Oil prices continue to rise and speculators are everyone?s favourite villain. But let?s recognise one thing first: oil isn?t allowed to be fully governed by market laws, so blaming the market can be a bit odd. Important oil producers are organised in an explicit cartel that fixes output in meetings of government officials. And a lot of large consuming countries, particularly in Asia, have governments subsiding the consumption of oil-based products. So, a market speculator could, quiet rightly, feel aggrieved at being blamed for distorting the equilibrium price of oil and pushing it way above ?acceptable? levels. Market players are simply accounting for these distortions and then setting what they think is the correct market clearing rate. Indeed, had fresh oil supplies been able to respond to demand, no one would have thought of speculators. And forward trading is really anticipating the future.
The fact is, the near future portends a further rise in the demand-supply gap. China and India, it is estimated, account for a little less than three-quarters of demand growth in oil-based products in recent times. And since both countries use extensive subsidies to insulate their consumers from the rising market prices of oil, there has been no correction in the level of demand despite rising prices. If anything, demand has continued to rise. Oil subsidies are rampant in other Asian countries too, which adds to the distortion. At the same time, supply has not kept pace. Some of this does have to do with politics?the war in Iraq and the noises about possible military action in Iran have not helped things on the supply side. Also, some oil producing countries, like Russia, Venezuela, Iran and Libya and their autocratic leaders are thriving on these prices. There isn?t much incentive to increase supply and lower the prices especially since demand cannot be guaranteed forever. Already, demand for oil in the US and Europe is falling as people cut back on consumption. The solution to bringing down oil prices is not in price control?price bands with ceilings?it is in reducing demand from Asia. Once that begins to happen, market ?speculators? will adjust their expectations downwards. Governments should stop messing around immediately and let the market do its business.
