Government looks set to survive, but oil prices still high - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
Government looks set to survive, but oil prices still high A  A  A

5 JULY 2008

There are too many factors, both domestic and global, affecting investor sentiment and the market is reacting violently as each factor plays out. Last week we saw immense volatility, with the BSE sensex going up a whopping 702 points, or 5.2%, on Tuesday, only to drop 570 of those the next day and then to regain 359 on the third day. It ended the week at 13454, down 348 points over the week. The Nifty ended down 120 at 4016.

In domestic factors the worry points are the possibility of early elections, if the Left parties withdraw support when the UPA Government goes ahead with the 123 nuclear deal (now abated, after the Samajwadi party has assured its support), the rising inflation, which is creeping towards 12% and the awful pain caused by the slipped fisc!

In global factors, oil prices touching $ 145/barrel is the main cause of worry, for this is what has resulted in India having, after 7 years of surplus, a current account deficit of $ 1b. This is an indication of how abysmal governance can make a mess out of the most wonderful of stories. For had the UPA Government discovered the backbone it is now discovering it has, on the 123 nuclear deal, and had raised prices of petro products from time to time, consumer behaviour would have been modified and oil imports come down.

Abysmal governance can also be seen in how Governments misappropriate resources. A cess has been levied to create a fund ostensibly to be used for developing energy resources. Out of the Rs 72,000 crores collected, some Rs 500 crores have been thus used; the rest has gone for fertiliser subsidy! What, one asks, is the role of the Comptroller and Auditor General of India? Had it been even partially used to develop efficient and affordable public transport systems, and had growth of private transport been discouraged through taxes, our current account deficit would have been much better. As it is, we are (still) encouraging the growth of private transport, which would become, as fossil fuels run out, wasted assets. Think of car factories, and a vehicle population, simply parked around when petrol prices become prohibitive.

Poor governance can inflict incalculable harm on an economy and on its people. Consider the plight of utterly mismanaged Zimbabwe, led to ruination by Robert Mugabe. Inflation is 1 million % in Zimbabwe, which should provide a measure of comfort for our 12%.

With worries of early elections seemingly out of the way after the partner-swapping recently concluded, the primary factor affecting markets is oil prices, now hovering at $ 145 /b.

Everyone generally blames China for rising demand for oil causing rising prices of crude. But, as pointed out in his testimony to the US Senate by hedge fund manager, Michael Masters, Chinese demand has, over the last 5 years, increased by 920 m. barrels. Speculation by institutional investors, whom he blames for runaway oil and food prices, has increased demand in the futures market by 848 m. barrels

These speculators, whom he calls as 'index speculators' as distinct from traditional speculators, have large pools of money part of which are allocated to different asset classes. These positions are rolled over and do not provide benefits, such as liquidity, to the market, but, instead, result in rising prices of oil, food and other commodities. He has suggested some ways in which such index speculation can be brought down.

Another way in which speculative element in oil and other commodities would be brought down is if the US were to raise interest rates sharply, perhaps taking a cue from YV Reddy! The US Fed has been reluctant to do that for fear of the impact it would have on US GDP growth, because the US is a consumption led economy which is heavily reliant on debt for consumption. An increase in the cost of such debt would, therefore, impact growth. On the flip side, keeping money cheap and plentiful, results in such harmful 'index speculation' which drives up prices and inflation. Sooner or later, there would be a brouhaha over rising inflation, compelling action.

There have been concerns, for long, over whether we have reached 'peak oil', a plateau in oil production after which it starts to decline. As per an article in Jun 27 Wall Street Journal Sadad al-Husseini, the former #2 at Saudi Aramco, the world's largest oil company, thinks so. His former colleague, oil reservoir manager Nansen Saleri, thinks that, with better technology, more oil can be extracted from existing resources. There are also other alternatives, such as shale oil, which in the US, if environmentalists permit extraction, would amount to 8 times Saudi Arabia's oil reserves.

There is, doubtless, a coming cruch in fossil fuels, hence developing alternatives, such as nuclear energy, becomes imperitive for any responsible Government, making those who oppose development of such alternatives completely irresponsible.

We should also strive to increase fossil fuel resources through new finds, something NELP VII tried to do. Here, strangely, the senseless greed of a mismanaged Finance Ministry has thwarted efforts. The Finance Ministry has now 'clarified' that tax concessions promised by the Petroleum Ministry, would be only for oil and not for gas! Such flip flops in policy send awful signals to investors taking high risks in exploration (the cost of hire of a deep water oil rig is, for example, $ 580,000 per day! With no guarantee of success, who would be willing to outlay such amounts?) Having mismanaged the fisc, the Finance Ministry now wants to scrounge for resources and not grant concessions for gas, as if oil and gas are separated under the sea! US oil majors Exxon and Chevron, have stayed away from NELP VII.

In corporate news of interest, R Com is looking at ways in which it can buy a 35% stake in MTN (at a cost reportedly of $12-14b) instead of selling R Com in a swap with MTN shares, since the sale would reportedly trigger a right of first refusal by RIL. This dispute is getting tricky.

One may well ask the market Quo Vadis, or whither goes thou?

The sharp fall has made the market ready for a bounce, and the drop, after the 702 point rise, seemed to test the bottom without going below it. It seems, therefore, that a bounce can be expected.

The ensuing rally could, hopefully, be a sharp one. However, the worrying factors of political uncertainty, domestically, and oil prices, globally, will impact the market, so it may dip to these levels again. Also, the mismanagement of the economy would impact corporate profits in Q3, which would be coming out in October. Thus one should bottom fish for fundamentally good stocks with a longer (two year) time frame, and not get overly perturbed about the Michael-Jackson-like gyrations of the sensex.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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