message is that unless serious efforts are made to step up domestic production of crude and gas, the prospects of rapid economic growth could be threatened.

And this mainly because of the unpredictable nature of crude availability and price on the world market owing to factors which are not always associated with the economics of demand and supply.

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