Why oil is at US$130

Posted by NP Editor - By John E. Lowe

One of the primary drivers of higher global oil prices over the last five years has been a sustained period of robust global economic growth, which led to stronger than expected energy demand growth.

A second reason for high global crude oil prices is constraints on expanding conventional supplies. The biggest constraint is rising resource nationalism that limits access to resources for development. In the 1960s, 85% of global oil and natural gas reserves were available for direct development by international oil companies, versus only 7% today. In addition, rising competition for access to the relatively limited resources that are open for development has enabled host governments to dictate fiscal terms that are so onerous that publically trade oil companies cannot economically pursue them. Increased taxes are a part of the change in the fiscal terms. Morgan Stanley estimates that the exploration and production tax rates of major oil companies have increased from about 30% to 45% since 2000. In some cases, governments change fiscal terms after investments have been made or increase taxes on existing production, even in mature producing areas in otherwise stable countries (Alaska in the United States and the United Kingdom). Such actions can make it uneconomic to invest the capital required to slow decline rates in existing fields. Increases in tax rates and other forms of government take are particularly problematic due to the maturity of oil provinces in areas such as the United States, the North Sea and Western Siberia and the increasing amount of capital required to offset the rising decline rates.

Resource access is also very limited in the United States, where an estimated 40 billion barrels of technically recoverable oil are either completely off limits or subject to significant lease restrictions. Similar restrictions apply to more than 250 trillion cubic feet of recoverable natural gas reserves.

Also pushing crude oil prices upward is the high geopolitical supply risk attributable to the world’s low level of excess oil production capacity and the fact that in several key oil-producing countries, political factors are constraining production. (E.g., Nigeria, Iraq, Venezuela and Iran.) The combination of strong demand growth and the need to offset lost production from these countries left the Organization of Oil Exporting Countries (OPEC) at year-end 2007 with only 2.5 million barrels a day of excess capacity, equal to just 3% of global oil demand. This contrasts sharply with the greater than 10 million barrels per day of excess capacity that existed in the mid q980s. This lack of spare capacity leaves world markets more vulnerable to oil supply disruptions caused by political events, storm damage to producing facilities, or unforeseen operational problems.

Within limits, OPEC could historically influence prices by adjusting its production to tighten or loosen the supply and demand balance. However, today the large amount of oil traded in futures exchanges (1.3 billion barrels per day) is 36 times greater than OPEC’s oil production of 36 million barrels per day. In addition, given OPEC’s small excess production capacity, its member nations have significantly less influence on the price of crude oil than they had in the past.

A final possible reason for recent increases in crude oil prices is the rising attractiveness of commodities to financial investors. Commodity index funds have been developed to provide investors with a financial vehicle to gain commodity price exposure. Investors have moved large amounts of capital into these funds in order to seek higher returns than are currently available through the stock and bond markets, to hedge the risk in their portfolios given the negative correlation between commodity prices and prices of stocks and bonds, or to hedge against inflation. Declines in U.S. interest rates or the value of the dollar stoke concerns about inflation, prompting an inflow of cash into these funds. According to Daniel Yergin, chairman of Cambridge Energy Resources Associates, “oil has become the ‘new gold’ — a financial asset in which investors seek refuge as inflation rises and the dollar weakens.”

Excerpted from yesterday’s testimony by John E. Lowe, executive vice-president, exploration and prroduction, ConocoPhillips, at U.S. Senate hearings on “Exploring the Skyrocketing Cost of Oil.”

Airport: Skybus Airlines Shutting Down

Another News reflects slowing US Economy...

COLUMBUS, Ohio (AP) — Low-cost carrier Skybus Airlines is shutting down Saturday and plans to file for bankruptcy protection next week, becoming the latest of the nation's airlines to fall because of rising fuel costs and a slowing economy.

The financial situation of the airline, which announced the shutdown late Friday, has worsened in recent weeks, said Skybus spokesman Bob Tenenbaum.

"We deeply regret this decision, and the impact this will have on our employees and their families, our customers, our vendors and other partners, and the communities in which we have been operating," Michael Hodge, chief executive of Columbus-based Skybus, said in a statement.
"Skybus struggled to overcome the combination of rising jet fuel costs and a slowing economic environment," he said. "These two issues proved to be insurmountable for a new carrier."

The airline makes 74 daily flights to 15 U.S. cities, Tenenbaum said. It has about 450 employees.
Tenenbaum did not know how many passengers would be affected but said the company has flights scheduled through Sept. 2. All passengers affected by the shutdown are eligible for a full refund.

The airline said that all flights were to be completed Friday and that it plans to file Monday for Chapter 11 bankruptcy protection.

Skybus is pulling the plug less than two weeks after CEO Bill Diffenderffer resigned to pursue a book-writing career. He was succeeded by Hodge, the company's chief financial officer for the past year.

Skybus has endured some bumps since it began flying May 22, 2007. Over two days during Christmas week, the airline canceled as many as a quarter of its flights because of problems with two of its planes. Recently, it has been dropping flights and destinations because of high fuel costs.

The announcement adds to a string of bad news for airlines, which have been hurt by a slowing economy, high fuel prices and maintenance concerns.

ATA and Aloha Airlines both stopped flying this week after filing for bankruptcy protection. American, Southwest and Delta airlines have all had to cancel flights recently to address safety concerns about some of their aircraft.

On the Net: http://www.skybus.com/

Bhutia says no to torch relay

This is the time for all those who feel for the Tibet cause to stand tall against the injustice Tibetians have been subjected to over the years. The dream of living in a free country is noT a crime under any law, but the Chinese Oppression is ceratinly the most heinous crime. China must respect the integrity and sovereignty of TIBET & TAIWAN and respect their culture and traditions.

The flame of protests seems to be raging mightier than the Olympic flame itself with protestors from over the world doing their bit to highlight the Tibetian point of view. In a shock for all, India football captain Baichung Bhutia refused to run with the flame when it reaches New Delhi on April 17.

The decision to not carry the flame was informed to the Indian Olympic Association on Monday through a fax after he had been bestowed with the honour of carrying the Olympic torch on the India leg of its journey.

Talking to a leading newspaper, Bhutia, a gifted athlete and a devout a Buddhist, said, ‘‘I sympathize with the Tibetan cause. I have many friends in Sikkim who follow Buddhism. This is my way of standing by the people of Tibet and their struggle. I abhor violence in any form.’’

The star footballer emphasized that he had not been requested by any group to pull out of the torch run. ‘‘This is an absolutely personal decision. I feel what’s happening in Tibet is not right and in my small way I should show my solidarity.’’

Bhutia is among a growing list of celebrities who have refused to carry the Olympic flame as a mark of protest against the violence done against Tibetians.

In February, Hollywood director Steven Spielberg withdrew as an artistic adviser to the Olympics over China’s support to the Sudanese government at a time when the regime had been charged with massacres in the country’s Darfur region.

Last week, French President Nicolas Sarkozy said he did not rule out France boycotting the games if the situation in Tibet worsened.

Suresh Kalmadi, president of the IOA, had apparently not received any intimation of Bhutia’s plans. ‘‘The fax has not reached me as yet since I’m not in my office,’’ he said. Kalmadi added that there were a plethora of top athletes like PT Usha, Milkha Singh and Gurbachan Singh Randhawa have been invited for the event.

Although Bhutia is known for not having strong political views, he has made up his mind to side with Tibet for their cause. Perhaps this stems out from the fact that even the most gentle of souls can be stirred beyond the point of being submissive when their core ethics are challenged.

Subprime crisis: Worst may be yet to come

Much has been written on the subprime crisis and the impact it will have on the world, in general, and on India in particular. However, the worst might be yet to come.

So what is the subprime home loan market? It is aggregation of those individuals in the United States to whom, normal banks do not lend, for the simple reason that their credit histories are not good. Hence, there is a greater chance of the individual taking the loan defaulting. And no bank likes to take on customers who are likely to default.

Here is where institutions which have a good credit rating and are willing to take some amount of risk, come in. They borrow money from banks and lend it to the Americans who have a bad credit rating. They divide this loan, into a lot of small tranches and give it out as home loans to Americans who do not have a good credit rating and to whom the bank will not give a home loan directly.

They give out the loan at a rate of interest, which is obviously higher than the rate at which they had borrowed from the bank. This higher rate is referred to as the subprime rate and this home loan market is referred to as the subprime home loan market.

The loans given out in the subprime market are largely adjustable rate mortgages(ARMs). These mortgages are somewhat similar to the floating rate home loans given in India, where as the interest rates vary, the equated monthly installment (EMI) of the floating rate home loan also varies. But there is more to the ARMs than that.

The two most popular adjustable rate mortgages are the interest-only ARMs and payment-option ARMs.

Interest-only ARMs, as the name suggests, involves paying only the interest on the loan for the first few years. This can typically vary anywhere from 3 years to 10 years. After that the principal repayment kicks in. What this does is that during the initial few years of repaying the loan, it keeps the EMI low. Once the principal repayment kicks in, the EMI starts increasing substantially.

Under the payment-option ARM, the interest rate for the first year is very low. After that, the interest rate is the same as other mortgage loans. But the low interest rate comes with a cost attached. The unpaid interest, essentially the difference between the offered interest rate and the real interest rate that is being charged on other mortgages, gets added to the overall loan and the overall loan keeps increasing.

There are certain dates on which these loans are reset. When these loans are reset, the EMI on these loans changes. The largest resets are expected to happen in the first six months of next year.

In 2007, around $197 billion of subprime loans have been reset. Estimates suggest that in the first six months of 2008, around $521 billion of resets are expected. Of this resets nearly 30% will be on interest-only ARMs and payment-option ARMs.

What this means is that the EMI of the subprime borrowers, who have either an interest-option ARM or a payment-option ARM, is expected to go up, as and when these resets happen. Once this happens, whether the subprime borrowers will continue to pay their EMIs is not very certain.

As we have seen in the earlier articles, the institution giving out the home loans in the subprime market does not keep the loans on its books. It does not wait for the principal and the interest on the subprime home loans to be repaid. It goes ahead and securitises these loans. Securitisation essentially involves, converting these home loans into financial securities, which promise to pay a certain rate of interest. These financial securities are then sold to big institutional investors.
The interest and the principal that is repaid by the subprime borrowers through EMI is passed onto these institutional investors who buy these financial securities.

Now once the EMIs go up, there is a great chance that subprime borrowers may not be able to pay them. If these EMIs are not paid, then investors who had bought the securitised paper will not get paid and hence suffer losses.

To cover their losses they may have to sell their investments in emerging markets like India, where there investments have been generating return.

And when they sell their investments in emerging markets, the markets are likely to fall, if there is less buying at that point of time.

Making Globalization Work - Audio

Making Globalization WorkJoseph StiglitzLecture delivered in Chennai on January 4, 2007

Listen to the Lecture!Instructions: The audio is available in mp3 format. If the file does not play automatically in your media player when you click on it,download the file and listen to it on your favourite media player. To download the file, right-click on each link and click 'Save Target As..' or 'Save Link As..' and save.

File
Duration(in minutes)
Size
Introduction; Part 1, by N. Ram, Editor-in-Chief, The Hindu - 6.10 - 1448 kb
Introduction; Part 2, by N. Ravi, Editor, The Hindu - 9.13 - 2163 kb
Lecture; Part 1 * - 8.48 - 2063 kb
Lecture; Part 2 - 10.00 - 2345 kb
Lecture; Part 3 - 5.18 - 1246 kb
Lecture; Part 4 - 3.32 - 829 kb
Lecture; Part 5 - 7.02 - 1650 kb
Lecture; Part 6 - 7.33 - 1772 kb
Lecture; Part 7 - 10.08 - 2377 kb
Lecture; Part 8 - 5.23 - 1266 kb
Question Time; Part 1 - 11.23 - 2672 kb
Question Time; Part 2 - 13.15 - 3110 kb
Question Time; Part 3 - 16.42 - 3917 kb

* Lecture Part 1 contains some boom and flutter in the first 27 seconds; this is an artefact from the original recording and has not been edited.

Copyright © 2007, The Hindu. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu