U.S. Oil Prices below Zero a Barrel
The price of a barrel of benchmark U.S. oil plunged below $0 a barrel in April for the first time in history, a troubling sign of an unprecedented global energy glut as the coronavirus pandemic halts travel and curbs economic activity.
There are dozens of different oil benchmarks, with each one representing crude oil from a particular part of the globe. However, the price of most of them are pegged to one of the following three primary benchmarks:
1. West Texas Intermediate (WTI) refers to oil extracted from wells in the U.S. and sent via pipeline to Cushing, Oklahoma. WTI crude oil is a specific grade of crude oil and one of the main three benchmarks in oil pricing, along with Brent and Dubai Crude. WTI is known as a light sweet oil because it contains 0.24% sulfur, making it "sweet," and has a low density, making it "light."
2. Brent Crude: Roughly two-thirds of all crude contracts around the world, referred as Brent Crude, making it the most widely used marker of all.“Brent” actually refers to oil from four different fields in the North Sea: Brent, Forties, Oseberg, and Ekofisk. Crude from this region is light and sweet, making them ideal for the refining of diesel fuel, gasoline, and other high-demand products. And because the supply is waterborne, it’s easy to transport to distant locations.
3. Dubai/Oman: This Middle Eastern crude is a useful reference for oil of a slightly lower grade than WTI or Brent. A “basket” product consisting of crude from Dubai, Oman or Abu Dhabi, it’s somewhat heavier and has higher sulfur content, putting it in the “sour” category. Dubai/Oman is the main reference for Persian Gulf oil delivered to the Asian market.
• With demand down 30% worldwide due to the coronavirus pandemic, and the main U.S. storage hub in Cushing, Oklahoma expected to fill up in a matter of weeks, very few want to be stuck with oil barrels that they have to take delivery on at some point during May.
• The world's major oil producers agreed to cut production by 9.7 million bpd in an attempt to get world supply under control as demand slumps, but those cuts do not begin until May. Saudi Arabia is ramping up deliveries of oil, including big shipments to the United States.
• Worldwide oil consumption is roughly 100 million barrels a day, and supply generally stays in line with that. But consumption is down about 30% globally, and the cuts so far are far less.
How are oil prices determined?
Oil prices are influenced by a variety of factors but are particularly responsive to decisions about output made by OPEC, the Organization of Petroleum Exporting Countries. Like any product, the laws of supply and demand influence prices; a combination of stable demand and oversupply has put pressure on oil prices over the last five years. The reason was straightforward: 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.
The first thing to understand is that, even before the COVID-19 outbreak induced lockdowns across the world, crude oil prices had been falling over the past few months. They were close to $60 a barrel at the start of 2020 and, by March-end, they were closer to $20 a barrel.
Historically, the Organization of the Petroleum Exporting Countries (OPEC), led 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 favorable 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.
The United States oil markets created history in April when prices of West Texas Intermediate (WTI), the best quality of crude oil in the world, fell to “minus” $40.32 a barrel in interlay trade in New York. At this price, the seller of crude oil would be paying the buyer $40 for each barrel that is bought.
Why can’t Nations simply reduce production and maintain prices?
It must be understood that cutting production or completely shutting down an oil well is a difficult decision, because restarting it is both immensely costly and cumbersome. Moreover, if one country cuts production, it risks losing market share if others do not follow suit.
Where did the trouble start?
In early March, 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 but what made it even more calamitous was 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.
Why did the Oil Price become Negative?
The May contracts for WTI were due to expire on April 21. As the deadline approached, prices started plummeting. This was for two broad reasons.
1. 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.
2. From the consumer side, that is those holding these contracts, it was an equally big headache. Contract holders wanted to wriggle out of the compulsion to buy more oil as they realised, quite late in hindsight, that there was no space to store the oil if they were to take the delivery.
This desperation from both sides — buyers and sellers — to get rid of oil meant the WTI oil contract prices not only plummeted to zero but also went deep into the negative territory. In the short term, for both the holders of the delivery contract and the oil producers, it was less costly to pay $40 a barrel and get rid of the oil instead of storing it (buyers) or stopping production (producers).
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.
1. If the government passes on the lower prices to consumers, then, whenever the economic recovery starts in India, individual consumption will be boosted.
2. 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.
The world’s top oil producers pulled off a historic deal in April to cut global petroleum output by nearly a 10th, putting an end to a devastating price war but not going far enough to offset the impact of the coronavirus pandemic. With the reduction in output the prices are expected to be stabilized in the near future. But even the most optimistic forecasts point to a reduction of 18.5 million barrels per day in the near future.
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