Whooping Prices – Crude Oil & Property

If the rising oil prices have been baffling people across, including Indians who own a property to sell, I would call it divine vengeance on my behalf.

Half a crore has become the basic asking price for a decent accommodation. ‘Decent’ has its limitations. It may not take into account basics such electricity, water, security, vicinity to school, hospital, grocers, etc. (But surely a great mall would be close by. And an International airport by 2020 though I wonder what I would do with the airport on a daily basis!)

Anyways, this write-up is about oil prices. So lets put that into perspective. The revelations that I am going to share here are not mine frankly. They’ve been inspired by an article in rediff. It kind of explains the reason behind the unprecedented rise in crude oil price at a global level. I’ll try and do that in even more simpler language for everyone’s benefit.

One word – Futures trading is responsible for it (it couldn’t have been expressed in a simpler manner :)

The fact of the matter is that supply of crude oil has not been a problem. Infact, Saudi Arabia has even offered to ramp up the production. That hasn’t helped the price surge. Demand is not the major problem. It has increased to some extent but not to an extent to push prices at the level they are.

So where lies the bug that’s rocketing crude oil prices?

It lies with the over optimistic expectations of people from the future. Speculators! They make the stock market rise, they make the property market rise, they are making the oil prices rise. Reminds me of the saying, ‘The future is so bright it burns my eyes.’

My understanding is that a lot of people are not buying property because they need it but because they expect it to give them a fantastic return. Best form of investment. Which is why, even if the property has no basic amenities, it will still carry an illogical price tag. Expectations from the future. Speculation.

Had the demand for housing been real, wouldn’t rentals have gone up the same way. I pay Rs.10,000 for a house that will cost me Rs.70 lacs were I to buy it.

OPEC no longer controls oil prices (though they’ve been profiting from it). Today’s oil prices are goverened by speculators trading in New York & London in US dollars. The futures trading determines the spot prices for oil. Let me illustrate with an example:

Suppose the market determines that price of oil will be $250 in 2011 basis trading of futures and derivatives. Now, they will use the time value of money and discount this $250 to today’s value. This value will then determine today’s spot price. So if oil will cost $250 in 2011, it ought to cost $140 in 2008. That ways!

And I read somewhere that these markets do not have governing bodies like we have SEBI for stock exchange which is why governments are no longer in control of oil prices, unless they decide to step up and tamper with 'free market' fundamental.

Markets seem like an an emotional game. Look at the stock market for example. Many a famous scrips have prices that just cannot be justified basis dividend earning capacity. Even if you were to rake in the expected dividends for the next 30 years and add it to the face value of the share, the market value will still outstrip this amount.

But I have a very limited understanding of the financial and property markets and the way they work. Would be great if someone can throw more light on these issues.