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High oil prices? Chidambaram has a solution
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June 30, 2008

I represent a country that has over 1.1 billion people; that began a long and arduous journey of development; and that has, in recent years, rediscovered its inner strengths and acquired the capacity to end poverty.

I speak with great anguish because the goals that we have set for ourselves are in grave peril.

Oil prices threaten to wipe out the economic gains made by developing countries in recent years. The irrational escalation in oil prices is the cause of diversion of scarce resources from education, health and other social sector schemes.

Three weeks ago, India passed on barely 9 per cent of the required price increase to consumers: the result is that inflation measured by wholesale prices has crossed 11 per cent.

We are sorry to note that even oil producing countries such as Indonesia, Russia, Saudi Arabia and Venezuela face double-digit inflation rates ranging from 10.5 per cent to 29.3 per cent.

How did this situation come about? And how may we overcome what appear to be formidable challenges? Let me focus on some key areas from the perspective of developing economies like India.

Questions have been raised about the fundamentals of the oil industry. There is a need for the oil industry to re-assert its leadership in price formation and not remain passive spectator of speculation and paper trading in oil. The global hydrocarbon community must address this situation through appropriate supply-side responses and calm the oil markets.

Today, the vulnerability of the supply chain to temporary supply disruptions stands exposed. Global oil consumption grew by 1.1 per cent or 1,000,000 barrels per day in 2007 whereas the global oil production fell by 130,000 barrels per day. Spare capacity, across the supply chain, has dwindled considerably. This has added to risks and uncertainty.

According to the estimates of the International Energy Agency, our future oil and gas needs call for massive investments of the order of $ 10 trillion by the year 2030. Such fund mobilisation can be achieved. Fresh investments are not materialising perhaps because of anticipated fall in demand. This is plainly wrong.

Respectfully, we reject the suggestion that rising demand is the cause of spiraling oil prices. Surely, demand and supply dynamics can not explain what has happened over the last 12 months.

How is it that oil prices were $70 a barrel in August, 2007, and how is it that they have doubled when there has been no dramatic change in demand? The causes for the current pandemonium in oil prices lie elsewhere: in unregulated over-the-counter markets and futures trading in oil.

There is ample evidence that large financial institutions, pension funds, hedge funds etc. have channelised trillions of dollars into commodity investments and commodity derivatives.

It is common knowledge that these financial transactions are unregulated and highly opaque. The demand for oil generated by these funds is purely speculative demand. In our view, the time has come for producers - especially OPEC - and consumers to wrest control over oil trading from the hands of the speculators.

The only way forward is for the both producers and consumers to find common ground. We have a proposal that will instill mutual confidence. We propose that we adopt a Price Band Mechanism. Consuming countries must guarantee that oil prices will not fall below an agreed level and producing countries must guarantee that oil prices will not rise above a guaranteed level.

In the band between these two levels, let prices be determined by market forces. This is the only way to shelter the world from volatility and unpredictability in oil prices.

We firmly believe that the current level of international oil prices is in the interest of neither the oil-producing countries nor the consuming countries. If the global economy slows down or slips into a recession due to high oil prices, that will eventually hurt all of us.

I appeal to you in the name of development; I appeal to you on behalf of all developing countries to seize the moment.

Remarks by Finance Minister P Chidambaram at the Energy Ministers' Meeting, Jeddah, Saudi Arabia on 22 June 2008.

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