Are China and India really driving oil prices?

How much oil do China and India consume?

One of the most popular notions these days is that India and China are driving the oil prices. You can flip through any business channel or read any pink paper, if it talks about oil, it talks about China and India.

So I decided to check out how much oil these two countries are really consuming and what are the growth rates like. Sure enough I found the statistics on the CIA website:

This link shows the total world oil consumption at 80.29 million barrels per day. The US consumes about 20.8 of those, EU 14.55, China 6.93 and India 2.43.

In percentage terms that means that US consumes 20.8%, China 6.9% and India 2.43% of oil globally. So the China and India combine; doesn’t even add up to half of what US consumes globally.

How fast should the demand have grown to warrant current prices?

The average Brent Blend price in 2006 was $64.72, in 2007 it rose to $72.96 and last week it has been 130 something. So in the last couple of years average oil price has doubled.

So looks like India and China who consume less than 10% of global oil somehow managed to double the demand for oil globally!

That is absurd, even US, which is the largest consumer of oil could not have done it.

I can do a few quick calculations and find out what is the percentage increase in demand from US, India and China that will warrant such prices. But that seems like such a waste of effort that I will skip it and google up some other figures.

Has anyone heard of Commodity funds?

The average open interest on Brent and WTI crude has risen from $22.6 billion in 2002 to $252 billion in 2008, a little more than 10 times. Compare this to the average increase of 6% in demand for oil by India over the last few years.

Which is more likely to raise the prices of oil, real demand or futures trading?

The trading in oil futures and speculation has grown at a much more rampant pace than the real demand for oil by India, China or even US (in absolute terms).

What does this mean for oil prices?

In all likelihood no one is going to do anything about speculation in oil in the near future. The reasons for this are multiple, the financial crisis that is plaguing most major institutions will be worsened if any action is taken against oil trading. Since most of these companies are involved in this speculation as well. No one in the world can afford that right now.

If the OPEC increases oil production that will be futile because we are not talking about a real shortage here, in any case the OPEC has indicated that it is not going to do that on a big scale.

It is not possible to increase oil production in other parts of the world because of the long gestation period so nothing is going to happen on that front as well.

So if speculation is not going to be stopped and real supply not increased then how will the oil prices be controlled?

Wait for the bubble to burst

We will have to wait for the speculative bubble to burst just like the Internet bubble burst. Does that mean oil prices will come down? In the short run, no but, in the longer time frame of about a couple of years to five years oil prices will have to reflect the underlying real asset value. Much like the internet stocks and any other commodity prices throughout the history of the world.

Manshu Verma

Warren Buffet on Market Fluctuations

It is a pleasure to read Warren Buffet’s letters to his shareholders; these letters contain information about how the company is doing and his ideas about economy and investing principles in general. They are a wealth of knowledge and Buffet is a very witty writer so they make fun reading too.

In his 1997 letter he takes an interesting analogy to explain common investor reaction to market fluctuations and we are going to take a look at that here.

Buffet asks that if you plan to eat hamburgers throughout your life, but are not a hamburger producer then will you hope for higher or lower prices?

Similarly if you are going to buy cars frequently but are not a car manufacturer, will you prefer higher or lower prices?

Most investors will find the answer to the two questions above very easy, they know that they will definitely prefer lower prices.

However this same outlook is somehow not applied, when it comes to investing. Take a look for yourself by answering the next question.

If you are going to be a net saver for the next five years, will you hope for higher or lower stock prices?

Most investors get this one wrong; it is very hard to find an investor who doesn’t get depressed when stock prices go down. Despite the fact that they will be net buyers of securities for many years to come investors get really jittery when stock markets go down. The natural investor reaction is to be depressed when stock prices are depressed and be elated when stock prices are on a high. Even if it means that they are going to buy the same stocks at a higher price now. Or to continue the earlier example, people rejoice when the price of the hamburgers they are going to purchase goes up and get depressed when the price of the hamburgers they are going to purchase goes down.

In times when the markets are down there are plenty of bargains for investors and they shouldn’t panic but instead make long term investments in a good companies with solid fundamentals that have performed well and are available at bargain prices.

Manshu Verma