International oil prices have been declining since January 2020. Brent crude has slid from $65 in December 2019 to below $30 in March.
On 18th March, Brent crude fell more than 14 % to $24.52 barrels per day.
Analysts expect the prices to touch $20 per barrel mark.
[Brent crude and West Texas Intermediate (WTI) are the two main benchmarks for international crude oil prices]
Why have the prices declined?
- Decrease in demand: The world demand for oil has reduced due to depressed economic activity against the backdrop of the coronavirus outbreak. Specifically, the demand from China reduced significantly as the virus originated in China. China accounted for 14% of global oil demand and for more than 80% of global growth in oil demand in 2019.
- Increase in supply: The supply of oil has increased as OPEC (led by Saudi Arabia) and Russia failed to reach a consensus regarding cut in oil production. At a meeting held on 6th March, Saudi Arabia proposed to cut oil production by 1.5 million barrels per day to maintain prices in light of the decrease in oil demand caused by coronavirus pandemic. But Russia did not agree with it. Therefore, Saudi Arabia declared a price war on Russia. On 7th March, Saudi Arabia announced that it will instead increase its oil production to 12.3 million barrels per day from 9.7 million barrels. It also gave out 20 % discounts in some markets.
Since 2017, Saudi Arabia and Russia have been colluding to cut their production to keep prices around $50-$60. But, this agreement collapsed in March leading to a price war.
[The Organisation of Petroleum Exporting Countries (OPEC) is a group of 14 major oil-producing countries. These countries account for about 44% of total oil production in the world. Therefore, they can control oil prices by coordinating their supplies. (It cuts production to drive up oil prices and hikes production to capture market share). The agreement between OPEC led by Saudi Arabia and 10 non-OPEC countries led by Russia is referred to as OPEC+]
Saudi Arabia can afford to operate at low prices because of its low costs of production. Other oil-producing countries will find it difficult to compete. If Saudi Arabia survives long enough at low prices, it can drive out others from the market. [It has to be mentioned that Saudi Arabia has tried out this strategy earlier in 2014 to 2017 and had to abandon it eventually as other OPEC members became concerned about diminishing foreign exchange reserves. Also, this was mainly targetted towards US shale oil producers (shale oil is expensive to produce. It needs price to be at least $50 to break-even) which mostly remained resilient. It is speculated that Russia is revisiting the strategy to hurt the US oil producers. This is because OPEC+ agreement actually helped the US shale oil industry to increase production and stay afloat. Russia did not agree to cuts as it wanted to export more oil to increase revenue and hurt the US rivals, but this has led to a price war]
How will oil prices impact India?
India is the world’s third-highest importer of oil. It imports over 80 % of its crude oil requirements. A reduction in oil prices will reduce India’s import bills and in turn, Current Account Deficit and Fiscal Deficit. It will also ease off inflationary pressures on the economy.
I’d highly recommend you to read this post- Why are petrol prices in India rising despite the fall in crude oil prices?
Updated on 21/04/2020: Oil prices plunged below zero dollars a barrel for the first time in history.
Let’s put it in context. Though oil-producing countries, led by the US, Saudi Arabia, and Russia, had eventually agreed to cut the world’s oil production by a record 9.7 million barrels a day (about 10 % of the world’s output), it was not enough to increase prices. The demand for oil fell even more by about 30 % this year due to the coronavirus pandemic which bought economies to a standstill.
Prices in negative territory imply sellers are willing to pay buyers to take oil deliveries. This is unprecedented in the history of oil prices.
But, it has to be noted that only the WTI (the benchmark for the US oil prices) fell to minus $37.63 a barrel. Brent crude also fell but was trading at a positive $25.3.per barrel. [Even in WTI, the prices plunged to negative for only a particular set of contracts for which delivery had to be taken in May. June WTI futures are still trading at about $20]
The prices for particularly May WTI fell due to two main reasons:
Scarcity of storage space: North American oil producers have run out of storage space due to an excessive supply of oil. Therefore, they wanted to sell oil even at low prices as shutting down production is not a viable alternative. Shutting down oil wells and restarting when the economy returns to normalcy would have been more expensive than incurring costs to get rid of oil.
Expiry of futures contract: The price of oil is determined through futures contracts. Currently, the futures contracts to deliver oil in May has been the most traded. These contracts are due to expire/ mature today (21/04/2020). So, whoever has the contract today has to buy the oil in May. As we already know, North America has run out of storage space. The buyers found it cheaper to pay someone to take the delivery for oil, instead of incurring transportation and storage costs. Therefore, investors started selling their contracts yesterday, putting downward pressure on oil prices.
[For those wondering, most commodities trade in the spot market and futures market. A spot market is a market where commodities are bought and sold at current prices. In the futures market, buyers and sellers enter into a contract to buy or sell commodities on a specific date in the future at a pre-determined price. These future contracts are traded like shares on a stock exchange. Investors who trade in these contracts do not necessarily want to buy the underlying asset (oil in this case). They could be trading for speculation or hedging purposes. One set of such contracts for WTI has an expiry date of today (21st April). Anyone in possession of the contract today will have to purchase oil in May]
You may also read- Forwards and Futures explained