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India moots a price band for petroleum

— PHOTO: AFP

OIL TROUBLE: Delegates attending the opening session of a summit on the soaring international price of crude in Jeddah, Saudi Arabia, recently.

The oil shock continues to engage governments and policy makers around the world. In India it remains at the centre of the political economy. With inflation climbing above 11 per cent in early June — and unlikely to come down over the next four or five months — the Reserve Bank of India intervened aggressively by hiking the CRR and repo rate by 0.50 percentage point each.

The spurt in inflation numbers is due to the hike in retail prices of petrol and diesel which were captured by the official statistics for the first week of this month.

Earlier, the Government had conceded that there were very few supply side options. Although having a much wider connotation in the current context, this simply reflects our inability to influence the prices of key commodities, notably petroleum.

A comparatively new idea to provide relief to oil consuming countries was put forward by the Indian Finance Minister, P. Chidambaram, at a recent energy ministers’ conference at Jeddah. He suggested a price band for petroleum to be set up and monitored by the oil producing countries.

Under the proposed scheme, oil producers will increase production if prices go above the band ceiling and will be free to curtail production if prices go below the floor.

This suggestion, based on the prevailing practice in foreign exchange markets, assumes that plenty of money, including the speculative variety, has gone into the oil and commodity markets.

This means that it is not the fundamentals of demand and supply but the entry of big money that is driving up the prices.

Indeed a number of sophisticated derivative instruments have been based on petroleum and other energy products.

It is also a fact that at times like this when the dollar comes under pressure large investors rush to other investment avenues.

Gold and petroleum figure high on their list. Practically every commodity is nowadays dealt with as a financial product in the global markets.

At the Jeddah conference, Mr. Chidambaram accused speculators in unregulated over-the-counter markets and futures traders for the “pandemonium” in oil prices, which threaten to wipe out the impressive economic gains made by India and other developing countries in recent years. According to the Petroleum Secretary, the “speculative premium” in oil amounts to $60 a barrel.

That high oil prices have wrought havoc on the economy cannot be disputed. Far less certain is the alleged role of speculative money in driving up prices.

The following points should be weighed before a judgment is passed on the issue.

One, derivatives in general might have earned a bad name in the context of the U.S. sub-prime crisis but no one has questioned the multifarious benefits they confer all round.

Long before derivatives entered the financial markets they were used extensively in agricultural commodities. For farmers around the world they remain an important source of price information well in advance.

In India, forward trading in certain agricultural commodities was banned because of a misinformed opinion that they were driving up prices. An expert committee went into all aspects and came out with a report that did not give unequivocal answers. The ban continues and large sections of the farming community remain deprived of an efficient source of price discovery.

Two, in any transaction of this type, there is a speculator pitted against a person who wants to hedge his purchase or sale. Risk takers and risk averse parties will have to come together to complete transactions.

Also as a rule, few transactions of this type end in physical delivery of oil or another commodity. “Hoarding” will occur only if delivery is insisted upon routinely.

Three, even if speculation is such a menace as is alleged, the sad fact is that no one can do much to break its hold on the global oil trade.

Four, specific to India’s suggestion of a price band, there are obviously a number of practical difficulties.

A high degree of co-operation between the producing and consuming nations is necessary.

Besides, countries in either category have diverse interests and are in different stages of economic development.

Their motivations to buy or sell oil at given price points will naturally be different. And, even within the powerful OPEC group, there are major differences among member countries. The situation becomes more complicated when Russia and other non-OPEC producers acquire a decisive say in fixing energy prices.

Five, markets need to anticipate future price movements. In global oil trade, deep understanding of supply and demand factors is important.

At present geo-political factors such as the tensions over Iran and the attacks on multinational oil companies in Nigeria weigh heavily on the supply side.

On the demand side, countries such as India have adopted policies that limit the sensitivity of demand and supply to price changes.

For instance, in India both producers and consumers are subsidised.

Logically, the sky-high oil prices should have suppressed consumption.

C. R. L. NARASIMHAN

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