Why did crude oil price fall so suddenly?

Before we try to analyse the reasons for the sudden sharp fall in the price of crude oil – let us pause for a moment to heave a sigh of relief. Rising oil price worsens India’s huge fiscal deficit, curtails expenditure in developmental activities, and dampens growth. Another round of petrol – and possibly diesel – price hike is imminent.

That would further stoke the already raging fire of inflation – notwithstanding RBI’s aggressive interest rate increase. After nine straight days of correction in the Indian stock market – during which the Sensex fell nearly 7.5% – the fall in oil price is as welcome as the first drops of rain after a long, hot summer.

Why did oil price fall so suddenly? The first and most obvious reason is technical. A look at the 3 months bar chart pattern of NYMEX Light Crude oil below shows the strong spurt in price from 83 in mid-Feb ‘11 to 114 in end-Apr ‘11 – a 37% gain in less than 3 months. Most of the gains was speculative, caused by the unrest in the Middle East which didn’t really hamper supplies much. Sudden unloading by speculators typically cause such sharp corrections.

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What triggered the sudden unloading? The entire commodities space got spooked by the disappointing unemployment data from USA. Not just crude oil, but investor favourites like gold and silver also nose-dived. There are reports that consumers in USA are opting for more fuel-efficient cars in the wake of rising gasoline prices and painfully slow growth of the economy. That will reduce demand for oil.

There is an interesting political spin on the fall in crude oil price. Apparently, Saudi Arabia played a behind-the-scenes role in persuading Pakistan to hand over Osama bin Laden to the Americans. In the process, they killed two birds with one stone. Bin Laden’s elimination expectedly came as a feather in the cap for US President Obama, and will boost his chances of getting re-elected. Why not keep the most powerful man on earth in good humour?

Saudis already contribute large sums of money to Pakistan. They may have promised more, as well as offering them a greater role in peace-keeping in the Middle East – thereby enhancing Pakistan’s prestige and credibility. Both have taken a severe dent after the covert US operation to eliminate bin Laden. Pakistan had previously helped Middle Eastern countries in quelling uprisings during General Zia’s regime. A Middle East sans strife means a fall in oil price to more reasonable levels.

However, the present supply is unable to keep pace with growing demand for crude oil from populous countries like China and India. So, there is no reason to expect a drastic fall in oil price. Experts are projecting oil price to stabilise at 90.