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Why are global crude oil prices out of control?

business Updated: Jul 02, 2008 00:42 IST
N Chandra Mohan
N Chandra Mohan
Hindustan Times
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Why are oil prices relentlessly rising? The current mood is to blame speculators for their inexorable increase to $150 a barrel, a surge that has little to do with demand-supply imbalances – the stock in trade of textbook economics. Global demand for oil this year is pegged at 86.6 million barrels per day while global supply is almost identical at 86.7 million barrels per day, according to the US Energy Information Administration. Global oil supplies, thus, are more than adequate to meet demand this year.

What is triggering speculation is that market participants believe, rightly or wrongly, that the world is running out of oil. “A ‘shortage psychology’ certainly seems to have become widespread in financial markets as prices have gone up,” observed Daniel Yergin of the Cambridge Energy Research Associates in his recent testimony to the Joint Economic Committee of US Congress. “This psychology is based partly on current market conditions and partly on expectations of tight markets for many years to come.”

The market’s perception of oil shortages is reflected in the behaviour of spot and futures prices of late. The price of oil on any given day, typically, is higher than the price of oil delivered at some point in the future. But of late, the futures prices of oil have been higher than current spot prices, clearly indicating worries over supplies with time. Oil for delivery four months later ranged between $133.27 a barrel and $137.78 a barrel during 17-24 June, 2008. Spot prices stood around $131.88-136.49 a barrel.

The global oil shock, thus, is reverberating through Indian stock markets. As prices stubbornly remain in double-digits, market sentiment apprehends a tougher monetary stance from the Reserve Bank of India. As interest rates now are negative, there is obviously scope for raising them further to curb industrial growth and household demand. With growing outflows from foreign institutional investors, market sentiment is likely to remain in a bear hug for a long while.