A Slippery Slope

Author: Shweta Sundram

With the Coronavirus pandemic raging across most parts of the world, bringing governments to its knees and exposing and furthering the different inequalities embedded in the society, there is nothing but panic and fear among people. Governments of various countries, including India have imposed nationwide lock downs to mitigate the spread of the virus. This has led to a growing demand of essential goods to stock up, some of whose prices have increased, lest the situation becomes worse.

But there is an unusual case of a commodity, traditionally regarded as essential, whose prices have not only decreased but became negative. The oil prices have crashed to a historic low,being sold at -$40 per barrel, which means that the seller has to pay $40 per barrel to the buyer to sell off the oil! What explains this seemingly illogical situation? Even before the COVID-19 struck the oil industry, crude oil prices were not doing great. At the start of the year, the price was $60 per barrel and $20 by the end of March. This was due to the fact that the supply of crude oil was more than its demand. Therefore, the oil markets globally, and especially in the U.S, were facing a downward trajectory.

Historically, among the OPEC (Organization of the Petroleum Exporting Countries), Saudi Arabia has been the leader when it comes to the oil market, catering to 10% of the global crude oil demand. It also meant having the leverage to fix favorable prices for oil. It would do that by bringing down the prices, by increasing oil production, and raising prices by cutting production. Recently, OPEC had formed an alliance with 10 other non-OPEC countries led by Russia called OPEC+. The main objective of this alliance is to manage the volatile oil market by undertaking production cuts. Trouble started brewing in the alliance in the early days of March, when Russia and Saudi Arabia bickered with each other on the issue of production cuts to keep the oil prices stable. This discord led the countries led by Saudi Arabia to start undercutting each other on price though they produced the same quantity of oil. The discord was finally sorted out with pressure coming from the U.S, but alas it was too late. COVID-19 had exacerbated the dwindling prices of crude oil, as lock downs in countries made sure that fewer flights, industries and vehicles, etc. were using oil.

There are three primary benchmarks of crude oil, which serve as reference price for buyers and sellers of crude oil, namely WTI (West Texas Intermediate), Brent and Dubai crude. Though all benchmark prices fell, it was the WTI which registered a negative price. This was due to the fact that rather than direct cash, WTI trades in contracts. The May contract of WTI expired on April 21, leading to desperation among buyers and sellers. With sellers wanting to get rid of their oil at really low prices, rather than choosing the expensive option of shutting down production, and the buyers on the other hand, trying to cope up with the loss in storage facilities of oil, resulted in the prices plummeting below zero.

India was not adversely affected as its crude oil basket does not contain the WTI. But oil being a global commodity, the crash in WTI prices has resulted in falling prices of other crude oil benchmarks, thus indirectly affecting India. Indian oil companies such as Indian Oil Corporation Limited have already begun to bear the brunt, as witnessed by a 53% decline in its value.

Nevertheless, the low oil prices do signal some amount of relief to India’s struggling economy. The government can avail this one-time opportunity to fill up its Strategic Petroleum Reserves (SPRs) in the country as well as rent spaces abroad in order to increase the storage facilities. This will ensure that our energy needs are met sufficiently at lesser costs. Having said that, the government should take a long-term view at this issue and should not let India’s commitment towards using and preferring renewable energy taking a backseat while meeting its energy needs. Thus, the government should take a balanced view on this and see this as a silver lining in these testing times.

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