Where’re we going with this soaring oil price?

Everyday the slippery stock prices and different derogatory results regarding inflation etc is killing the investors in the Wall-Street. With the disturbing news like soaring oil prices, OPEC controversies and supply shortfall is showing enough blood sheds in any stock and equity market. Despite of the very good Q1 results most of the company’s stock prices are suffering and selling the cheapest at this present moment while I’m bringing this topic for my readers and the market is all about immense blood shed of investors while we’ve reached the highest crude price today of $142 which had broken its earlier high. Let us get into the problem and try to find the reason about this crude oil story, and find why its price is sky rocketing. This soaring price of light sweet crude’s demand is basically rising in all over the world because of growing population and economy, and supply to this demand is not rising proportionately. This would lead us to a long term problem.

In International market the price of a barrel of (1 Barrel= 139 Litres) crude has already reached to the level of 139$ (USD) and today its $142 while I’m finalizing this article, which is all time high so far. You’ll be amazed by knowing that, this price was $8 for a barrel in the year 1999. Last year September one barrel was priced $80. The investors, Government and most of the consumers are now looking shaky and mostly they’re expecting this price would reach to the level of $200 a barrel by the end of this year. If oil reaches to that level, most probably it would hurt any developed or developing economy to the worst. Without the oil, any economy is going to slow down and this oil resource for any country is dependent on imports. The quantity wise and price wise, this light sweet crude is the largest commodity in the world trade at the present moment. So if the oil prices rise, any economy gets the bad effect of recession, because of the commodity price goes high. See, Gold is now selling all time high. Almost like any commodity pricing is dependent on the transportation costs, and the prices of the basic food corp goes high due to the rising oil prices. In my February write-up, about recession and jobs, I've predicted this free fall.

Some experts are saying that in the oil market, traders are jacking up the prices and creating a false panic of soaring demand, which is leading people to gamble with the oil futures. Some are saying that in last one year the price of dollar had diminished enough so that, investors are perking most of their money into oil only and mostly trying to pile up the stocks to create the false shortage of supply and trying to sell it in higher price. There could be many schools of thoughts and many ways to contradict and I’m sure there would be many suggestions from the experts in this field would be also forthcoming too, but the gap between supply and demand is beyond any contradiction though.

The Supply & Demand equation:

In the market offcourse, the demand is much higher than the supply of light sweet crude. So the price is skyrocketing like anything. In last few years the rate of supply has not been increased as it was needed. In the last year, the total production capacity had been reduced by 6.5 Million barrels from all those top 15 oil producing countries from the previous year. OPEC (Organization of petroleum exporting countries) constituted by 13 top oil producing countries brought down the supply, while the cost of crude was decreasing in the year 2006. OPEC countries supply atleast one third of the total supply of the oil internationally. The instruction of production reduction is still unchanged by OPEC and some conflicts are looming up there with United States which might send the oil price to next record level. There’s another reason why the production could not ramp up just like that, just because except Saudi Arabia and Arab Emirates, no other country has got the capacity to enhance the production. The demand is soaring, India and china are the fastest moving growing countries with booming economy and are having enormous demand of oil at this present moment.

If we take a close look at the graph we can easily find that, how the oil price is rising just after Sept 2007 from $80/barrel to till now 27^th June, 2008 to $143/barrel. There’s a sharp rise. The demands of having personal vehicles are rising in these developing nations, so the resultant is the soaring oil prices. Though, the demand had been controlled in those developed nations in last two years, but at any case the resultant is the necessity of more supply of crude because developed and developing both these categories of nations need now enormous quantity of supply to continue the civilization. Or else, the demand rises and as the resultant the price rises, if the supply is less or diminishing.

How much Oil we get from the Crude ?

Mainly there’re two types of crude oil light sweet crude and heavy crude. We get more quantity of oil after refining light sweet crude than heavier one. From Heavy Crude the more quantity of Kerosene kind of output comes than gas or petrol. Moreover, the costing of refining is much higher for heavy crude. So the demand for light crude is more in the market than the heavier one. Right now, in the international market the supply of diesel is much lesser than the demand. Hence, the refined diesel price is much higher than the price in which we generally buy it from the market. But, fuels like kerosene’s supply are more than the demand for which the pricing is also less. There could be two ways to extract diesel, either from light crude or from the heavy crude. But the quantity we get out of the light crude is more than what we get out of heavier one. Once the diesel is being extracted from the heavy crude the refining cost would go up such an extent in which we cannot sell kerosene kind of fuels to the market within the marketable pricing, hence even if the heavy crude is cheaper than lighter one but as far as the productivity goes, the oil extracting companies cannot make profits out of it. So, the demand of sweet light crude is growing and its pricing is also sky rocketing.

Now major supplier of heavy crude to the world is Iran and they’re reducing the pricing of it. Most probably this is the crux of the entire story and key to protect this price sensitive market and which would eventually might try to confine this slippery oil prices within a limit. Oil refiners have to come out with a kind of new technology to extract more diesels from the heavy crude. If that process proves to be profitable for those oil companies, the supply of oil would raise, which would ultimately bring down the pricing.

Why the supply is not growing by now if the demand is looming up high?

This is a long term solution, cannot happen overnight. The new technology of extraction has to come but it may require some more time. If they try hard, they might cut down the time span of getting this new technology handy sooner. But, the resistance is actually somewhere else, these oil companies don’t invest so easily. Also, when the demand is high its been a long practice to raise the price and do the profit booking as fast as possible. Then what could be the possible solution?

Nowadays building a refinery needs huge amount of money which needs huge investments in turn. The return is very slow which comes out of market eventually, but it takes time, the life of a refinery is also long (40 Years) enough. In this long span of time, there could be a risk of very low oil pricing, where u may book enormous loss even. During 70’s there had been two of such instances, when the oil pricing spiraled up twice and been brought down to the minimum level within few days time frame. The price dropped to the maximum level. So one who is prepared enough and did good calculations of long term profit booking would only invest money into such activities. The refinery making costs had gone up by 76% more than what it used to be during 2000. Mining costs also gone high, approximately 110% by now. So despite of the fact that there’s a scarcity in the supply of oil in the market, none seems to be very interested to bring new investments here.

So now the reasonable question is, if the pricing is so high in the international market, then why we’re not trying to cut down the usage of it in the domestic market. Most of the common people don’t get effected by the regular price up down of crude in the International market. Most of the countries try to make a ceiling of oil pricing and try to stick to that, so that the regular up down of crude don’t make the domestic market so volatile. Take the example of India, though the oil price started growing in the beginning of the year, but just recently Government had to hike the price and we all had seen 48 hrs strikes from the two major opposition parties to the ruling party of the Government against this price hike. Basically Government takes that heat and deficit, which ultimately goes to the tax payers of the Nation. More than 50% of the entire population in this Earth gets this benefit of deficit balance by the Government. People of Germany pays the maximum oil prices, around $2.35/ lt and people from Venezuela pays the least around 79 cents per litre. United States is the major importers of oil at this present moment and the demand of oil is rising to the maximum level in China. So due to the Government, the rapid crude price volatility don’t affect the mass easily. So the demand never goes down neither the prices.

This is where we need to work out more and Governments must come out of different incentive programs, by which they promote the energy conservation ideas more. Also, world needs some magic at this moment to come out of this blood bath globally. May be some kind of alternative fuel like hydrogen or bio gas driven cars or may be the N-power driven vehicles, which we had only seen mostly in different science fictions. Because I trust that, some ending is the initiator of a new beginning, change is inevitable, that’s the bottom line.