Why oil is in the doldrums

Why oil is in the doldrums

Shafqat Qurashi

It’s such a huge global disruption that we are not able to find an adjective to describe it. Do we call it Big Shock or do we call it Knock Out? Before we go into the semantics, let us discuss why it is being called “historic”.
Oil is the crown jewel of commodities. It goes into plastic to asphalt to fuel. The oil industry is the world’s economic powerhouse and oil prices are closely watched by investors as well as traders. Any change in oil prices sends ripples throughout the global economy. Oil prices have seen many ebbs and tides but nothing compares to the plummeting that Covid-19 has brought about.
As crude oil is produced by more than 100 countries, the top producers being USA, Saudi Arabia and Russia, it is difficult to compare the quality and value of crude oil. To make things easier, certain benchmarks have been set, the top two being the West Texas Intermediate (WTI) and the Brent Crude. Let’s understand briefly these benchmarks. Brent Crude is the international benchmark price used by the Organization of Petroleum Exporting Countries (OPEC) while West Texas Intermediate is for USA crude oil prices. OPEC consists of 15 nations that produce about 44% of the world’s oil and own over 81.5% of the world’s oil reserves. It includes Saudi Arabia, Iran, Iraq and Venezuela. India imports primarily from OPEC counties, so Brent is the benchmark for oil prices in India. Most of the oil produced in Europe, Africa and Middle East is priced according to Brent Crude. Usually, Brent Crude oil is extracted from seas and has a higher sulphur content (0.37) that makes it “sweeter” and costlier. The West Texas Intermediate is used for oil extracted from Texas, Louisiana and North Dokota. This oil has less (0.24) sulphur content. Both oils are relatively light, but Brent has a higher density, making the WTI lighter among the two. Oil is a commodity and as such it tends to see larger fluctuations in prices than more stable investment such as stocks and bonds. There are several influences on oil prices, a few of which are outlined below:

1) Supply and Demand: The law of supply and demand states that if supply goes up, the prices come down. If demand goes up, the prices also go up. The supply of fuel has exceeded demand by a huge margin since the Covid-19 outbreak. The unprecedented lockdown has put everything to standstill. The aviation industry, transport, factories have all been closed down, so there is no consumption of oil. If oil demand remains at the current level or falls even further, the prices will fall even more. It is worth mentioning that Covid-19 has disrupted daily demand so much that 30 million barrels are getting accumulated every day in unused stock.
2) Trade Wars: A long trade war has been going on between USA and OPEC, with no country willing to cut down oil production. Finally, on April 13, the USA, Saudi Arabia, Russia and other oil producing nations agreed to cut output by a record 9.7 million barrels per day. It was done to stabilise the prices of oil amid the pandemic. However, the production cuts were smaller than required and thus the prices continued to fall throughout the following week, hitting a multi-year low in the process.
3) Trade and Future Contracts: All the world’s oil trade happens through contracts. Oil future contracts are traded just like shares. In India, oil is traded at the Multi Commodity Exchange of India Ltd (MCX). In market commodity exchange there is a contract, which is a legal agreement between buyers and sellers binding them to buy and receive a certain quantity in barrels of oil. What happened in the United States was that the value of futures contracts plummeted sharply ahead of the expiry of contracts. It is important to mention that each contract trades for a month before expiry. But investors who held many contracts did not want to take delivery of oil and incur additional storage costs. They literally paid to not receive what they had paid for. On April 20, the West Texas Intermediate (WTI) traded 306 percent lower to settle at – $37.63 a barrel. This happened for the first time in history. But the situation is not so bad with respect to other benchmark oil indexes. Brent Crude oil future is just below 25 dollar after 3.6 percent fall.

The writer is studying for an MBA at Kashmir University

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