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Thursday March 26, 2009
Making a Point - By Jagdev Singh Sidhu
We don’t need another price bubble
EQUITY markets over the past two weeks have experienced a rally not seen since before World War Two on hopes that the latest plan by the US to tackle its banking sector’s toxic assets, together with previous stimulus plans, will launch the economy and the rest of the world towards recovery.
That optimism, which was first ignited by Citigroup saying it had posted a profit in the first two months of the year, has also led to global commodities rebounding in tandem with equity markets.
But the performance of one commodity that has caught my eye is the price of crude oil, especially for its stickiness in maintaining a relatively high price in a recessionary period.
The price of Nymex futures, one of the benchmarks for measuring crude oil, is now at US$53 a barrel, having rebounded off a low of just under US$34 in December last year.
Energy prices are very sensitive to the balance between supply and demand and a small deviation from the finely-tuned equilibrium normally has tremendous impact on prices.
It was not a surprise that the International Energy Agency, which projects that world consumption of crude oil in 2009 will be 1.5% lower than in 2008, called the contraction staggering.
The price of crude oil has been kept from falling through a combination of planned supply cuts by oil-producing cartel Opec to meet an anticipated reduction in demand in 2009, and the hope of demand increasing as the global economy recovers.
The argument is that too low a price will mean trouble for the energy markets as higher costs have already seeped into the business. Refining costs have gone up and so too have exploration and drilling costs over the past few years as oil companies venture off the deeper waters and harder-to-access places in search of the commodity.
But the current price of oil, even though on a recent historical basis is cheap, is much higher than what some might have expected with the world economy facing its greatest challenge in decades.
The current “high” price of crude is also a clear warning sign that the price of the commodity will soar again when more credible evidence of an economic recovery starts filtering through.
Should oil prices rise again, there is a good chance that other commodities will follow. Whether global commodities rise to their previous recent heights sooner than later is debatable, but the impact will certainly be felt.
And the last thing the world wants to deal with now is another bout of high oil prices and other commodities such as food crimping on consumption and disposable incomes when incomes are fragile.
Plans to limit excessive speculative trading in commodities by hedge funds must be carried through and enforced. The world doesn’t need higher priced commodities raising inflation, hitting the public’s wallets and slowing any recovery in the economy.
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