HISTORIC DOWNTURN: FALL OF THE CRUDE OIL PRICE


There is a saying that, “Supply always comes on the heel of demand”.
But if there is no demand, then what is the use of the supply?

With the wrath of Coronavirus pandemic, the entire global economy is shaken, with a major loss in businesses, financial markets are going down, many people have died, many are recovering,  a lot has happened within a span of few months.

With all such mayhem caused by COVID-19, the fall in the Crude Oil Price which went below $0, became another victim of this pandemic. 

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But the question that arises here is that when we check the Brent Crude Oil which is the Benchmark of Crude Oil (Crude oil Benchmark is the platform to check the prices of Crude Oil) the price showing here is, $26.
Well, this has reduced as comparison of January 2020 when it was at the price of $62. 

But the issue remains the same, that if the crude oil price in the Benchmark of Crude oil is showing $26 then what is the issue of crude price going to ZERO?

Well, let’s start from the beginning.

The import of Crude Oil in the entire world is handled by the OPEC (Organisation of the Petroleum Exporting Countries) which is led by Saudi Arabia. With the recent past, OPEC has been working closely with Russia, as OPEC+, in order to fix the global prices and the supply of oil. 

Let’s focus on how this whole incident started. 

The whole incident of Crude oil is related to the Commodity Exchange of the U.S. As everyone knows, with the COVID-19 many countries are facing lockdowns. With these lockdowns, no movements are allowed. And due to this, the demand for the crude oil which is used to make petrol and diesel has reduced a lot. 

In other words, one can say that the demand has reduced to almost or more than half of its earlier supply. Whereas when we talk about its supply, it hasn’t reduced. The supply is ongoing but with no demand. 

You must have heard that in economics, there is a basic formula of supply and demand. This stated that if the demand is high and the supply is low, the price increases. Whereas, if the demand goes beyond the supply, the price increases. And when the supply is more and demand is low, then the price decreases. 

And this is what happened with the Crude Oil price. 

It is understood one of the issues is that if the demand was not high and the supply was high of the Crude Oil, but again how has it gone below ZERO when it is showing $26 in the Benchmark of Crude price? 

Well, this whole issue is based on the U.S Crude Oil price. 

ISSUE OF WEST TEXAS INTERMEDIATE (WTI)-

As we have seen above, Brent Crude oil is the benchmark for the crude oil in the International Market, and just like that in the U.S market, the benchmark for crude oil is West Texas Intermediate (WTI). 

Now, you must be knowing that in the Stock market the buying and sharing of shares happens within the Stock Exchange. This is a similar case with commodities. When we are trading commodities, like oil, it happens within the Commodity Exchange.

*Concept of Future Contract-

A future contract by its name suggests a contract which is set for the future date. For each month there is a future contract, and people willing to buy the future contract of, for example, May month has to buy it from the  New York Mercantile Exchange.

Every future contract has an expiry date as well, this means that if you wish to exit from that contract you need to exit before the expiry date.  Different countries carries different dates. 

So in the U.S, all the future contracts of WTI gets traded in the New York Mercantile Exchange. And the expiry date for the Future contract of WTI for the month of May was 21st April. On 20th April, a news broke out in the world, stating that all the Crude Oil Storage capacity is full.

The main storage of WTI is in a city called Cushing. And as soon as this news broke out that the Storage capacity of Cushing is full, the traders started to panic. And thus, with this panic, the traders at any price started selling their contracts and took exit from the contracts. 

But the thing is that why after the news of Storage capacity being full, led to the traders to exit in panic?

Well, whatever oil which is being made is kept for the storage. But from that storage, the oil is not able to get dispatched, because of the lesser demand of the crude oil. In this scenario, the oil is being produced but the consumption of oil is not happening, and thus it was meant to be stored. 

But with this worsening situation, traders thought that if their no storage capacity then after buying the oil, where would they keep it? Secondly, there is no demand for crude oil and due to the coronavirus pandemic, no one knows when this will get over. 

Thirdly, if they even plan to keep the crude oil, they don’t know how long they will have to carry it and due to which they plan to get a storage, then they have to bear the cost of the storage, which is expensive. 

oil

Also, Many refineries are unwilling to turn oil into gasoline, diesel and other products because of the pandemic, only a few people are commuting or taking planes. No major use of oil can be seen due to COVID-19. 

And with such a situation, the best options which these traders found was to take an exit from their contracts. 

On 20th April, when the New York Mercantile Exchange opened up, the price of WTI Crude was $18 per barrel. And as soon as the traders started taking an exit from the contracts, this price went drastically down and down and reached $0 and lastly, it reached -40$. Only in a span of one day the price of crude oil dropped by almost 55$. 

People who sold their contracts when the price went in a negative, they had to pay an extra price also. If they wished to hold onto the WTI crude contract then they would have taken a physical delivery, for which they had to buy a storage and then indulge cash for it, and this would have been costly. 

This is the reason why people even sold their contracts in negative.
And thus this led to WTI crude price to go in negative.

This problem of storage capacity is only limited to the U.S market only.
And if the other countries don’t plan to reduce the production of crude oil, or they don’t focus on the concept of supply and demand, then they will also face the same consequences. 

WHY OIL PRODUCING COUNTRIES ARE NOT SHUTTING THE PRODUCTION?

People think that shutting the production is an easy task. Well, it isn’t. With this, there are 2 main reasons why the oil-producing countries are not shutting down the production. 

Well, the primary reason is that, if the oil-producing countries stop the production then it would be extremely costly, difficult and time-consuming. 

And the second reason is that if a particular country plans to stop the production of oil, and the other countries are not in favour of shutting down then the countries who are in need of oil will have to buy from other countries. This is the reason why the countries which are planning to shut down will have to bear the Market share loss risk.

In a subtle way, this means that if the country plans to shut the production, then they will have a fear that their customers will get diverted, and there will be even a chance that from next time they will buy oil from that country only. 

Thus, in order to handle this situation, the oil-producing companies had a meeting. They decided that all countries should reduce the production of oil. In that meeting held in March, Russia was not in favour of stopping its production. Due to which other countries also didn’t stop the production. 

Thus, the continuous oversupply of oil went on and one. Due to which the effect was seen in the decreasing price of crude oil. 

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Within the end of the March, these countries again held a meeting. And at this meeting, they decided to reduce the production. 

But as they say, “Be wise today, so you don’t cry tomorrow”.
This decision was made so late that its impact had already led to drastic impacts, as already there has been an oversupply of oil in the market.

Countries, traders, are facing trouble. But should the public be happy from this outcome? Will the prices of diesel and petrol lower down, or maybe will it get free? Is there any sort of benefit for the people? 

Let’s find out. 

Thinking of getting petrol or diesel at low price has very few chances. This is mainly of two broad reasons- 

One is that the currency of India is Rupee (). Few months back only, the value of 1$ was around 70$, and currently this 1$ has rose up to around 77rs. India is the main importer of oil and due to which the payment of oil is done by India through Dollars ($).

Due to this, if the rupee weakens, the loss will be faced by India only.  If the rupee weakens, then on per dollar basis India has to pay more money. But this won’t create a much difference. So it is not mandatory that if the crude oil prices go down so will the prices of petrol and diesel. 

Petrol, diesel, gasoline they all are refined with the crude oil. So when you buy petrol, you also end up paying its refining cost, transportation cost and distribution cost. Also, you need to pay taxes, as petrol and diesel doesn’t come under the GST, which leads the government to imply heavy taxes. With that tax, the government aims to earn revenue and to reduce its fiscal deficit. 

CONCLUSION-

This historic downturn has impacted many companies drastically. It has been stated that the emergence of this negative oil prices is expected to prompt some of the oil companies into debt or even bankruptcy. 
ExxonMobil which is considered as one of the world's largest publicly traded international oil and gas companies is down with 38% of their value.

In the 2nd half of the year, the recovery is being expected, as the restrictions on travel and many things will help to curb the spread of the virus. 
However, again many analysts believe that the oil prices will fail to reach the same price levels. 

The economic impact of coronavirus had led to many downfalls, hope this situation gets stable. 

Till then Stay at Home
Stay safe!!

By Anjali