Economics Blog

Just like last week, the talk of the town remains oil prices. While prices did fall about $10 in 2 days to even $130/bbl, on Thursday they decided that they had enough of being in the $130s and missed being in the limelight of $140s…so off they went…and what was the news? Well, of course, our old friend Iran and Israel were of course involved…lets say, less Israel this time, but more Iran and the US. Then we had Nigeria and finally the icing on the cake was provided by Brazilian union workers.

Iran apparently test-fired two rounds of missiles, including one which could reach Israel. The debate, interestingly, surrounded whether the missiles were fired on Wednesday (according to the US) or Thursday (according to Iranian media). Well, irrespective of when they were fired, missles were fired and that’s what’s important. Perhaps Iran is doing the right thing by sending signals about their strength, and thus avoiding being attacked. Whatever the politics behind this is, it is working to add jitters to the oil market. Then there were rumours that Israel performed air force drills - rumours that were denied by Iraqi intelligence. The market has added about say at least a $15 premium for geopolitical issues at the moment, and unless a statement is issued saying that a complete resolution to this matter has been achieved, this premium is likely to stay…the exact amount will probably be determined everyday depending on the level of rhetoric between the 3 playes (Iran, Israel and US).

The Nigeria situation is an ongoing one as well…with both Shell and Chevron being badly hit recently. The output from this OPEC member state has been lower for the last 2-3 months - around the region of 1.8-1.9 million barrels per day (mbpd) - than usual due to the militant attacks, and thus, Saudi Arabia’s attempts to pump some more fuel in the world economy to ease supply worries will get a lot more quickly absorbed than they probably expect, as it will end up compensating for falling output elsewhere. Lately, MEND has ended all unilateral ceasefire starting today on comments by UK’s prime minister pledging support to help solve lawlessness in the region. MEND has warned that UK is supporting an illegal government and hence justified their decision. This does not bode well for the oil companies based in this region, as more militant attacks are likely to result in more force majeures being called.

Now, over the Atlantic Ocean to Brazil, and here we have Petrobras’s unions threatening to strike starting Monday. The Campos basin, where the strike is supposed to take place, accounts for 80% of Brazil’s 1.8mbpd oil output. The strike concerns counting the day workers leave for the rig as a working day, and despite Petrobras being willing to negotiate, the strike is expected to continue. Separately another union has threatened to strike at all Petrobras’s refineries due to pay disputes.

So, what we have here is supply disruptions across the world, and threats of even more likely to emerge. In a situation like this, (and with China’s Olympics coming soon, oil demand is unlikely to go down from this country!), OPEC will have to step up and expand output. If not, I pray for a miracle to emerge, in this life or next, for if not, I don’t even know where prices will stop!

The question many have asked over the last few weeks is whether oil prices will fall ever, and if so when? The latest move up was pretty much in the span of a few hours, when from about $132/bbl, prices shot up to nearly $139/bbl, with many scratching their heads as to what could have possibly happened to warrant such a move. Then, as the newswires reported, Libya’s oil chief said that they could possibly cut output, and in the face of already tight supplies failing to match demand, this resulted in prices shooting up. Ghanem was reported as studying the possibility of reducing Libyan oil output, following a bill passed by the US House of Representatives allowing the Justice Department to sue members of OPEC for limiting oil supplies and working together to set crude prices! Whether such a vague statement justified a $6-$7 move up is, of course, a completely different question. All said, the market is nervous and any comments signalling supply shortages or rising demand will only make situations worse.

Then came the whole Israel-Iran row. Israel, celebrating it’s 60th anniversary of its foundation, claimed that an attack on Iran’s nuclear installations was unavoidable and apparently practised for it. Then, last weekend, Iran’s foreign minister claimed that he did not believe that Israel was in a position to “engage in such adventurism” and attack his country, as Israel was still dealing with the consequences of its war with the Hezbollah. Heightening rhetorics between the two reached a new height, when a senior Iranian military official is believed to have said that Iran is digging 320,000 graves for their enemies, should they be attacked. Eventually what really shook the market was Iran threatening to impose controls on shipping in the Gulf Straits of Hormuz, which accounts for nearly 40% of the world’s traded oil flows, if it was attacked and warned regional states of reprisals if they participated in any attack against their country. While the US has, of course, criticised these comments and have stressed on the importance of dialogue to solve the issue, the oil market has taken no notice of that.

While crude fell from its record highs late Friday and over the weekend as Iran said it gave a ‘constructive’ response to incentives intended to persuade the nation to stop uranium enrichment, thus slightly allaying concerns of an immediate attack, prices nonetheless stay at record levels. In an environment where non-OPEC supply is continuing to fall (Russian production fell for the 6th consecutive month in June) and growth of oil supply from outside the OPEC countries looking more and more grim going forward as well (IEA’s Medium Term Oil Market Report points to only a 1.2 million barrels per day of non-OPEC supply growth in oil till 2013), one wonders whether irresponsible statements by government officials heightening tensions in the Middle East is what the market requires at the moment. Lately, many have pointed to ’speculators’ and ‘investors’ as the key factors for driving oil prices up. I think we should perhaps shift gears and have a look at politicians having a significant impact in creating unnecessary jitters in the market, thereby resulting in record oil prices for days.

The commodity markets have taken centre-stage in the media today, not just because of their record breaking prices, but also because of the US Congress threatening to put position limits in these markets. The Congress is convinced that it is the wretched speculators who are driving up commodity prices and the CFTC is being pressured to take various measures against them.

There have been several testimonies in front of the Congress, including the famous George Soros claiming that while he is no expert on oil, he is an expert on bubbles and he does indeed think that the oil market resembles the bubble of which led to the stock market crash of 1987. The latest to join the list is Lieberman, a prominent lawmaker, who proposes to ban large institutional investors from participating in the commodity markets. While going through all these testimonies and reading the one-sided blames, I stumbled across a very interesting (and almost,, shall I say, refreshing) take on this debate. It’s actually a counter-argument that seems to spell out the common fallacies that surround the market. Titled ‘Headlights through the fog’, this article highlights the importance of good quality analysis and the impact this can have on policies; and more importantly warns us that misguided information can have serious implications for the financial market as a whole. I definitely recommend a read….

Corn prices are shooting through the roof, giving sleepless nights to policy makers as rising food and feed prices result in higher inflation at a time when economic growth in slowing in most parts of the western world. Now, linkages between corn and crude oil through biofuel has meant that when oil prices rise, corn prices follow as efforts to find alternative sources of fuel (such as biofuel) gain momentum. And over the past few months, linkages between the energy and grains markets have only intensified. According to the United States Department of Agriculture (USDA), this year the country is going to use over 30% of its total corn crop for the production of ethanol, and this figure is only set to increase over the following years. Making maters worse in the recent weather concerns in the US, resulting in the recent surge in corn prices through $7/bushel.

Torrential rains across the US Midwest have delayed corn plantings and have also caused widespread destruction to the some of the already planted corn crops. Various forecasters are comparing the situation to the floods in 1993, when thunderstorms and tornadoes completely destroyed the key corn crop belt in the US. Corn and soybeans planted in wet, cool soils develop shallow roots, increasing the threat of damage from dry weather in July and August. Further, the yields of the crop are lower too. With more rains forecast for the coming few weeks, one can only sit back and pray and keep out of those mexican restaurants where tortilla prices are likely to skyrocket!

There is a lot being said these days about rising commodity prices, in particular oil prices. Yesterday, after 2 consecutive sessions of price fall, oil prices jumped to record highs, fleeting close to the $140/bbl mark. While loads of market participants are blaming speculators for manipulating the market, others point to the constraint supply not matching rising demand as the key reason. It is undoubtedly true that emerging economies like India and China’s unquenched thirst for oil has more than offset any slowdown seen in the US, and with the Olympics coming up in China, things are unlikely to change, at least in the short term. Moreover, OPEC is reluctant to pump in any oil, even at these ridiculous prices and non-OPEC supply is faltering.

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