The story of crude oil

The global crude oil prices have been plummeting since March 2020. US oil price fell below $1 for the first time in history. Of all the shocks received by the global economy after the outbreak of Covid 19 pandemic, this is the most jaw-dropping. Jason Gammel of Jefferies calls it ”bleakest oil macro outlook”. Kit Juckes of ‘Societe Generale’ (a leading European financial services group) comments, “Too much oil, with nowhere to put it.” Crude—the world’s most important energy source—has been suffering from this stunning price drop due to a number of reasons. Global lockdown is the first & the foremost reason. Novel Coronavirus and the global price war between top oil producers have come as a double-whammy to the U.S oil economy. Although, the oil-importing countries like India may benefit from this price plunge, yet the consequent shock would be long-lasting and far-reaching.

What is crude oil and why is it so important?

Crude oil is the naturally occurring oil. It is an unrefined and finite fossil fuel. It’s not going to last forever. This raw oil is refined and then only we get products like diesel, petrol, gasoline, jet fuel, kerosene and so on.

Crude is the lifeblood of industrialised nations. It has been the most important source of energy since the 1950s. The chugging engines in factories, the jarring jets, roaring racing cars and grating gensets all use one or the other form of purified crude. Its wide use makes it the most important source of energy. Today’s global economy is an industrialized economy with manufacturing being one of the biggest sectors contributing to the Gross Domestic Products (GDP) of most of the countries. Many economies are, therefore, oil-intensive. The average worldwide consumption of oil in the year 2018 was nearly 10 crore barrels per day. Of this, India alone consumed 50 lakh barrels a day. The United States tops this list with 2 crore barrels a day. It’s the blood that runs in the capillaries of the world.

Why have crude prices plunged?

Covid 19 has created the fear of a deep global recession. The energy sector has seen a decrease of nearly 3.3%. The corona timeline throughout the first and second quarters of the current calendar year has been displaying a deteriorating diagram for the global economy.

Timeline of Corona

  • Jan 23: Lockdown starts in Hubei, China
  • Jan 31: WHO declares global health emergency
  • Mar 06: OPEC plus rescue talks to save the oil market end
  • Mar 09: National quarantine declared in Italy
  • Mar 11: WHO declares corona a pandemic
  • Mar 23: 21-day lockdown announced in the UK
  • May 07: UN launches Global Humanitarian Resource Plan for $6.7 billion.

Superficially, it’s very simple to understand the reasons behind the price plunge. Global lockdown forced people to stay indoors. Cars didn’t ply on roads. Jets didn’t fly. Factories were closed. Life paused. Consequently, demand has dramatically declined. This has resulted in a situation wherein we have enough of crude being drilled out and stored but there are no buyers and so because there are no consumers! Globally, on average, there has been nearly 300% decline in the demand for crude!

Has all crude production suffered a collapse in demand?

Generally, yes. However, to comprehend the crisis we need to break it down. On the basis of location, there are two kinds of oil facilities—Landlocked and Seaborne; former generally being facilities located somewhere away from the waters and the latter being those located in a sea. Similarly, there are ‘futures contracts’ in the world of oil trade. For a layman, such contracts are those in which the sale & purchase happens at an agreed price but at some future date. At the time of making the deal, prices are set, but there is no physical exchange of money and comb modity. Crude is the world’s most important commodity involving numerous majuscule & long-term futures contracts. It’s valuable here to understand that it’s the landlocked facilities and futures contracts that have faced the brunt of demand decline. The ‘below $1 per barrel price drop’ that we are talking about involves these futures contracts and not necessarily other oil-producing heavens. Nonetheless, overall, all the global crude business has drastically gotten stirred.

What are the major benchmarks of oil?

There are two major benchmarks of crude oil: The Brent North Sea Crude (commonly called Brent Crude) and The West Texas Intermediate (WTI). The latter refers to the oil extracted for North America. It’s called ‘sweet crude’ because it contains the lowest percentage of sulphur (below 1%) and is the benchmark crude for North America. The former (Brent Crude) is the crude supplied to Africa, Asia (including India), the Middle East and Europe. It’s their benchmark crude. The crude installations which are seaborne, like the Brent Crude, are still able to thwart the ongoing brunt of demand downfall because they have been supplying crude to high demand areas as it becomes easier to supply directly from the sea with no need to store. The International Brent was down by 5.5% in the month of June. It closed at a price of $44.40 a barrel on August 08. On the other hand, WTI suffered the worst decline. This crude costs around $41 a barrel now. Brent crude collapsed by more than 65% in the first quarter & WTI dangled by 66%. At a time between 2010 & 2012, the prices of crude rose to as high as $150 a barrel. But, today, the picture hangs topsy-turvy.

Another consequence of this demand decay is the problem of storage. A large volume of oil was produced. In the absence of takers, the oil needs to be stored. As a result of the demand crunch, producers are now running out of storage space. This has posed a grave challenge which seems to be invincible for now. The little demand seen now is likely to get exhausted in the coming months. Stephen Schork, the editor of the oil-market newsletter, The Schork Report, says, “The biggest demand months aren’t going to happen. This summer is dead on arrival.” The global lockdown has compelled people to stay indoors and nobody is travelling. This is sharply going to aggravate the condition. “Sharply rising unemployment would mean fewer drivers during peak summer” he adds.

(The author, an MBA, NET, IBPS, works as Manager in the Middle Management of a reputed PSU; the views are personal.)