Crude Oil Prices Drops But Still Too High

After touching a record high of 147.27 dollar per barrel on 11th July, currently the crude oil prices is hovering in range of 110-120 dollar per barrel. A drop of about 20 percent from the peak level.

This is a matter of relief to everyone as this has lead to reduction in food item prices like Soyabean oil, Palm oil, Corn etc.

However, oil prices are still too high if we look into the current demand-supply situation. As per The International Energy Agency(IEA) report, at the end of June, the production at 86.4 million barrel per day (mbpd) exceeded the prevalent demand of 86.2 mbpd.

If we compare current oil prices with previous year prices, these are too high. It clearly shows that still speculators are manipulating oil prices.

Therefore, I feel we should continue our reduced oil consumption for personal transportation for next 2-3 months as well so as to check the rampant speculation.

Moreover, as far as possible, we should avoid consuming imported fruits and vegetables. For example - In India, starting of organised retail like Reliance Fresh, Big Bazaar etc. had made imported fruits and vegetable available to common man. And, at times we do consume these for change and pleasure even though local farm produce are available in plenty. A lot of hydrocarbons are consumed in transportation and storage of these imported perishables.

By avoiding consumption of imported perishables, we can reduce the oil demand which in turn will soften Crude Oil prices.

A powerful strategy to bring down the Crude Oil prices

All of us are hit hard by high and rising Crude Oil prices. Since the grains are being used to produce bio-fuels, food prices too has risen sharply. Due to rise in both food and fuel prices the inflation is scaling new heights across the globe. In India, current inflation rate is at a 13 year high.

Production cost and Demand-Supply situation

Most of the nations, for their oil need, are dependent on OPEC (an organisation of 13 oil exporting nations). For OPEC nations, the production cost of one barrel (1 barrel equals 158.9 litre) oil is around 15 to 20 dollars(Source: Business Today). In last one year, world oil consumption has increased from 85 million barrel per day to 86 million barrel per day. However, the oil production is stagnant at last year level of 85 million barrel per day.

Abnormal Oil price rise is due to speculation

Even though there is only 1.2 percent mismatch between demand and supply, the oil prices in last one year has doubled from about 70 dollar a barrel to 140 plus dollar a barrel. Clearly, this abnormal rise is not reflecting natural market forces of demand and supply.

This abnormal rise in oil prices is a result of very high level of speculation taking place in oil futures at NYMEX in New York and ICE Futures exchange in London. As per one estimate, speculators have taken huge positions of more than 12,000 billion dollars which is roughly seven times of world's annual oil bill of previous year(Source: The Economic Times). Since OPEC decides actual delivery prices on the basis of prevailing future prices, therefore, we (the oil consumers) are forced to pay an additional speculative premium. According to some experts, this premium is about 50 to 60 dollar per barrel.

The OPEC's inaction

World's top leaders including US President George Bush have requested OPEC to increase oil production and thereby check the price manipulation by speculators so that oil prices may come down and adjust to their natural level as guided by true demand-supply forces. However, OPEC is not interested in increasing oil production and thus leaving oil prices for manipulation by speculators.

Alternatively, Even without raising production OPEC can stabilize oil prices by completely disconnecting delivery prices from future market prices. If OPEC starts delivering oil at a fixed price for example @ 80 dollar a barrel, irrespective of future market prices, then even future prices will cool down immediately.

However, by not taking a positive step, OPEC is indirectly supporting speculators.

Windfall gains to OPEC nations

In fact, OPEC has vested interest in high oil prices. At current price level of about 140 plus dollar a barrel, the OPEC nations will get 1,000 billion dollars extra, for same oil quantity, in current year compared to past year. And, this amount is equal to India's last year GDP i.e. the value of goods and services produced by 1100 million Indians in the whole year. And don't forget, India is world's tenth largest economy. In this manner, non OPEC world's wealth is quickly transferring to OPEC nations.

Why Oil prices will not come down ?

We are bound to have high energy prices situation in future also because following factors which are working in favour of speculators today may continue in future as well :

1. The unwillingness of OPEC to raise production or disconnect delivery prices from future prices.

2. Low margin requirement in futures market is giving enormous financial leveraging to speculators. Currently, it is about 6 percent which means to take position of 100,000 dollar one is required to pay only 6,000 dollar as a margin. This gives speculators a financial leverage of about 16 times of their money.

3. The low cost of capital. Since last year, when US sub-prime (bad housing loan) crisis came to surface, the US central bank Federal Reserve has continuously reduced interest rates to save the real economy from going into recession. This low interest rate is a boon to speculators.

4. The constant depreciation of dollar against other major currencies like euro etc. is prompting speculators to hedge their dollars in oil futures. The trend of dollar depreciation may continue is a common perception.

All this shows that we, the oil consumers, are totally at the mercy of producers (OPEC) and price manipulators (speculators) and are bound to pay exorbitantly high prices for our energy needs. Moreover, recently OPEC Chairman has indicated that oil prices may rise to 150 to 170 dollar a barrel in coming months.

Damaging effect on global economy

In addition to quick transfer of non OPEC nations wealth to OPEC nations, these high crude oil prices will damage global economy seriously. As per an IMF research report, a permanent 5 dollar a barrel rise in oil prices reduces world GDP growth rate by 0.3 percent(Source: Business World). It may be noted that last year world GDP grew by 3.7 percent. The rise of about 60 to 70 dollar a barrel in oil prices in last one year, if it sustains at these levels, will not only reduce world GDP growth drastically but may even trigger a global recession.

Due to slowdown in global economy, there will be large scale of job cuts across the globe and millions of people will become jobless. Grains, in larger quantity, will be diverted for production of more bio-fuels as a oil substitute, which in turn will take already high food prices to newer heights. This will hit hardest the poor people. Millions of poor people will be forced to die of hunger. Out of desperation, many of them will indulge in food riots, a phenomenon we have witnessed in recent past in more than 30 countries.

Rich people, especially of oil importing nations, will not be spared either. They will see massive erosion in their wealth. Sensing the possible global industrial slowdown, Industrial Assets i.e. Shares are biting the dust all over the world. Real Estate prices are also on southwards journey. In India, bank deposits have already started giving negative returns i.e. inflation rate has exceeded interest rate. This may be true in other countries also, I presume. The negative wealth effect leading to reduction in consumption and investment will accelerate economic downturn.

Our collective action is the only solution

The crude prices has taken world economy into a danger zone. In today's integrated global economy, we all are interdependent and our fortunes are linked. Therefore, all of us are bound to face dire consequences of high energy prices. Should we silently watch OPEC's inaction and oil speculators price manipulation? I feel, we should not. Then, what should we do? I have a two pronged action plan as detailed below :

1.Reduce oil consumption : We, the oil consumers of non-OPEC nations (as OPEC nations citizens are rather insulated) in general, and individual vehicle owners in particular, should take a collective step to reduce our personal transport oil consumption by 10 to 20 percent in litre terms for next few months. Since personal transportation accounts more than one third of global oil consumption, hence, our collective action will result in about 3 to 6 percent lesser global oil demand. This will completely reverse the demand-supply equation. In the changed scenario of supply exceeding demand, speculators will not be able to hold prices higher for a longer period as they will be forced to unwind their positions. And, this will bring down oil prices.

2.Make protest for margin rise : My US friends should make a strong protest to their government to direct NYMEX to raise margin on oil futures from current level of about 6 percent to the higher level of say 25 to 50 percent. This will reduce financial leveraging power of speculators considerably and will force them to cut their positions. As a result, crude prices will start downward journey. My British friends should also initiate a similar action for ICE Futures Exchange.

Dear friends, if you feel that by above strategy we can collectively bring down oil prices then please tell your friends and relatives to visit this blog so that we can trigger a collective action globally. In case, you are authoring a blog, please make a link to this blog.