Anarchic Analogy

Oil's on the boil. Yes, this phrase is making headlines across channels over the past few months. Sometime back, it broke through the 100 Dollar mark and is all set to breach 150 Dollars in the near future (considering the rapid rise in Crude price in the month of May). Even the government is now considering a raise in the petrol and diesel prices to offset some of the losses that the Oil Marketing Companies are suffering.

Even if the rising price of Crude seems to be a gospel truth, it hides more than it reveals. A price rise, by simple economics, is the result of increased demand and the inability of supply to keep abreast. However, in the case of crude, it is not that simple.

All newspapers and channels keep on harping about Crude breaching important levels, but few tell you that the price being quoted, is the price at which the 'precious' commodity is being traded on the bourses, specifically, the NYMEX. Essentially, it's the price at which Crude 'Futures' are being traded. Although my more informed peers might argue, future trading, is nothing but gambling for the intelligent. It's basically quoting a price at which the particular commodity would trade in the future, and the inherent speculative nature of the transaction leads to a situation of artificial price rise. My informed peers would argue that there is no conclusive fact to support this theory, but a look at the mechanism (with some amount of common sense) would clearly reveal that the picture is a lot more murky.

The price rise in Crude, even according to my 'informed' peers and 'experts', has been most unnatural. Although there is no denying this fact that we are rapidly running out of this precious commodity, nothing in the recent past suggests that such a sudden rise is justified. Infact, International Energy Agency report suggests that in the world's largest market for oil, the demand has actually decreased. The USA is the largest consumer of Oil and oil products in the world, but due to an impending recession the demand has actually reduced. Infact, IEA has even revised its target for consumption of Oil in the USA. (Just to give an idea about the 'largeness' of this number- USA consumes more oil, than India and China combined) . The other oft stated reason for the rise in prices is the increased demand in China and India. Well, to be honest, the demand has increased and has increased significantly, but this is no surprise. Infact, the growth in demand has been in accordance to IEA estimates.

If the demand side story seems a bit surprising, the supply side tale is even more interesting. Oil production has 'increased' by a considerable amount and most of the oil wells are producing at peak capacity ( According to IEAs report current Oil Wells across the world are supposed to have peaked around 2006 and would continue to show peak production for a few years before the figures start to show a decline). OPEC is at peak production, and except for the Eurozone countries the rest of the world is producing more oil now than they ever did! (Just for the record...Eurozone's oil production is almost negligible)

So, is there any justification for Crude's northward trip? Is NYMEX the benchmark? Is future trading the right mechanism for price discovery? Probably not...probably yes. Probably this is the Crude Reality staring us in our face!