Crude shock

GS Paper III

Topic: Indian Economy

Prelims: OPEC, OPEC+

What’s the News?

  • US oil markets created history on 20th April 21, 2020 when prices of West Texas Intermediate (WTI), the best quality of crude oil in the world, fell to “minus” $40.32 a barrel in New York.
  • Not only is this the lowest crude oil price ever known, the previous lowest was immediately after World War II — but also well below the zero-mark.

Background:

  • Historically, the Organization of the Petroleum Exporting Countries (OPEC), lead by Saudi Arabia, which is the largest exporter of crude oil in the world (single-handedly exporting 10% of the global demand), used to work as a cartel and fix prices in a favourable band.
  • It could bring down prices by increasing oil production and raise prices by cutting production.

OPEC+:

  • In the recent past, the OPEC has been working with Russia, as OPEC+, to fix the global prices and supply.
  • It must be understood that cutting production or completely shutting down an oil well is a difficult decision because restarting it is both costly and cumbersome. Moreover, if one country cuts production, it risks losing market share if others do not follow suit.

U.S reaction: 

  • US became the largest producer of crude oil in 2018. And that is one reason why, unlike all the previous US Presidents, who always pushed for lower crude oil prices, especially in an election year, Donald Trump has been pushing for higher oil prices.
  • Saudi Arabian officials have forecast that total global supply cuts from oil producers could amount to nearly 20 million bpd, but that includes voluntary cuts from nations like the United States and Canada, which cannot simply turn on or off production in the same way as most OPEC nations.
  • Crude oil futures fell on Monday, with US futures touching levels not seen since 1999, extending weakness on the back of sliding demand and concerns that US storage facilities will soon fill to the brim amid the coronavirus pandemic.

Impact on India:

  • While oil producing countries will suffer, oil consuming countries like India will benefit.
  • Lower prices should not only help in reducing the current account deficit, but could also ease inflationary pressures if governments do pass on the benefit, even partially, to end consumers.
  • However, it is also likely that as the lockdown restrictions are eased, and as economic activity gradually picks up, the Centre and the states raise taxes on crude oil to shore up their struggling revenues.
  • Further, as lower oil prices will impact the economies of oil producing countries in the Middle East, they could also affect remittance flows to India.

Opportunity for India:

  • India must seize this opportunity to build on its oil reserves and fill its strategic petroleum reserves.
  • The country’s strategic petroleum reserve facilities have a capacity of 5.3 million metric tonnes — amounting to 9.5 days of its crude oil requirements.
  • In comparison, each International energy agency (IEA) country has to hold emergency oil stocks equivalent to at least 90 days of imports. India should be working on similar lines.

Conclusion:

  • This extreme price movement is indicative of how deeply oversupplied the US market is owing to the collapse in demand as economic activity has come to a standstill and the fact that there isn’t storage capacity to absorb this excess supply.
  • The “negative” price indicates that the storage will continue to be a problem.
  • This implies that unless supply in the US is cut back further to readjust to the collapse in demand, more pain is likely.

Why oil prices fell below zero

GS Paper III

Topic: Indian Economy

Mains: Reasons behind oil prices felling below zero.

What’s the News?

  • US oil markets created history on 20th April 21, 2020 when prices of West Texas Intermediate (WTI), the best quality of crude oil in the world, fell to “minus” $40.32 a barrel in New York.
  • At this price, the seller of crude oil would be paying the buyer $40 for each barrel that is bought.

Reasons behind:

Crude oil is not like daily household waste that one wants to pay to get rid of; it is indeed an essential component for modern life and economic growth. So at one level, the negative pricing of oil is misplaced.

  • Too much supply and too little demand. To a great extent, oil markets, globally and more so in the US, are facing an enormous glut.
  • Historically, the Organization of the Petroleum Exporting Countries (OPEC), lead by Saudi Arabia, which is the largest exporter of crude oil in the world (single-handedly exporting 10% of the global demand), used to work as a cartel and fix prices in a favourable band.
  • It could bring down prices by increasing oil production and raise prices by cutting production.
  • In the recent past, the OPEC has been working with Russia, as OPEC+, to fix the global prices and supply.
  • It must be understood that cutting production or completely shutting down an oil well is a difficult decision because restarting it is both costly and cumbersome. Moreover, if one country cuts production, it risks losing market share if others do not follow suit.

U.S unique case:

It is important to note that it was only in the US markets that oil prices went so low. Crude oil prices elsewhere fell, too, but by not so much.

  • US became the largest producer of crude oil (shale gas) found inland in 2018. And that is one reason why, unlike all the previous US Presidents, who always pushed for lower crude oil prices, especially in an election year, Donald Trump has been pushing for higher oil prices.
  • By 21st April 22, 2020, there were many oil producers who wanted to get rid of their oil even at unbelievably low prices rather than choose the other option — shutting production, which would have been costlier to restart when compared to the marginal loss on May sales.
  • From the consumer side, that is those holding these contracts, it was an equally big headache as there was no space to store the oil if they were to take the delivery.
  • They figured that it would be more costly for them to accept the oil delivery, pay for its transportation and then pay for storing it (possibly for a longish period, given the circumstances) especially when there was no storage available, than to simply take a hit on the contract price.

Impact on India:

  • While oil producing countries will suffer, oil consuming countries like India will benefit.
  • Lower prices should not only help in reducing the current account deficit, but could also ease inflationary pressures if governments do pass on the benefit, even partially, to end consumers.
  • However, it is also likely that as the lockdown restrictions are eased, and as economic activity gradually picks up, the Centre and the states raise taxes on crude oil to shore up their struggling revenues.
  • Further, as lower oil prices will impact the economies of oil producing countries in the Middle East, they could also affect remittance flows to India.

Opportunity for India:

  • India must seize this opportunity to build on its oil reserves and fill its strategic petroleum reserves.
  • The country’s strategic petroleum reserve facilities have a capacity of 5.3 million metric tonnes — amounting to 9.5 days of its crude oil requirements.
  • In comparison, each International energy agency (IEA) country has to hold emergency oil stocks equivalent to at least 90 days of imports. India should be working on similar lines.

Conclusion:

  • This extreme price movement is indicative of how deeply oversupplied the US market is owing to the collapse in demand as economic activity has come to a standstill and the fact that there isn’t storage capacity to absorb this excess supply.
  • The “negative” price indicates that the storage will continue to be a problem.
  • This implies that unless supply in the US is cut back further to readjust to the collapse in demand, more pain is likely.