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Energy: Price spike or reality?

Jul 5, 2001

Crude oil has been much in the news over the past year, as prices of the natural resource scaled 20-year highs of $30 / barrel. Oil prices have now been trading above $20 / barrel over the past two years.In 4QFY01, as the northern hemisphere came out of the winter months, oil prices declined from their highs to approximately $26 / barrel during this period. Anticipating a decline in global oil demand, having seen the back of high consumption months, the Organisation of Petroleum Exporting Countries (OPEC) cut back on oil supplies by an aggregate 2.5 m barrels per day (mbd) in early 2001. Following the cut back, however, were the high consumption months of motor spirit with the onset of the summer season, which ate into oil stocks. Further, with Iraq playing truant in the oil markets by cutting off exports the seeds for a fresh rally were sowed. Crude oil prices climbed their way back to $28 - $29 / barrel in the first two months of 1QFY02.

Oil importing countries could be breathing easy, as oil prices have declined over the month of June by an estimated 14%, back to $25 / barrel. However, the drop in prices could be more out of the deteriorating health of the global economy, which in itself is not very encouraging. The U.S economy continues to sputter along as economic indicators reflect conflicting trends. The Japanese economy has once again slumped into negative growth and key European countries, part of the European Union (EU), have registered slower economic growth. However, much of the growth in incremental oil demand is from fast-growing Asian economies, especially China, which is now the third biggest burner of crude. Consequently, hints for crude price movements and consequently OPEC action could depend on economic growth in the Asian region and whether the 'slowdown' malaise afflicts these economies.

The OPEC, which met on July 3 to review their production policy, this time around, probably had a cakewalk in light of the above economic developments. The cartel has decided to leave the current production levels untouched. The uncertain economic environment and a build up in global oil stocks has kept the cartel wary of any supply hike, in an effort to prevent a slump in crude prices. The cartel has stated $25 / barrel, as its preferred price of crude. The OPEC meets next in late September to review the global energy situation. Oil markets, however, are apprehensive of the large gap between the two meetings, as Iraq continues to threaten to stay out of the oil markets. The rogue producer contributes an estimated 3 mbd or 4% to world production. Further, the Northern Hemisphere once again is moving into the high consumption winter months, which could draw down oil stocks leading to a run up in oil prices. One hopes it does not result into a price spike similar to last year. The OPEC may need to stay on guard to turn on the taps.

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