labels: oil & gas, economy - general, environment
Why oil at $100 may be desirable, after all news
03 November 2007
When a 2005 Goldman Sachs report talked about the possibility of a ''super-spike'' period for oil prices, with the possibility of prices surging as high as $105 to a barrel, many dismissed it as alarmist and self-serving. After all, Goldman was and continues to be one of the most active traders in energy futures. However, the report did end up pushing up oil prices and may even have helped Goldman''s energy trading desk to report even higher profits; not that it was doing badly before the report.

The report triggered a wave of new analysis and commentaries on the oil markets, most of which harped on the ''peak oil'' them and some even talked of $200 per barrel oil. The wave of new theories and predictions ebbed when oil prices corrected subsequently, and the entire episode was often cited as another example of how markets get unduly excited.

$100 oil will soon be a reality and that too much earlier than the Goldman report had predicted. Prices have jumped more than 50 per cent so far this calendar year, nearly 20 per cent of which has been over the last one month alone. After adjusting for inflation, prices are now at historic highs - even above the levels seen during the ''70s oil crisis, which many said would not happen for another century.

So, should we now start fretting about this once unimaginable price for a commodity that has some influence on the lives of the entire population of the planet, and even those yet to be born?

Not necessarily. On the contrary, it may not be a bad idea to wish for a prolonged period of $100 oil - for our own prosperity as well as that of future generations. Outrageous as it may sound at the outset, there are solid reasons why we should. And, no, preventing global warming need not always be the primary reason. Trust Al Gore to find a solution to that, with some help from Dr Pachauri and the rest of the green brigade.

It is non-renewable, let us pay the price
We can debate endlessly whether global oil output is yet to peak, at the peak or even well past its peak. Theories about ''peak oil'' are many and assumptions underlying each of them cannot be more diverse. But one thing is certain; one-day the world will run out of it. No question about that. And it won''t really matter whether it happens in a few decades or several centuries down the line if the world has a reliable alternative in place by the time oil wells run dry.

It is an equally undeniable fact that the quest for fuel alternatives will continue in right earnest only if the cost of the current oil resource really pinch. High oil prices will encourage even more investment flows into research for alternative energy sources. All alternate energy sources that are now considered promising are prohibitively expensive, unless they are subsidised heavily.

Technologies to produce and distribute energy from alternate sources have to mature and become a lot more efficient before they can be considered really viable. That needs more R&D investments and only high oil prices will ensure that.

It may be true that non-conventional hydrocarbon reserves like shale sand deposits in Venezuela and Canada hold more oil than the entire Middle East and Russia. But extraction of oil from such sources is very costly and can compete as a commercial fuel either if their prices cam, somehow, be brought down, or they become cheaper in comparison to oil prices. Eventually, they will also be exhausted as global energy demand can only increase. At best, they can extend the grace period until the world runs out of hydrocarbon reserves and starts relying on other sources.

Encourage better energy efficiency
Most of us need to be really pushed before we change our bad habits. We need high oil prices to force us to become more efficient in our use of energy. American vehicle owners are already dumping their monstrous, petrol-guzzling SUV''s for more fuel-efficient smaller vehicles as fuel prices have begun to hurt. It is estimated that if vehicles in the US are as fuel efficient as those in Europe, aggregate American oil consumption would fall by as much as 3 million barrels a day - or nearly 4 per cent of world''s current daily oil demand!

There is no doubt that, like combustion engines in automobiles, other technologies and processes can be improved to achieve better energy efficiency. The International Energy Agency (IEA) estimates that nearly a third of the world''s total energy output is wasted, mostly in losses related to electricity generation and distribution. The gains from even a modest improvement in efficiency will be quite substantial, and more importantly, long lasting.

The world needs petrodollars
If you are one of those who thought that the Chinese have the biggest oil surpluses in the world, you need to think again. Oil exporting countries in the Middle East and Central Asia will accumulate a staggering $1.9 trillion between 2004 and 2008 from higher oil prices, says the IMF. This is not total oil revenue, but the additional cash they generate through higher prices. Now, imagine the kind of surpluses these countries will build if high oil prices persist for the next two or three decades!

How are they going to spend all this cash? Most of it will go into building more for themselves and the rest will be parked overseas. Either way, the world will benefit from their cash.

The six members of the Gulf Cooperation Council, led by Saudi Arabia, have investment plans of over $800 billion over the next five years. Entire cities in the region have already been transformed into massive construction sites. Artificial islands for the mega-rich, the world''s tallest skyscraper, one of the biggest airports and so on are under construction; not to mention new roads and other infrastructure. Not that the region really lacked infrastructure, now that it has too much cash, it just decided to build everything new on a much, much grander scale.

This unprecedented building boom accounts for part of the bull run in commodities and the huge demand for engineering and design services - ask L&T. The region also remains a large provider of employment for migrant labour from neighbouring countries like India. Nearly half of the around $25 billion that India receives annually from its citizens working abroad comes from those in the Middle East.

Not content with what they are building in their own backyards, some of these countries are increasingly seeking greener pastures. Oil-rich countries in the Middle East have also built up vast pools of capital, now widely defined as sovereign funds, to be invested elsewhere. If you thought they are going to be passive investors, like they were during the earlier oil booms, you couldn''t be more wrong. They have already started gobbling up entire companies in an attempt to build global corporations that can dominate their respective industries.

Dubai Ports is already one of the largest operators of seaports in the world, though the US government could browbeat it into ceding control of some US ports it acquired. Saudis are focussing on oil and petrochemicals, naturally, and have recently acquired GE Plastics. Some of the Middle East airlines like Emirates and Qatar Airways are already among the largest and fastest growing in the world. It is almost certain that these companies will look at more overseas acquisition targets for growth. This investment spree, like private equity funds, will support global equity valuations and creation of investor wealth.

Much of this holds true for Russia as well. If oil prices had not boomed, the country could have easily become a basket case and not one of the BRIC stars it is today. Excluding record oil revenues, Russian GDP growth will be negligible. Thanks to the boom, the country now has a chance to re-build its economy. Russian oil and metal companies like Severstal Steel have already started eyeing overseas acquisitions.

There is some merit in the argument that we will be better off if we keep the money to ourselves rather than enrich a bunch of autocratic Middle East sheikhs and Czar Putin of Russia. But concentration of wealth in the hands of a few has its own merits, especially if they spend the money on grand projects and overseas investments that will support employment and growth across the globe.

Former US treasury secretary Bob Rubin, who is now with Citigroup, is said to have advised President Clinton, "don''t hurt the rich, they create all the jobs". We may hate to admit it, but the fact is we need the rich more than we may pretend we do. Even if enriching the Arabs and Russians is a bad idea, it may be worth paying higher price for oil because of the other positive effects.

If oil prices decline, the petrodollar flows will obviously fall. To quote the IMF again, every $10 per barrel drop in oil prices will lead to a loss of around $90-billion in the revenues of oil exporters in the Middle East and Central Asia. That may not be too much, but the trend reversal could make these countries more cautious and they may hold back their spending.

Help Mukesh Ambani retain his world''s richest crown
I am serious. Record oil prices have helped Mukesh Ambani to perform feats that are unparalleled in the history of market capitalism anywhere in the world - something we Indians should be proud of. Like for instance, getting a $25 billion valuation for a company - Reliance Petroleum - that is still in the process of building its refinery. Its current valuation is nearly four times the total project cost! This is at a time when most global refiners are reporting declining margins. Don''t be shocked if you hear a market rumour that gold could be a by-product of oil refining, but only from the Reliance refinery!

Do you think the huge stock price run-up in Reliance Industries would have been possible, without the high prices it will get for its natural gas - starting next year? The price agreed to recently by the government for Reliance''s gas is more than double its earlier contract price for supply to NTPC.

Even Anil Ambani could not have dreamt of giving big brother hot competition in the ''world''s richest'' sweepstakes. One of his companies, RNRL, enjoys a market value of $3.5 billion only on hopes of getting cheap natural gas from Mukesh Ambani''s Reliance Industries. It is another matter that Mukesh may not part with the gas so easily and so cheap.

Reliance Energy, the other Anil Ambani company which has seen a flare up in stock prices, also owes its fortunes to oil prices which in turn drives prices of other forms of energy. Investors are betting on sustained demand and high prices for energy. Reliance Power, equally owned by Reliance Energy and Anil Ambani''s privately-held investment companies, which is due to come out with an IPO would have struggled to get its 4,000 MW Sasan mega power project going if it were not a pit-head project with captive coal mines allocated by the government. Coal prices have gone up substantially and having captive resources is invaluable

What is likely
Even if $100 per barrel oil is desirable for many reasons, it is unlikely that prices will stay above that level consistently over the next couple of years. Most of the 50 per cent gain in crude oil prices this year is driven by geopolitical concerns and increased trading interest in the commodity. Part of this premium will be eroded if we are headed for more peaceful times. But, there could be flare-ups driven by specific events that may see oil prices way above $100 as well.

If there is a further slowdown in the US economy next year, as some expect, which in turn pulls down growth in other parts of the world, oil prices are likely to correct and settle around $80. Other major economies like Japan and the Eurozone countries are showing signs of a slowdown while China may make more drastic efforts to cool its economy after the 2008 Olympics.

Of course, that prediction of slightly cheaper oil is on the assumption that there will be no disruption in oil supplies because of geopolitical developments.

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Why oil at $100 may be desirable, after all