George Bush claimed recently that higher living standards in India and China are responsible for the spike in global food-commodity prices. This is odd as both nations are food-sufficient. In truth, a long drought in Australia coupled with the diversion of American corn into alternative fuels, are both more critical factors.
Food-to-fuel diversions have been triggered by crude prices that have tripled since 2003, when the US invaded Iraq. Iraq is still so chaotic that its 2007 crude production (2 million barrels/day(Mbd)) was 45 per cent lower than its 1990 production of 3.5 Mbd (pre-Kuwait invasion).
There's fear of Iranian supply disruption in case of US-Iran confrontation. Iran is also struggling to maintain its infrastructure, given US hostility that makes equipment-sourcing difficult.
Between them, these neighbours hold over 20 per cent of known global reserves. The Iraq invasion may have brought about a variation on the classic "Peak-oil" scenario. Peak Oil theorises that once global production peaks, it will decline rapidly and lead to massive disruption as prices rise and demand outruns supply.
Outside Iran-Iraq, production may be very close to peak. Bush has himself speculated (January 2008) that the Saudi refusal to raise production is actually due to its inability to produce more oil.
So uncertainty about Iran-Iraq supplies could be a detonator triggering peak-oil-style scenarios of rising prices (visible) and demand outrunning supply, which hasn't happened yet.
Demand is rising due to fast growing Asian economies. Indonesia has just pulled out of OPEC. It will stop exporting to service its domestic demand. India and China are net importers and their demands are growing very fast.
The demand for necessary goods like crude is inelastic with respect to price. Small changes in supply result in large price changes. Many oilmen are assuming a deficit in crude supply during the next two years. Even if everybody kissed and made up today, it may take that long to spruce up infrastructure in Iran-Iraq.
This has caused high and very volatile crude prices. In turn, that has meant a bonanza for both conventional and non-conventional energy sectors and ancillary industries. Oil and gas production and exploration firms have made killing; drill and rig outfits are charging astronomical rates.
Coal prices, gas prices and coal-bed-methane (CBM) prices have zoomed and the Indian government, to its credit, is trying to channel investments into these industries. No wonder, a lot of money is funnelled into alternate energy.
The government's subsidy policy hinders investor from benefiting directly from much of this. You could, in theory, take up to $200,000 a year abroad and park it in the Shells, BPs and Chevrons.
But ONGC hasn't been allowed to charge at prevailing rates for its gas and oil and PSU retailers and marketers have received IOUs called oil-bonds for bearing massive losses. At least, the downside for ONGC is defined and capped by the latest hike. Cairn may be a better buy because it doesn't have similar subsidy issues.
Private refiners have exited the retail business though they have been able to earn better margins abroad. Incidentally, without petro-product exports, the petroleum-oil deficit would be a lot higher.
The shipping and logistics firms have done well since they can charge global market rates. Mining has barely taken off yet and it's associated with violent labour issues. In mining and CBM exploration, the specifics of nascent businesses, especially their downstream linkages, will be important.
In the alternate energy space, Suzlon Energy and Praj Industries are old stories and ones that have been backed heavily. Both are expensively valued companies but may see positive re-ratings if there is money thrown at the alternative and renewables industry. Any new listings in these sector spaces would also be worth checking out.
Alternates/ Renewables are bound to be fads of the near future. The difficulty is in assigning valuations. Suppose, alternate fuels are cost-effective and plug the demand-supply gap at a crude price of $125/ barrel.
Crude prices may then slide rapidly as supply (inclusive of alternates) exceeds demand. At what price-level these alternates are unviable? The cost of crude production is a lot less than producing the alternates. The implication is that alternate energy may be more violently cyclical than oil.
