A couple of weeks ago when oil was hitting record $140 per barrel, I over-heard a comment, which stopped me right in my tracks as I was hiking the mountains of Santa Cruz in California. I heard a fellow hiker loudly proclaim to another hiker in his group “India and China are responsible for the latest price hikes in crude oil”. I stopped him and asked him to explain himself.

His explanation went something like this – “It’s all a matter of supply and demand. India and China are so power hungry that to fuel their economic growth, they are willing to pay any price thus pushing the price up”. I thought to myself another victim of the media propaganda.

I agree about the part of market fundamentals but what have India and China done to double the price of crude oil in less than a year. These days it’s impossible to read any news of the oil crises or even the global food crisis without India and China being blamed. The US blames the practice of oil subsidies in developing countries like India and China for the recent hike in oil prices and these countries in turn blame the oil speculators.

The basic argument used by all media is that more than 30% of the increased consumption of oil is attributed to countries like China and India and this number is going to increase to 40% by the year

  1. But does that mean that their crude consumption is high? There is the absolute consumption and there is the increased consumption (and there is the total consumption to date as well). Let’s take a look at the crude oil import data as given in UN data website (the data provided has been upto the year 2005 and the graph below has been plotted from the data).

Image Very interesting!! The USA not only imports much more crude oil than India or China but their increase in crude oil imports has been of the same order or even steeper than India or China!! Now let’s take a look at the daily oil consumption of the three countries in question. I downloaded the data from the BP Statistical Review of World Energy 2008 and plotted the following figure of average daily oil consumption from 1965 through

  1. Again, not very surprising. Daily oil consumption in the US is far greater than India and China combined!!

Image Let’s take a closer look at the numbers:

  • US was consuming 20.7 million barrels of oil per day in 2007, while India was consuming 2.75 million barrels of oil and China was consuming 7.85 million barrels per day.
  • US consumed 23.9% of total world share of crude oil in 2007, whereas China 9.3% and India 3.3%.
  • The US consumption is 7.5 times that of India and 2.5 times of China. That means 1% increase in oil consumption is equivalent to 7.5% increase in consumption of India and 2.5% of China.
  • India's total annual consumption of oil in 2007 was equal to US's 1 1/2 months oil consumption.
  • India is more than three times as populated than the US (1.1 billion vs. 300 million) i.e., it has three times more population to support than US while consumption is less than one-seventh.
  • The Per Capita consumption of energy by US is 24 barrels per person per year while India's consumption is 1 barrel per person per year. So, when the media reports of the increased consumption in China and India without mentioning the absolute consumption of developed nations, it’s misleading the public without giving the whole truth. Irrelevant data is being fed to general public and then completely baseless inference is being drawn. It is important to analyze facts and figures before drawing conclusion or else there is the danger of falling a victim to media propaganda as our friend, the hiker, has been. With an inflow of $250 billion to commodities indexes indicates that speculators have had a big role in the run-up in prices. Recently the price of oil dropped to $120 a barrel and is still dropping. In essence speculators have played a greater role in the market than either buyers or sellers. It seems clear that the USA holds the biggest lever to reduce crude oil demands. India and China are emerging economies where 2/5 of the world population lives. They are trying to lift millions of people out of poverty. As such, they may not have the political capital to cut back on their increasing (but still small) usage of crude oil. The government can't pass the price hike on to the public as most small businesses, the vehicle of growth, depend on the oil subsidies. On the other hand, even a small percentage cutback in the USA will reduce demand significantly. Lets hope that the USA moves towards more efficient cars, better public transport systems and away from its suburban driving culture and oil dependency in order to keep crude oil within reach of poorer nations of the World. While rising oil and gas prices are pinching consumers’ wallets and corporate profits in the United States and Europe, the consequences have been more drastic in many developing countries. The price of oil has become a hotly debated theory. But what is keeping prices close to record levels? In a nutshell, BBC News online has summarized it quite well.

Weak US dollar

  • The sharp jump in prices since 2005 has coincided with the plunge in the value of the dollar against other leading currencies

  • Dollar weakness encourages financial investors to look for other more lucrative investment opportunities, with oil top of their list

  • As oil is traded in dollars, it also makes it cheaper to buy

  • Signs the US economy may be on the brink of recession have undermined the dollar, boosting prices. Prices rose $11 on a single day last month when the unemployment rate rose

Supply Concerns

  • Analysts say growth in global supplies is worryingly failing to keep pace with growth in demand

  • Supplies from countries such as Russia are thought to have peaked and finding new sources of oil is difficult and expensive

  • Increasing reliance on members of the Middle-East dominated oil producers group Opec, many of which are already pumping as much oil as they can

  • Saudi Arabia is one of few countries with spare capacity but it has been reluctant to boost output substantially

Demand Growth

  • Global thirst for oil is intense. Demand has risen by about 3 million barrels a day since 2005 and is expected to rise by 32 million barrels a day in the next two decades

  • The US remains the world's largest oil consumer and high individual fuel usage continues to put pressure on crude stockpiles

  • Fast-growing China and India are forecast to account for 40% of the growth in oil demand by 2030, as industry grows and demand for travel increases

Political Instability

  • Much of the world's oil is concentrated in volatile regions, leading to fears of frequent and unpredictable disruptions to supplies

  • Despite oil output being at a six-year high, Iraq is still beset by violence while militant groups in Nigeria's main oil-producing region have recently impeded about a quarter of its output

  • Tensions over Iran's nuclear program. There are fears that an Israeli attack on Iran's nuclear installations could trigger a wider conflict and threaten traffic through the strategically vital Strait of Hormuz, used to ship 40% of the world's oil.

Market Speculation

  • Oil exporters say the price surge cannot be explained by the fundamental ratio of supply to demand and point their fingers at market speculators

  • It is claimed that some traders are making huge amounts of money betting on the direction of prices, in turn forcing prices higher

  • Others maintain that traders are simply hedging their investments against future market developments to reduce risk

  • US regulators are looking for evidence of market manipulation while the IMF is examining the role of traders in the price spike

Is there a solution to this problem? I’m not an economist but here’s my quick fix. Regulate the oil market. Ban future trading in commodities. Create an oil buyer’s cartel to keep OPEC in check. Seek alternative sources of energy. Go green!