Consider the following situation(s). There has been civil war in Libya and Syria for three years. In the past six months, a militia of hooded hoodlums called the Islamic State has carved out a so-called Caliphate, across large chunks of Syria and Iraq. Meanwhile, Ukraine is also fighting separatist rebels, who want to amalgamate eastern Ukraine with Russia.
Taken together, these conflicts should have a predictable impact on global energy prices. Crude oil (and to a lesser extent, gas) is freely traded in vast quantities, and multiple currencies, on many exchanges. Forward contracts and derivatives can run years into the future.
Libya and Iraq are major energy exporters. Fighting in the WANA (West Asia and North Africa) region causes fears of supply disruption. Another major exporter, Iran, is under sanctions. Russia supplies about a third of the European Union (EU)'s gas, and most of that supply is delivered via pipelines running through Ukraine. The EU wants to impose sanctions on Russia, and the most obvious retaliation would be for the country's president, Vladimir Putin, to cut off gas supply.
So why have crude prices declined by 15 per cent and gas prices stayed soft, even as these situations have developed? The consensus answer has several strands of rationalisation. One is that America's successes in shale gas and tight oil extraction have altered global supply-demand equations. As Canada and Mexico also open up exploration, American supplies will rise.
Another partial answer is that global growth is weak. Chinese growth is not very high and the euro zone may see recession or stagnation. Hence, energy demand is low. A third partial answer is that European summer demand is low, and there are hopes the Ukrainian situation could be settled before winter comes.
Indian consumers will not complain if prices stay down. It could be a windfall for government finances. The petroleum subsidy bill will reduce substantially, and it means lower inflation as well. Weak crude oil prices could even give the government the courage to permanently eliminate diesel subsidies. If gas prices stay low as well, the review of domestic gas prices will be less politically sensitive, whatever the formulae employed in price recalculations.
However, only the fantastically optimistic will trust to the consensus rationalisations given above. There are several underlying assumptions that look dubious when examined. The United States has strong laws against energy exports. It won't have much fuel to spare, even if it can meet its own domestic needs. American inventories are being mopped up and fuel demands will rise if United States gross domestic product growth rates accelerate.
There is also a good chance that the WANA conflicts will not get sorted out in a hurry. The Caliphate's shenanigans could lead to total disruption of supplies out of Iraq. The Ukraine crisis may prove intractable since it is an open question how much control Mr Putin has over the rebels and nobody knows what he will do anyway. Another more paradoxical possibility is that there will be a spike in energy prices if growth assumptions are revised up, along with demand projections.
There could, therefore, be a sudden reversal in sentiment and an uptrend in energy prices occurring in any of several scenarios. The chances that one of those scenarios will occur is reasonable, and if it does, we would have to redraw assumptions about India's twin deficits.
Under the circumstances, there are some more axioms worth bearing in mind. One is that the market can stay irrational longer than any rational investor can stay solvent. A market can also turn rational just when investors assume it will stay permanently irrational.
Twitter: @devangshudatta