Tuesday, June 17, 2008

Oil touches an Intraday high of $139/bbl

Oil shot an intraday high of 139 yesterday. I was watching an interesting debate yesterday on CNBC Europe wherein one of the guests termed this phenomenon as a transfer of wealth. I am afraid this is a very myopic view towards international trade. Wealth is not just measured in monetary terms. In realty oil is an asset for the oil producing country. So we are essentially purchasing this asset and giving out cash in return. Here is how the transfer takes place:

Now the key here is that what really country I and E does after this transfer. For the importer nation oil purchased at $139/bbl should yield more value than the price paid for it and if that is the case it is not really a transfer of wealth, wealth is still created in country I though some may argue that the pace of wealth creation can certainly slowdown, but again my answer to this argument would again be – ‘it depends’.

Since the oil price spike has been fairly quick and sharp the economies of the oil exporting nations are still not mature enough to absorb such sudden inflows (remember the funds flow problem in India during October – December 2007) so they are then forced to invest abroad and hence ultimately a large part of money ends up coming back into the Importer country (provided its assets are attractive enough for investment), so if the oil utilization is prudent enough any slowdown in growth due to the oil price hike should be compensated with the capital inflows, ofcourse if import oil and just burn it without any productive outcome then it will always yield you into a problem. Let me also add that subsidies also contribute to the inefficiencies in the oil utilization, however the Indian subsidy bill especially on petrol is just a farce as thanks to the taxes on petrol we end up paying much more than warranted.

So here is summary of the article:

- The rise in oil prices does not really lead to a transfer of wealth.
- Any possible slowdown in the importer country is avoided due to the capital inflows from the oil exporting nations.
- However for this to happen the attractiveness of its assets has to be proportional to the possible slowdown as a result of oil price hike.
- This is only possible if the utilization of oil is prudent, subsidies hamper this process in a big way.

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