The Hindu Business Line : Oil may soon begin to hurt

MARKETS on both sides of the Atlantic cheered as oil fell from its all time high mark of $67.10 last Wednesday. The mid-week slide in the crude to $62.25 came despite a lower build up in crude inventories and a higher draw on gasoline inventories than what was expected before the weekly report by the Energy department.

Why then did crude fall? Well, a simple OPEC confession that China and the US were consuming oil at a reduced rate. That was a sharp tug on the rug under the hoofs of the oil bulls. While the stampede to book profits in long oil contracts was understandable there was no reason for the equity bulls to come snorting back.

Last year, two-thirds of the world's incremental oil demand came from China. But if China, the engine of world economic growth, and the US, which consumes 25 per cent of the oil production, are beginning to feel the pinch, can the stock markets continue to play Nero?

While the Indian consumer may well have been saved by the protective arm of the Left, for all we know, it may have already begun to hurt the world economy. Statement by the Wal-Mart's CEO, Mr Lee Scott, last week that high gasoline prices are crimping consumer spending is a first admission by an industry leader that crude prices are beginning to hurt. The Lowe's CEO, Mr Robert Niblock, also voiced the same concern.

Crude inventories in the US are at a six-year high. The world in general is sitting on a 56-day inventory as against 54 days last year. Despite this, we have crude which refuses to come down. The primary reason is the reduced spare capacity, which now stands at around 1.5 million barrels a day, exposing the commodity to frequent spikes triggered by supply concerns.

Failed rocket attacks in Jordan, though itself a non-exporter, and turmoil in Ecuador, which saw production tumbling by 1,80,000 barrels, saw oil climbing back to $65 level at the end of last week. Refinery fire in Venezuela and reduced oil output in Nigeria reminded the markets how fragile the world supplies of crude were.

The biggest issue on hand is Iran, OPEC's largest oil producer after Saudi Arabia. Iran last fortnight rejected a resolution from the United Nations nuclear watchdog agency urging it to freeze its uranium processing program, and vowed to become a nuclear fuel exporter within the next decade. With Bush having said that all options, including use of force, are on the table, Iran's continuation of its processing may prod the European Union to move the UN for sanctions. Even if Iran cuts its production by one million barrels, a fourth of its capacity, it will be enough to send oil futures soaring to $75.

While Russia and China may intervene and prevent Iran from going on a collusion course, the markets will have to deal with a very active hurricane season in the Gulf of Mexico, which has already seen arrival of nine tropical storms and another 12 are expected in the remaining period till November. While the US oil facilities have been spared by the earlier storms, the law of averages favour at least one direct hit by the yet to be born storms.

Political compulsions have prevented the Government from hiking fuel prices. But as things hot up on the crude front, it is not a question of whether but when. The BSE Sensex has technically posted the 16th weekly positive close, another record. But the weekly closing for the Sensex has been in the region of 7754, 7767 and 7780. That means the Sensex has moved just 26 points in three weeks.

Should the benchmark tumble below the crucial 7727-mark, investors could look at entering the oil ancillary and alternate energy sectors for refuge.

The author is Director and Head of Research, Anagram Securities Ltd

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