It is India’s Rs 2,00,000 crore problem. And it’s called crude oil.
With the global economy in general and the Chinese economy in particular slowing down, it was widely expected that the price of crude oil will also come down.
China has been devouring commodities at a very fast rate in order to build infrastructure. As Ruchir Sharma of Morgan Stanley writes in his recent book Breakout Nations “China has been devouring raw materials at a rate way out of line with the size of its economy…In the case of oil China accounts for only 10% of total demand but is responsible for nearly half of the growth in demand, so it is the critical factor in driving up prices.”
Even though the Chinese growth rate has slowed down considerably, the price of crude oil continues to remain high. According to the Petroleum Planning and Analysis Cell (PPAC) which comes under the Ministry of Petroleum and Natural Gas, the price of the Indian basket of crude oil was at $ 113.65 per barrel (bbl) on September 11. The more popular Brent Crude is at $115.44 per barrel as I write this.
The high price of crude oil has led to huge losses for the oil marketing companies in India as they continue to sell petrol, diesel, kerosene and cooking gas at a loss. The oil minister recently said that if the situation continues the companies will end up with losses amounting to Rs 2,00,000 crore during the course of the year.
So why do oil prices continue to remain high?
The immediate reason is the tension in the Middle East and the threat of war between Iran and Israel. Hillary Clinton, the US Secretary of State, recently said that the United States would not set any deadline for the ongoing negotiations with Iran. This hasn’t gone down terribly well with Israel. Reacting to this Benjamin Netanyahu, the Prime Minister of Israel said “the world tells Israel, wait, there’s still time, and I say, ‘Wait for what, wait until when? Those in the international community who refuse to put a red line before Iran don’t have the moral right to place a red light before Israel.” (Source: www.oilprice.com)
Iran does not recognize Israel as a nation. This has led to countries buying up more oil than they need and building stocks to take care of this geopolitical risk. “In the recent period, since the start of 2012, the increase in stocks has been substantial, i.e. 2 to 3 million barrels per day. These are probably precautionary stocks linked to geopolitical risks,” writes Patrick Artus of Flash Economics in a recent report titled Why is the oil price not falling?
At the same time the United States is pushing nations across the world to not source their oil from Iran, which is the second largest producer of oil within the Organisation of Petroleum Exporting Countries (Opec).
What also is happening is that Opec which is an oil cartel, has adjusted its production as per demand. Saudi Arabia which is the biggest producer of oil within OPEC has an active role to play in this. “This adjustment in the supply of oil mainly takes place via changes in Saudi Arabian production:this country keeps its production just above 10 million barrels/day to avoid the excess supply that would appear if it produced at full capacity (13 million barrels/day,” writes Artus.
If all this wasn’t enough gradually the realisation is setting in that some of the biggest oil producing regions in the world are beyond their peaks. As Puru Saxena, a Hong Kong based hedge fund manager writes in a column “it is important to realise that several oil producing regions are already past their peak flow rates and have entered an irreversible decline. For instance, it is no secret that the North Sea, Mexico, Indonesia and a host of other areas are past their prime.”
All eyes are hence now on the Opec nations. The twelve nations in the cartel currently claim to have around 81.3% of the world’s oil reserves. The trouble is that this has never been independently verified. As Kurt Cobb, the author of Prelude, a thriller based around oil puts it in a recent column on www.oilprice.com “Opec reserves are simply self-reported by each country. Essentially, Opec’s members are asking us to take their word for it. But should we?”
Saxena clearly doesn’t believe that Opec countries, including Saudi Arabia, have the kind of reserves they claim to. “Given the fact that the vast majority of Saudi Arabia’s super-giant oil fields are extremely old, one has to wonder whether the nation is capable of boosting production…We are of the view that Saudi Arabia has grossly overstated its oil reserves and it is extremely unlikely that the nation has 270 billion barrels of petroleum. After all, the Saudi reserves have never been audited and a recent report by WikiLeaks suggests that the Saudis have inflated their oil bounty by 40%,” he writes.
This is something that Cobb backs up with more data. “Another piece of evidence that casts doubt on Opec members’ reserve claims came to light in 2005. That year Petroleum Intelligence Weekly, an industry newsletter with worldwide reach, obtained internal documents from the state-owned Kuwait Oil Co. The documents revealed that Kuwaiti reserves were only half the official number, 48 billion barrels versus 99 billion,” he writes. “In 2004 Royal Dutch Shell had to lower its reserves number by 20 percent, a huge and costly blunder for such a sophisticated company. If Shell can bungle its reserves estimate, then how much more likely are OPEC countries which are subject to virtually no public scrutiny to bungle or perhaps manipulate theirs,” adds.
Given these reasons the world cannot produce more crude oil than it is currently producing. The production of oil has remained between 71-76million barrels per day since 2005. “When you take into account the ongoing depletion in the world’s existing oil fields, it becomes clear that the world is heading into an epic energy crunch,” feels Saxena.
In these circumstances where the feeling is that the world does not have as much oil as is claimed, the price of oil is likely to continue to remain high. India’s Rs 2,00,000crore problem can only get bigger.
The article originally appeared in the Daily News and Analysis (DNA) on September 14, 2012.
(Vivek Kaul is a writer. He can be reached at [email protected])
Central banks around the world seem to have only one solution for every problem that the various economies have been facing: print more money. And a large portion of this money has been used to prop up banks and financial institutions that would have otherwise fallen and shut shop by now. “It is unfortunate that nobody is allowed to default these days, because all these bailouts are only adding to the inflation menace and the ongoing money creation is confiscating the purchasing power of the public,” says Puru Saxena, the founder and CEO of Puru Saxena Wealth Management. Based out of Hong Kong, Saxena is also the editor and publisher of Money Matters, a monthly economic newsletter. In this interview he speaks to Vivek Kaul.
In a recent column of yours you said “the world’s stock and commodity markets are defying all logic and advancing in the face of adverse economic conditions”. Why has that been the case?
All asset prices are determined by the risk free rate of return and by suppressing interest rates near historical lows, central banks in the developed world have engineered this rally in risky assets. When it comes to investing, monetary policy trumps economic fundamentals and cheap credit triggers a rally in stocks and commodities. This is why, despite sluggish economic growth in the US, Wall Street has been rallying for over 3 years. Conversely, despite good economic growth in India, due to monetary tightening, Indian equities have underperformed over the past year!
Do you expect this trend to continue?
As long as the Federal Reserve keeps interest rates at historical lows, the uptrend on Wall Street is likely to continue. Of course, the bull market will be subject to periodic corrections, but the primary trend should remain up. In our view, the next bear market on Wall Street will arrive after several months of monetary tightening by the Federal Reserve and we are at least 3 years away from this scenario. After all, Mr. Bernanke has pledged to keep short term rates unchanged until at least December 2014, so there is clear visibility for another 2 and a half years.
In Europe, the attention seems to have shifted to Spain. I was reading somewhere that the assets of the three biggest banks of Spain are at $2.7trillion or around twice the size of the Spanish economy. And the banking sector in Spain seems to be in a pretty bad shape. How do you see that playing out?
Spain is in real trouble, but the politicians will probably not let it default. So, either the European Central Bank will bail out Spain or it will continue to provide cheap loans under its LTRO(long term financing operations) scheme. It is unfortunate that nobody is allowed to default these days, because all these bailouts are only adding to the inflation menace and the ongoing money creation is confiscating the purchasing power of the public. Already, the Federal Reserve and the ECB have provided trillions of dollars of loans to hundreds of banks and this trend should continue for the foreseeable future.
What are the other dangers that you see the European markets throwing up in the days to come?
Many European nations are essentially insolvent and they cannot repay their loans in today’s money. So, unless they are allowed to default, the central banks will probably continue to bail out all the distressed bondholders and banks. The truth is that the central banks do not want anybody to default because the losses will be catastrophic for the financial institutions; so they are shoving even more debt down the throats of these heavily indebted nations! It is easy for us to see that more debt cannot solve a debt crisis but this is the strategy the central banks have come up with and we all have to live with the consequences.
The European Central Bank seems to be going the Federal Reserve way. The Federal Reserve in 2008-2009 seemed to have been rescuing banks and companies, the ECB is rescuing countries? Aren’t some of these countries like Italy and Spain are too big to bail-out?
So far, nothing has been ‘too big to bail out’! Already, the ECB has extended over $1.4 trillion of loans under its LTRO scheme to several hundred banks and if need be, it will probably create more currency units to bail out its banking cronies. If the situation becomes desperate, then, we may even get fiscal integration within the Euro zone but we don’t think that the establishment will let the Euro fail.
In all this talk about Europe, attention seems to have shifted away from the problems in the United States, which is where it all started. How good or bad is the scene there?
Although the economy is struggling in the US; things are much worse in Europe. Fortunately, the US is in the enviable position of being able to print its own currency at will and this is a luxury which the distressed European nations do not have. Under a crisis scenario, the US can always create even more dollars out of thin air and repay its creditors, but this is something Greece, Italy and Spain cannot do! Moreover, despite having a federal debt to GDP ratio of over 100%, the US still controls the world’s reserve currency and this is a big advantage.
One talk in the market seems to be that the Federal Reserve Chairman Ben Bernanke will initiate QE III given that Presidential elections are scheduled this year. Several Federal Reserve Chairmen have in the past have run easy money policies to help the incumbent US President who is running for the election again..
In our view, Mr. Bernanke will only initiate QE3 after a big dip in the CPI. Currently, the CPI is hovering around 2.7% and it is conceivable that QE3 will be announced when the CPI dips to around 1-1.5%. With the CPI close to 2.7%, we believe that Mr. Bernanke will find it difficult to unleash more stimulus.
You have maintained for a while that world’s developed nations are all bankrupt. In fact in a column last year you wrote “Let’s face it; many of the world’s ‘developed’ nations are insolvent and the writing is on the wall. Either these indebted states will default or they will try and inflate their currencies into oblivion.” How do you see this scenario playing out?
Given the developments of the past 3-4 years, it is clear that the policymakers do not want to see defaults. So, they have chosen the monetary inflation route and this is destroying the purchasing power of currencies all over the world. As a result of massive money creation, currencies are being debased and prices are rising all over the world. In fact, inflation is surging in most nations and people are struggling to make ends meet. In the US alone, the Federal Reserve has created trillions of dollars to bail out the banks and the ECB has also created and loaned out over US$1 trillion to hundreds of banks over the past six months! Never before in history have we witnessed such monetary inflation in so many nations and nobody really knows the consequences of this strategy.
“When the interest payments on US debt become painfully high, Mr. Bernanke will be called upon to unleash the hyperinflation genie.” This is something you wrote last year. When do you see this happening?
As long as foreigners are willing to invest in US Treasuries and demand for US government debt is high, hyperinflation will not occur. However, if one day, bondholders stop financing the US deficit and they stop buying US Treasuries, then Mr. Bernanke will have no other option but to use the printing press to purchase US Treasuries. Already, the Federal Reserve is a very large player in this market but if other investors flee this market, then out of desperation, we may experience hyperinflation in the US. Fortunately, there are no signs of that happening anytime soon as demand for US Treasuries is still strong.
Many pundits in the last few years have forecast the crash of the dollar. The biggest among them being Pimco’s Bill Gross. But that hasn’t happened. Every time there is a slight hint of some new trouble, money rushes into the dollar. How do you explain this?
In the global beauty contest, the US Dollar is being perceived as the least ugly candidate! This is why the US Dollar has not collapsed against major world currencies, although it has depreciated gradually over the past decade. If you review the world today, Europe is a mess and Japan is still struggling. So, apart from the US Dollar, we don’t really have very many choices! In the developing world, no nation wants a strong currency and countries such as China, India and Brazil are all engaged in competitive currency devaluations. Under this scenario, the US Dollar cannot really crash against other currencies because either they are equally bad or they are being held down on purpose.
What is your prognosis on gold?
Gold is in a multi-month consolidation phase and currently, it is trading under the 200-day moving average. So, in our clients’ portfolios, we do not have any exposure to gold at present. In our view, QE3 will be required to trigger the next big rally in gold and until then, prices are likely to drift lower. Furthermore, after 11 years of gains, investors should be mindful of the fact that gold is no longer cheap and the bull market is now in its mature phase. Thus, owners of gold should be very cautious and consider booking their profits on the first sign of trouble.
What about India? Which are the sectors and stocks you are positive about?
It appears as though India’s monetary cycle has peaked for now and further rate cuts should assist the Indian stock market. Usually, there is time lag between monetary easing and its effects on the economy, so in our view, the Indian stock market may not take off for another few months. Nonetheless, we remain optimistic about Indian stocks and continue to like those companies which earn high rates of return on shareholders’ equity.
(The article originally appeared in the Daily News and Analysis on May 21,2012. http://www.dnaindia.com/mumbai/interview_in-the-global-beauty-contest-the-dollar-is-the-least-ugly-candidate_1691544)
(Vivek Kaul is a writer and can be reached at [email protected] )