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Energy: Good news, bad news

Feb 21, 2003

The end of the two month long US-Iraq stand off does not seem in sight. With the US pushing for armed action against Iraq, fear of supply disruptions has pushed crude prices to a two year high last week. However, the latest reports from UN weapons inspectors indicating no concrete evidence of Iraq possessing weapons of mass destruction (WDM), concerns have eased a bit. Increasing anti-war protests across the world, including the US, and backing by the other security council members for a diplomatic solution to the current impasse has resulted in easing of pressure on crude prices, which declined marginally yesterday. The good news therefore, is that in the short term it is likely that the pressure on crude will ease from the current levels, as stockpiling and reserves building by refining companies across major consuming markets will gradually reduce. Since India imports over 70% of its crude requirement, easing of pressure on crude prices will come as a relief, as it will reduce the import bill and save valuable foreign exchange. The good news, however, ends at that. This is because we believe that even in event of possible diplomatic solution to the current US-Iraq stand off, crude prices will continue to remain above US $30/ barrel in the medium term.

There are several reasons for that. Let's take a look at them one by one. First, during the current year the global demand for petroleum product has increased at a healthy rate (2%) resulting in an increase in demand for crude. Second, supply of crude has been lower due to lower output from the OPEC as a result of the Venezuelan crisis. Its must be noted that Venezuela contributes significantly towards OPEC's output, but is currently producing only around 50% of that. Third and most important reason is that US strategic reserves have plummeted to 270 million barrels (the minimum level prescribed by the US government) and hence it goes without saying that it will need to scale up its imports of crude in the medium term.

These factors will deter any sharp decline in prices of crude and therefore average YoY increase in crude prices for the current year is estimated at over 30% to US $ 29.5/ barrel. Though India is contemplating to build its own strategic oil reserves along the lines of those in the US, it seems bad timing keeping in mind the current crude price trends.

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