Falling oil prices add a sparkle to Christmas cheer

Ground Floor: Energy consumption in the Republic must surely have surged this month as consumers welcomed the arrival of the festive season with even more domestic lighting displays than ever before.

It's impossible to walk anywhere these evenings without being overwhelmed by the sight of Santas, snowmen and reindeer shining brightly from their watchful positions on the roofs and in the gardens of suburbia where every second house boasts lighted icicles, multicoloured light displays and light-bedecked trees.

I do have a strand of indoor lights myself, which may make it out of the attic by next week, but the nod towards Christmas lighting in our house is generally made by candles so anyone hoping for a contribution to the overall disco display is wasting their time if they drop by.

For those who indulge in festive illuminations, however, the cost will be greater this year thanks to the increased costs of energy. But not as great as they could have been if oil prices hadn't retreated from their highs of a couple of months ago.

In fact, West Texas crude is down 25 per cent since last October, despite the recent attack on the US consulate in Saudi Arabia. Had that happened during the summer, it's likely that it would have added a few dollars to the price. But sentiment towards higher oil prices has abated in this last quarter of the year. And now OPEC is considering cuts in production again.

During much of 2004, the emphasis was on dealing with ever-increasing oil prices and reassuring traders that supply would not be interrupted even with the ever-present fear of terrorist attacks, as well as the increased demand thanks to the robust Chinese economy and political hi-jinks in Russia.

OPEC was forced to increase supply to stabilise prices but now, looking at around $40 (€30) per barrel (from highs of more than $55) and a declining dollar, it is reconsidering. Last Friday, it agreed to cut back production by around one million barrels per day - although this is not due to take effect until the beginning of January.

OPEC claims that the oil price volatility of 2004 was more about speculation than real supply and demand, and the organisation has a point. But then, most market volatility is grounded in fear and greed rather than actual events yet, in the end, it's the consumer who pays a real price.

According to the Saudi Arabian oil minister, Mr Ali Naimi, the terror premium is about $15 a barrel.

At the same time, OPEC itself didn't help matters by cutting production back in February, despite the fact that, this year, worldwide demand increased by its highest level since 1978. There is a feeling in the market that many of the smaller OPEC countries rather like the concept of an oil price that is closer to $50 than $30 and that the cartel has higher levels in mind for the future, despite Saudi Arabia's protestations that price stability is what's important. Which will keep the traders and the speculators on their toes. Whether they'll make money out of it is another question.

In China, home of the economic boom that caused such a surge in demand, oil prices have had an impact in more ways than one. On November 29th, China Aviation Oil (CAO) announced $500 million in trading losses and looked for court protection from creditors.

The losses occurred because CAO was happily trading in crude oil futures. As a company whose parent is a monopoly supplier of jet fuel in China it had a reason to trade in oil futures. But, instead of simply hedging its parent's exposure to prices, it embarked upon a series of speculative trades on the future course of prices. Guess what? It got it spectacularly wrong.

CAO's chief executive, Mr Chen Jiulin, was voted one of the "new Asian leaders" by the World Economic Forum last year. He was arrested on November 30th.

It really doesn't take long for people to realise that there is huge money to be made in trading derivatives. What many of them seem to be congenitally incapable of grasping is that there is equally huge money to be lost. The problem is that most traders are also incapable of accepting that they have got it wrong.

China Aviation Oil ignored its own internal trading limits and simply doubled up its positions in the hopes of recouping lost money - while saying nothing to its investors. In fact, last October, the parent company sold a $120 million stake to outside investors without telling them anything about the trading losses, although the funds raised were apparently used to pay margin calls.

It's an extremely messy situation, but the courts have given the company six weeks to come up with a rescue plan.

Of course, the debacle has focused a lot of attention on the whole issue of corporate governance in China, which is generally seen to be poor. Standard & Poor's commented recently that "complex corporate structures and unreliable accounting practices make it difficult to perform substantive analysis on some China-related companies", which is another way of saying that it's a complete mess and we have no idea what's going on.

Naturally, when everyone is looking for a slice of the action, corporate governance is one of the first things to fall by the wayside. (Entrepreneurs rather scathingly just call it "red tape".) However, if enough people lose their money, only companies with good governance structures will maintain investor confidence.

In the wider scheme of things, demand from those entrepreneurial companies in China for oil has actually decreased a little during the past few months, which has probably been part of the reason why OPEC wishes to regain control of prices now. But it's never easy to keep prices where you want them.

So it looks as though the twinkling lights can continue a little longer. Happy Christmas.