In your interest.
Online Personal Finance Magazine
No beating about the bush.
In July, crude oil price was around $100. Now it’s around $65. What has caused the oil price to crash 35% suddenly?
The US Benchmark Western Texas Intermediate (WTI) fell to $64.47 today which was its lowest level since May 2010. This comes after the WTI contracts for January had already crashed 10% at market close on the New York Mercantile Exchange on Friday. Why has crude oil price oil been on a relentless slide over the past four months? Normally, declines such as this are associated with fears of recession. What are the reasons this time?
US shale oil revolution: The main reason is that there is an oversupply in the oil market thanks to shale oil revolution in the US. Most people had barely heard of shale oil until a few years ago. As recently as two years ago, shale oil was being dismissed by all market participants as a sideshow. Now, shale oil production from the US has taken its oil production back to the level seen in the 80s, causing a major oil glut in the markets. This, combined with the other two factors noted below, has caused a prolonged drop in world oil prices.
OPEC holds production: Conspiracy theorists say that OPEC, the cartel of oil-producing countries wants to break the back of US shale oil companies and actually wants prices to go down. This is why in the meeting held on 27 November, OPEC countries voted to continue oil production at current levels, which stands at 30 million barrels a day.
Disregarding worries from Venezuela, Iran and Iraq, the Saudis pushed for higher production to sustain market share, and bankrupt US shale oil companies, and OPEC subsequently voted for the Saudi position. Of course, OPEC countries depend on oil exports for their economic balance and may suffer serious financial setback by selling their oil for cheaper, in the hope that they would be able to bankrupt shale producers before they bankrupt themselves. At least three OPEC members were apprehensive of fighting a war of attrition against the shale oil producers. Expert opinion on whether shale will stay viable is divided considering that the technologies and economics of shale oil are still not widely understood.
Chinese consumption slump: While the drop in oil prices is largely because of increased production by the world's largest oil consumer, the US, there is a third major factor at play. Until a few years ago, OPEC could tweak production to manage oil prices according to demand. With the slowdown in China, the oil demand itself is slowing down.
Over the last few years, China was the new market for oil that grew but no new large market seems to be on the horizon that can consume the way China did. If there is a slowing growth in the overall market, coupled by increased production by the world's largest oil consumer itself, it is anybody's guess as to how long the price wars can go on.
Falling oil prices have however been good news for India. Share prices of Indian oil marketing companies shot up as higher oil consumption is expected as a result of lower prices. An improved economic scenario, lower oil import bill and input costs have already spurred the stock markets higher. The overall result of the oil price saga will play out over the long term and for now oil importers and consumers will remain a happy bunch.
The choice facing OPEC is that it could hold production and grow the number of overall oil consumers while taking a short term fiscal beating, with the hope to drive shale oil out of the game. Or OPEC to drop production and hold prices but with the guarantee of losing market share to shale oil and almost inevitably causing long term harm to its interests.
In choosing the former, OPEC seems to have dug in for the long fight.
While Bitcoin investors have been quick to revolt against regulations, the system reeks of a lack of transparency and Bitcoins have exhibited a characteristic typical of a highly speculative market
Bitcoin is a highly speculative and unregulated virtual instrument, which has been the subject of a global controversy since its genesis. Bitcoin was created by an anonymous hacker to facilitate decentralised online transactions using Bitcoins as a quasi currency.
Transactions in this system are made with no intermediaries, banks or regulatory agencies. Bitcoins are a completely decentralised form of money, which is not regulated or issued by any government. To classify Bitcoins as a virtual currency is wrong. It is an undefined virtual exchange without any economically or empirically sound price discovery mechanism or rationalised process for generation.
Bitcoin has been created by cryptographic software running on a network of volunteers’ computers, making the system both hard to track, and decentralised to operate on exchange platforms set up in various jurisdictions, which results in regulatory issue in regulating of such a currency. Clearly, Bitcoins do not fit the legal definition of “money” that is a medium of exchange authorised or adopted by a domestic or foreign government, whereas there exists no such central authority to govern Bitcoins. The promoters of Bitcoins have naively argued that the decentralised system ensures that there is no control dependence on a particular centre of control. This also ensures that inter-jurisdictional regulation of Bitcoins is impossible.
Bitcoins have a striking and rather ominous similarity to the derivatives, which were designed to challenge the most financially literate investors. Since Bitcoins are neither stable in terms of price, nor underwritten by any government, they fail to serve as a virtual currency. Potential investors in Bitcoins are lured into ‘investing’ in Bitcoins merely by the promise of riding the speculative wave, which has incentivised by the skyrocketing price of Bitcoins.
Although the Bitcoin has been tremendously successful, it has been wildly volatile as the its value is pegged to the whim of investors and can only be assessed by speculation. The market value of the Bitcoin has exhibited a characteristic typical of a highly speculative market, starting with a rapid, parabolic jump to the top, followed by an inevitable crash. Bitcoins have continued to operate solely on the naïve trust of online purchasers who continue to purchase Bitcoins from Bitcoin miners, who generate Bitcoins.
In a press release, the Reserve Bank of India (RBI) has pointed out glaring issues with the virtual currencies, including Bitcoin and has raised concerns about the potential hazards of trading on an anonymous peer-to-peer basis without an authorised central agency, which regulates such payments.
Market manipulators could potentially inflate prices of the Bitcoin, and then offload their entire holdings, leading to a cataclysmic meltdown. Using a modus operandi similar to that of a Ponzi scheme, market manipulators could allow the Bitcoin bubble to grow till there is a critical mass of investors who have earned from the speculative trade and lure more investors into the scheme. What remains to be seen if the entire system collapses after a massive disposal of Bitcoins.
This concern has been underscored by the bankruptcy of Mt.Gox, the world’s largest Bitcoin exchange in 2013. The implosion was triggered when half a billion dollars worth of Bitcoins ‘disappeared’ triggering a mass withdrawal and raising allegations that the collapse was an orchestrated scheme. The price of Bitcoins on Mt.Gox eventually became completely disengaged from the wider Bitcoin market, and in the days leading to its collapse, the exchange’s total Bitcoin holdings were just at 2,000, while customer deposits totaled 6,24,408.
This highlights the fact that there is no established framework for Bitcoin users and investors to recover their investment in Bitcoins in the event of market manipulation or any economic offense for that matter. In the absence of regulators, the possibility of market rigging and price manipulation is a very real possibility.
This dilution of control has become a critical concern as the decentralisation could lead to serious jurisdictional issues when there is an attempt to regulate the currency is a serious regulatory challenge. The amorphous classification of the Bitcoin also raises concerns as to the actual value of the Bitcoin, which neither has any inherent value nor is it pegged to the value of any underlying asset or commodity.
Regulators around the world, including the US Securities and Exchange Commission (SEC) and Federal Bureau of Investigation (FBI) have been grappling with the jurisdictional issues due to the ambiguity of Bitcoins being a currency, a derivative and an investment contract. While Bitcoin investors have been quick to revolt against regulations, the system reeks of a lack of transparency in the asset structure, and any rationalised, empirical basis for the generation or appreciation in the value of the Bitcoin.
A critical issue that continues to plague regulators is this classification of Bitcoins. Since its value is not pegged to any underlying asset, it cannot be classified as a derivative. The incredible part about Bitcoins is that it does not qualify as a fiat currency since there is no central authority that issues Bitcoins. This raises concerns about the sustainability of Bitcoin, but since it is the first decentralised digital currency, perhaps a new regulatory framework needs to be set up to retrospectively regulate such instruments and prevent their misuse.
With the current rhetoric surrounding the legitimacy and classification of Bitcoins it may be prudent to desist from investing in an instrument which has the dubious distinction of being beyond regulatory purview in most countries.