Oil@125

Recently, crude oil futures smashed the US $125 benchmark to make a new record, amid worries over production interruptions in Nigeria, Iraq and Saudi Arabia, exacerbated by a further weakening of the Dollar against the Euro. Soaring oil prices, which have grown by over 70% since the last year, will undoubtedly have a negative influence on the world economy, which has shown signs of easing already. In turn, this is expected to have an impact, and probably a huge one, on India.

Is not the price of crude oil rising for no reason now? Has a froth formation started which is soon going to be cleared? May be this is the time to buy some cheap “puts” on the oil. May be not. Yes, our resources of oil are dwindling and are soon to be exhausted in the next century, but why must the prices be so high? Yes, the dollar has weakened but not become a mere piece of paper yet. In fact, initially I read the experts claiming the rise of oil prices due to a weakening dollar (as the benchmark is in USD). Having rallied till much above $100, now I also read analysts attributing return of steam in the dollar as the reason for rising oil prices – basically an increase in US demand as fears of recession allay.

The economic pundits argue that the futures market are an efficient way to discover price. And Oil is the most liquid, most traded commodity in the world. So have the supply-demand equations altered to the extent that there are spikes in the price of oil? Were the markets not efficient when the price of oil was $70 a year ago, or are they not efficient now?

In India, the serving (I prefer not to use the word “ruling”) Congress government is going to be (or already) in a real fix. The subsidies, whether direct and transparent by the government or indirect as in tax cuts, oil bonds and compensation by government owned upstream companies, are a drain on the resources of the government. The losses to the exchequer can only be reduced when the consumer pays the right price for the product. But the rising inflation numbers released every week makes it dangerous for the government to play with the price of petrol.

So whats in the store for India? Are interest rates going to rise because the bonds issued by the government will keep on sucking the excess liquidity in the system and make money expensive? Inflation obviously will be really difficult to put a chain around. Probably, there can be several other unforeseen issues which we may have to tackle with. Lets see what is it that we have.

What we definitely need now is a strong push for research in alternative energy. I am sure at some price of oil, not too distant from the current $125, even the cost of generating power from sun will become cheaper.

For now lets hope the froth gets cleared and there is some sanity discovered in the price of oil.