• AUGUST 30, 2005

Colour of oil is...

Black? Green? Blue? Whatever! That does not matter, at least when the global crude prices have breached the US$ 70 per barrel mark. But, is anyone listening! At least, the Indian equity markets do not seem to! This is when the importance of understanding the impact of such high crude prices is all the more important because of the increasing role of India in the global economy and the high level of dependence that the country has on external sources of oil.

Readers should note that, apart from the traditional big oil consumers like the US and European counties, there has emerged a new group of developing nations that threatens to upset the crude demand-supply balance in the world, as it seems now to be doing. And especially with these economies growing at a much faster and sustainable pace than earlier, energy demand in the transportation, industry and residential sectors continue to gallop.

Now, should policymakers be concerned about the developments in the global oil market? The International Monetary Fund's World Economic Outlook for 2005 states that recent oil price spikes may have a major impact on the global economy with world GDP growth expected to be hit by 0.7%-0.8% in the current fiscal. The report further indicates that the impact of rising crude prices could be stronger in the developing world 'that faces external financial constraints. Besides generating price volatility, the current lack of spare production capacity also makes oil-importing economies, especially in the non-OECD region, vulnerable to supply disruptions.'

A case in example is the recent 'Katrina' storm in the US that has disrupted supplies causing crude price to spike by over 5% in a single session to cross the US$ 70 per barrel mark. The situation for India now appears grave. India's oil demand is likely to rise from the existing 2 million barrels per day (mbpd) to 2.54 mbpd by the end of this fiscal. In fact, India's oil demand is increasing at high growth rates of 5%-7% per annum, almost equivalent to China's growth in demand for crude oil. And thus, the rising costs of energy are concerning for the country's future growth.

Now, one may argue that 'this time it is different!' Right, India is in a new league now. Things have changed structurally for the country's economy. The economy has more firepower now than, say 10 years back. All's right! But, amidst all this positives, there has to be someone to bear the rise in energy prices. Oil companies have been doing that currently as the government is in no mood of passing the burden to the consumer. And that is the reason that inflation at the consumer level is still benign.

Finally, investors should note that while the country is better equipped to handle emergencies like these in the medium term, there needs to be some respite from the rising crude prices, which have the ability to derail the growth engine. Also considering that stocks across the sectors are valued even from a long term perspective, fresh investments need to be undertaken with utmost caution and discipline.

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