Oil prices fell below zero for the first time in history last night as the global lockdown decimated demand for the commodity in the midst of a price war between suppliers.May futures for the West Texas Intermediate (WTI) U.S. crude plunged below zero to touch a historic low of -$40.32 a barrel. A negative price implies that a seller would have to pay the buyer to hold the oil to be supplied. There are a number of reasons for the same:
1.For a very long time, the Organization of the Petroleum Exporting Countries (OPEC), led by Saudi Arabia( the largest exporter of crude oil in the world single-handedly exporting 10% of the global demand), used to 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.
This came to an end recently as Saudi Arabia and Russia disagreed over the production cuts required to keep prices stable. As a result, oil-exporting countries, led by Saudi Arabia, started undercutting each other on price while continuing to produce the same quantities of oil.
This was an unsustainable strategy under normal circumstances.
2.In already uncertain times, the growing spread of novel coronavirus disease, which, in turn, was sharply reducing economic activity and the demand for oil. With each passing day, the developed countries were falling prey to COVID-19 and with each lockdown, there were fewer flights, cars and industries etc. using oil.
By the time the discord between Saudi Arabia and Russia was sorted out last week, it was too late . Oil-exporting countries decided to cut production by 10 million barrels a day — the highest production cuts — and yet the demand for oil was shrinking faster.The supply-demand mismatch resulted in almost all storage capacity being exhausted. Trains and ships, which were typically used to transport oil, too, were used up just for storing oil.
3.The US became the largest producer of crude oil in 2018. And that is one reason why, unlike all previous US Presidents, who always pushed for lower crude oil prices, especially in an election year, Trump has been pushing for higher oil prices.
4.WTI oil is traded as futures contracts in the NYMEX (New York Mercantile Exchange) where traders buy and sell monthly futures such as, for instance, May futures, June futures and so on. The sellers of such futures will have to deliver a barrel of crude oil at the contracted price in the contracted month just as buyers will have to take delivery at the contracted date.What aggravated the matter was that the May contracts for WTI, the American crude oil variant, were due to expire on Tuesday, April 21. As the deadline approached, prices started plummeting. 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 is even more costlier.From the consumer side, that is those holding these contracts, it was an equally big headache.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
5.How will this impact India?
The Indian crude oil basket does not comprise WTI — it only has Brent and oil from some of the Gulf countries — so there is no direct impact. But oil is traded globally and weakness in WTI is mirrored in the falling prices of the Indian basket as well
There are two ways in which this lower price can help India. If the government passes on the lower prices to consumers, then, whenever the economic recovery starts in India, individual consumption will be boosted. If, on the other hand, governments (both at the Centre and the states) decide to levy higher taxes on oil, it can boost government revenues.
India runs a current account deficit and hence will gain from lower crude prices, as the oil import bill will narrow. Besides, lower oil prices will soothe inflation. Also, savings from lower fuel costs in the hands of consumers is unlikely to result in a boost to consumption due to lockdown and hence growth.
India is quietly building up its strategic reserves, taking advantage of the cheap prices. India has a capacity to hold over 39 million barrels of oil at its strategic reserves in Vishakhapatnam, Mangalore and Padur, near Udupi. These are underground salt caverns converted and built to store crude oil. The strategic storage capacity is now being increased even as the existing caverns are being filled.
6.For cash-strapped airlines, the decline in crude prices will make it cheaper to operate flights that are already nearly empty as people remain homebound due to the coronavirus.
7.The link of food with oil is obvious : Sugarcane and corn are as much sources of food as substrates for ethanol that can be blended with petrol. Only 34 per cent of cane crushed by Brazilian mills in 2019-20 went for sugar production, the rest to make ethanol. Palm oil is used to manufacture bio-diesel. Indonesia, last year, mandated a 30 per cent mix of bio-diesel in the regular transport fuel, while India requires 10 per cent ethanol-blending in petrol.
The above diversion of “food crops” for fuel made economic sense so long as oil prices were reasonably high; both US and Brent crude ruled well above $50 per barrel till two months ago. Oil’s collapse — refineries have significantly curtailed operations, with the coronavirus-induced worldwide lockdowns leading to a plunge in road, sea and air traffic volumes — has meant that ethanol processors are shutting plants and Brazil’s mills will allocate more cane for sugar. It is a matter of time before the transmission from crude to sugar, corn and palm oil also spreads to other grains and oilseeds. Low oil prices have brought down the prices of cotton and natural rubber as well, because of synthetic substitutes becoming much cheaper. Simply put, oil producers, refiners and drilling services firms aren’t the only ones feeling the heat. Farmers will also suffer. Payment arrears to cane growers in Uttar Pradesh are already mounting as there’s little domestic or export demand for sugar. Moreover, given weak petrol sales, oil companies are reluctant to lift ethanol from mills. And with liquor vends shut, no offtake of potable alcohol is happening either.