There’s no stopping the surge in oil prices

“So what’s the plan for Valentine’s Day?” I asked my friend Ruma as we got out of office.

“Oh, you still into these things?” she asked.

“Not me, but I did notice the pedicure and manicure you got a couple of days back.”

“That was just general grooming.”

“As Hector Hugh Munro, better known by the pen name Saki, once wrote, “A woman and an elephant never forget an injury.”

“What do you mean?” she asked.

“Never mind.”

“Never mind,” she said. “By the way, have you noticed this ‘don’t buy petrol’ email campaign?”

“Nope. What is it about?”

“Well, there is an email going around, urging people not to buy petrol on February 14.”

“That’s weird. What’s the idea?”

“According to the email, petrol prices in India are above of Rs60 a litre, whereas in countries like Pakistan and Malaysia, petrol prices are in the range of Rs17-18 per litre.”

“So?”

“It says the petroleum companies in India are minting money and hence, if none of us bought a drop of petrol for one day, the oil companies would choke on their stockpiles.”

“That’s a stupid argument. Petrol in India is costly because it is used to subsidise diesel, kerosene and LPG cylinders. So anyone who says the companies selling petrol benefit from selling petrol at a high price sure doesn’t know the way it works.”

“Oh. Is that right?” she asked.

“Of course,” I said. “And lately, the government has given the companies selling oil some sort of freedom in setting prices. But as oil prices continue to go up, it remains to be seen whether that flexibility remains.”

“So you feel oil prices will continue to go up?”

“Yes.”

“How can you be so sure?”

“Numbers, my dear, just numbers.”

“What numbers?”

“The World Energy Outlook 2010 report brought out a couple of months back by the International Energy Agency (IEA) expects total oil production to increase to 96 million barrels per day by 2035, from the current 88 million barrels per day. A growth in production of 9.1% over 25 years or so is not too encouraging.”

“Certainly.”

“The assumption behind this forecast is none too encouraging —- that the world will find an extra 900 billion barrels of oil over the next 25 years —- considering new finds of oil have been limited to around 10 billion barrels of oil a year in recent times.”

“So even a 9% growth rate is under threat.”

“Yes. I read a rather interesting column by Puru Saxena, a Hong Kong-based fund manager. According to him, “the International Energy Agency now expects the output from the currently producing (oil) fields to drop from approximately 70 million barrels per day to only 16 million barrels per day by 2035. Furthermore, the IEA also believes that 60% of oil production in 2035 will come from oil fields not yet found or developed.”

“It sure doesn’t look good.”

“There’s more. We just talked about the supply side of things. The demand side is also going to get worse. As Lester R Brown writes in Outgrowing the Earth: The Food Security Challenge in an Age of Falling Water Tables and Rising Temperatures, “If China had Japan’s automobile ownership rate of one car for every two people, it would have a fleet of 640 million, a 40-fold increase from the 16 million today.”

Imagine what that would do to global oil demand. A similar scenario is likely to happen in India as per capita income goes up.”

“Are we done yet?” she asked.

“Hold on. Saxena further writes, “It is our contention that the world will struggle to produce more than 91-92 million barrels of total liquids per day and global demand will collide with available supply. Of course, we do not know the exact timing of this event but if global consumption continues to grow by 1.5% per annum, we will get there within the next 2-3 years. Needless to say, when aggregate demand hits available supply, the price of oil will rise sharply. More importantly, if demand continues to increase in the developed world, there will be a permanent shortage of crude and governments will probably end up rationing petroleum.

Furthermore, it is our firm belief that ultimately, oil will only be used for its highest uses (agriculture and aviation).”

“What about other forms of fuel, such as ethanol?”

“Ethanol, produced from corn in the United States and sugarcane in Brazil, is a substitute for oil. But for ethanol to be financially viable, oil has to touch a price of $200 per barrel from the current $100 barrel level. Also, ethanol uses a lot of electricity and is difficult to transport given that it is corrosive and thus it has to be transported using special pipes or tankers.

"Despite the tag of 'renewable energy' that ethanol comes with, it is still putting carbon dioxide into the atmosphere when it burns. And surely, it does not help that more corn and sugarcane used to produce ethanol means lesser of these commodities available for food needs. Imagine what this would do to the price of sugar?”

“I was reading somewhere that the oil industry is betting big on something called “shale gas” as an alternative energy fuel. What is that?”

“Shale gas is essentially gas trapped within shale (rock) formations. It is deep within the earth’s crust and only recently technology which can release this gas has been developed. So getting this gas out is very expensive and thus not financially viable. Also, there are several environmental concerns regarding the hydraulic fracturing process which is used to get this gas out.

As Saxena points out, “It is worth noting that hydraulic fracturing is a process whereby water, sand and chemicals are injected at high pressure deep into the ground to break up the porous shale and allow for enhanced recovery of gas. Although this sounds simple enough, the problem is that this process of injecting chemicals close to the water table may pose a serious health risk.””

“So prices will keep going up.”

“Yes, they sure will. And the government will not allow the oil companies to pass on the increase in price to consumers beyond a certain level. And so, oil companies will start bleeding again in the days to come,” I said, accelerating my SUV.

The writer works in the financial services industry and can be reached at chandniburman@yahoo.com. Views are personal.