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Economy

Crude up 9% on the Libyan Unrest

Crude oil is up more than 7 dollars at 94 dollars, a rise of 9%, which is HUGE. Libya is seeing huge unrest after Egypt’s revolution, and the Great Gaddafi is likely in some trouble after about 40 years at the helm. Bahrain, too, is seeing serious protests, and oil supply is under some threat, it seems. Or at least, the markets think so.

Brent Crude, more relevant to India, is at $104+.

Crude oil up 9%

Brent Crude up too

Can you imagine what this kind of spike will do to our inflation? Till now we worried about onion prices and milk. But at least we produce that. We don’t produce much oil (just about 25% of our usage). Importing oil at higher prices will either mean higher government subsidies or higher retail prices – both of which are bad. More importantly, if prices keep rising worldwide, it will precipitate a hoarding crisis by countries and citizens alike.

At this point, the risk is real. But it’s tiny. You have to consider that the world has enormous economic firepower against rising inflation, with interest rates being low. But rising rates almost surely are a negative for equities, and so is a rising crude price. Overall, if you’re an equity investor you have to hope that there isn’t too much damage now.

Stocks: Crude rises hurt BPCL and HPCL. Since crude price rises are immediately passed on to ATF, Kingfisher Airways and Jet will be hurt. The auto majors – Tata Motors, M&M, Maruti – will hurt as well (and the budget doesn’t look like it’ll be kind on them). FMCG hurts as well – even soap takes some of the oil refining process output! Indirectly, banks are hit – rising interest rates aren’t good for them.

  • Anonymous says:

    >"Can you imagine what this kind of spike will do to our inflation?" – Hm. If price of oil increases due to supply shortage, price of those goods&services that are based on oil or transportation should increase relative to numerous "other" goods & services that do not depend upon oil/transportation. In an environment of constant money supply, you should expect demand for the "other" goods to go down & the prices of those should go down.

    Talking inflation as the "govt" defines it is meaningless. "Inflation" in the true sense is ALWAYS & ONLY a "monetary" phenomenon as Milton Friedman correctly explained it.

    Blaming inflation on oil shortage is meaningless. Blame the Govt of India.

  • Anonymous says:

    >"Importing oil at higher prices will either mean higher government subsidies or higher retail prices – both of which are bad." – Govt fixing or manipulating oil prices is the only bad thing here.

    Higher retail prices can only be a good thing. "Price" is the only feedback to either producers to produce more oil or consumers to consume less of oil or may be another good. Prices of these other goods should come down.

    The notion that increasing cost of oil has this ripple effect on the economy that prices all over go up is just ludicrous to say the least.

  • Deepak Shenoy says:

    >Anon: Good points. Let me take it piece by piece.

    1) It's bad for inflation as a headline figure. You will see a higher inflation number witha higher oil price, regardless of what the economics textbooks say. Plus, the price elasticity of demand differs for oil with respect to various oil-dependent goods – that is, certain goods respond instantly, others take too much time on the way down but much faster on the way up, some the other way around etc. The cycle you mention is great in theory (and for stuff like onion or sugar prices) but oil price shocks can be hugely distortive. both short and long term.

    2) If you see the oil price shocks in the 70s, you'll see how inflation was almost a direct hit. There were wars in the ME (Egypt and Syria attacked Israel) and then inflation went to 14% in the US and so on.

    3) Monetary measures are overrated in India. The transmission system is broken, for one. OR really really slow. Second, you have a problem with the money multiplier – there is simply too much available to lever, and leverage is hidden within weirdo restructuring/mark-to-make-believe/risk weighting practices.

    4) Theoretically we should have found serious alternatives to oil by now. We haven't. And building anything alternate will take too much time; so inflation is acceptable to a ceratin

    5) The problem is also that there is some flooding through QE2, and while we continue to keep our rupee weak by artificially stifling foreign demand for our corporate and govt. bonds, we simply can't imagine that we are in an efficient monetary transmission system. Typically – money flows in due to higher interest rates, your currency appreciates, imported inflation eases and so on – but practically, none of this is happening; fund flows are negative, foreigners can't buy our bonds, and we are getting hit with imported inflation. Add to that a weak local monetary transmission system.

    Maybe you speak of money supply based inflation, which could be entirely different. – but I speak of inflation as it's being measured. Sure, that's not the truest of numbers, and neither is money supply expansion if you ask me.

    On your second point, I agree that higher prices can be a good thing. But in the short term, the prices of stuff directly impacted by oil price rises will go up. Prices are sticky on the way down too, at least at the derivative product level.

    What I also think is that if this was one-off we should have been able to take it. But primary articls inflation has been high for over a year, and the secondary goods (manufactured goods) prices haven't yet gone up. This might just be the price shock required to breach that dam.

    Time will tell us who's right. I say that if oil prices stay this way, India will see higher inflation first and only after dramatic measures will it ease off.