Friday, January 9, 2009

Volatility in Crude Market

The Liquid which revolutionized the energy sector and transformed the lives of nomadic tribes of barren, desert land of West Asia, made it the world’s most sought-after destination with all the ultra modern facilities, making it the hotbed of international politics, causing various catastrophic wars(Gulf wars, Kuwait war etc.) is nothing but Petroleum.
Its prices have been increasing steadily for past four decades. Just a few months ago crude oil was traded at an all time high price of 147$ a barrel and when it seemed that it is going to touch the magical figure of 200, the prices nosedived and right now it is at 43$ a barrel. The volatility in the prices can be attributed to a constellation of factors.
First let’s look at the demand side factors. There is no denying to the fact with advancement of the world the demand for energy has increased manifold. Energy is the main catalyst in the growth of any nation. With more and more countries joining the path of development and the ever increasing population of the world, the demand of the sweet liquid spiraled, with majority of it coming from India and China. The epitome of this is the Olympics 2008 (the most spectacular in its history) organized by China which increased the prices of the petroleum and other essential commodities, with Indian inflation rate reaching the psychological double digit mark.
And the simple law of economics says that when demand increases supply remaining constant, the price will increase. That is the reason where the cartel OPEC meets as soon as prices starts falling and decides to cut back the production decreasing the supply.
Now let’s analyzing the supply side reason. The most important is the one related to the reserves of the crude oil. Not even a single country has declared the amount of oil reserves it has. With remote possibility of finding huge oil reserve and the fact that the current reserve anyhow are not going to last long leading to lower supply, is the most fundamental cause of rising prices.
In addition, turbulence in Middle East, US led invasion of Iraq, Israel aggression towards Palestine, Lebanon and Syria, has led to decreased exports. Outside Middle East, there is political turmoil in Venezuela and growing instability in West Africa, the other two oil exporting regions.
Moreover the cost involved in extraction of oil has also increased. The easily accessible sources of light sweet crude oil are almost exhausted and in future world will depend on more expensive sources of heavy oil, which is difficult to extract and refine thereby adding to the cost of oil.
There is another group of economists which says the volatility in the prices of oil is not due to the simple game of demand and supply. Instead the prices are rising due to speculation in the market that is trade in Future and Options. [It means that one buys or sells a commodity without actually possessing it and he can cancel the agreement by paying a particular sum]. The Economist (newspaper) pointed out that the “number of transactions involving oil futures on the New York Mercantile Exchange (NYMEX) the biggest market for oil, has almost tripled since 2004. That neatly mirrors a tripling of the price of oil over the same period.” OPEC secretary Abdullah al-Badri says the current world consumption of oil at 87 million bpd is far exceeded by the “paper market” for oil which equals about 1.36 billion bpd (about 15 times the actual demand) The current economic slowdown which has decreased the demand for oil and the slump in the stock market which has subdued the speculation market are the chief reasons for current fall in oil prices.
There are other causes which may not significantly maneuver the prices but certainly have impact. Countries like Iran, UAE, Venezuela want the prices to be high, as they it an opportunity to earn more money which help in their nation building. Therefore they exercise their clout in the oil cartel OPEC and do not let the prices to moderate.
Another area is related to international politics. Russia under the able leadership of Putin has befriended several Middle East Asian countries and is in the process of joining OPEC. It is also putting pressure on OPEC not to moderate prices as it sees this as the rare window to bring the power hungry western Europe and USA on its knees. The current suspension of Gas supplies to Ukraine from which pipelines to Western Europe radiate. Keeping this scenario in mind, USA is toying with the idea of building new pipelines through Turkey coming from Central Asian countries, effectively bypassing Russian mainland.
These are the various causes responsible for volatility in the market. But one thing is sure that prices of petroleum will be increasing with time until any cheap, renewable and green source of energy is not found.

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