Danger in oil prices

Last February, before the Iraq war, Brent March futures were being quoted at around $ 31.50 a barrel, and the futures price fell off steeply to $ 23.02 per barrel for April, and to $ 22.42 for August delivery.

Currently, April Brent is being quoted at $ 33.18 per barrel. Oil prices have behaved very differently from what the market expected. One reason, of course, is the situation in Iraq.

The steep discount in oil futures last March was based on the assumption that Iraqi oil would speedily come to the world market after a short war, creating a glut.

Unfortunately, Iraqi oil production has been hit by the continuing insurgency and the country's oil is yet to come to the world market.

At the same time, a global economic recovery has gathered pace, with the US, Japanese and Chinese economies gaining steam.

China's oil demand grew 10 per cent last year, it is expected to maintain a scorching pace of growth this year too, and its demand for commodities, including oil, appears insatiable.

While demand has strengthened, Opec has continued to restrict supply, its latest tightening move being the decision to cut production by a million barrels a day from April.

Worries about disruptions in supply from Venezuela persist. And finally, there has been the precipitous fall in the value of the dollar. Opec members have been pointing out that the oil price looks high only when it is priced in dollars.

But since the dollar has been depreciating against all currencies, these gains are much lower when oil revenues are converted into the oil suppliers' own currencies.

With the prospects of global economic growth continuing to improve and with no signs of China slowing down, oil demand is likely to remain high.

At the same time, the massive US current account deficit continues to put pressure on the dollar, despite the recent efforts of both the Japanese and the European central banks to defend their currencies.

Nor has there been any improvement in the situation in Iraq. In other words, there has been no recent change in the oil demand and supply scenario.

The rise in oil prices has obvious implications for India. The rise in the fuel component of the wholesale price index has been 7.7 per cent in the last year.

The expected revision of kerosene and LPG prices after the elections will be an additional source of inflation.

Oil companies continue to bear the brunt of subsidy losses, losses that increase when international crude prices rise but domestic product prices are kept under check.

And apart from the effect on inflation, the improvement in the economy will also be reflected in a higher oil import bill. The question is, will all this affect growth? So far, there has been little indication of any such eventuality, but that could change if oil prices rise further.

The markets, however, seems to believe that the worst is behind us. For example, Nymex light crude futures for June are being quoted at $ 35.23 a barrel, at a substantial discount to the spot, and the discount gets steeper every month.

In short, the market is expecting that prices will fall, which will be good for the economy. It's worth remembering, however, that the market was wrong last year.