Falling Crude Oil Prices - Below the $0 Mark

Why in news?

The oil prices of West Texas Intermediate (WTI), the best quality of crude oil in the world, fell to “minus” $40.32 a barrel in New York, US.

What is the key reason?

Even before the Covid-19 induced global lockdown, crude oil prices had been falling over the past few months.
They were closer to $60 a barrel at the start of 2020 and by March-end, they were closer to $20 a barrel.
To a great extent, oil markets, globally and more so in the US, are facing an enormous glut.
Certainly, the price fall is thus a result of the supply being more than the demand.
[This is not only the lowest crude oil price ever known but also well below the zero-mark. The previous lowest was said to be immediately after World War II.]

What are the other recent developments?

Historically, the Organization of the Petroleum Exporting Countries (OPEC) used to work as a cartel and fix prices in a favourable band.
[The OPEC is lead by Saudi Arabia, the largest exporter of crude oil in the world (single-handedly exporting 10% of the global demand).]
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.
But in early March 2020, this cooperation that is crucial for the global oil market's seamless operations came to an end.
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.
However, they continued to produce the same quantities of oil.
The Saudi Arabia and Russia discord was sorted out recently, under pressure from US President Donald Trump.
However, it was too late.
The oil-exporting countries decided to cut production by 6 million barrels a day, the highest production cuts.

How has the lockdown worsened the situation?

Given the lockdown condition, there is a sharp reduction in economic activity.
With fewer flights and fewer cars, the demand for oil has been shrinking (9 to 10 million barrels a day).
The supply-demand mismatch continued to worsen right through March and April 2020.
The 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.

What is the immediate cause?

The May contracts for WTI, the American crude oil variant, were due to expire on April 21, 2020.
As the deadline came near, prices started reducing, for two broad reasons.
By April 2o, 2020, many oil producers wanted to get rid of their oil even at unbelievably low prices.
The other unattractive option was to shut production, which would have been much more costly to restart.
The consumer side that is those holding these contracts could not go by the compulsion to buy more oil.
This is because there was no space to store the oil if they were to take the delivery.
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 longer period).
This desperation from both sides - buyers and sellers - to get rid of oil led to the present condition.
In the short-term, for both the contract holders and the oil producers, it was less costly to pay $40 a barrel, and get rid of the oil.
[This means the seller would be paying the buyer of crude oil $40 for each barrel.]
All this meant that the oil prices not only dropped to zero but also went deep into the negative territory.

How does the future look?

It is important to note that it was the WTI price for May 2020 in the US markets that went so low.
Crude oil prices elsewhere fell but by not so much.
Moreover, at least for now, oil prices for June 2020 are pegged at around $20 a barrel.
It is likely that the WTI price was a one-off event and will not happen as producers are forced to cut back production further.
However, there is still uncertainty given the continuing spread of Covid-19 and the demand falling every day.
In all, it would be the demand-supply mismatch (adjusted for storage capacity) that will decide the fate of oil prices in the coming days.

Source: Indian Express