The Fall of Global Oil Prices

The Double Whammy of High Supply and Low Demand

The Fall of Global Oil Prices
The Fall of Global Oil Prices

Recently, the world witnessed a steep fall in oil prices at a global level. On March 10, crude oil prices went down by about 30% and touched 35 dollar per barrel. Oil prices witnessed unprecedented single day fall in past 30 years on March 9. The price of Brent crude oil also fell from 66 dollar per barrel on 31st December 2019 to about 33 dollar per barrel on 12th March 2020. Crude oil prices were 147 dollar per barrel in 2008 and the steep fall to about 30 dollar per barrel has marked a significant change in the global oil trade scenario. World’s prominent oil suppliers like USA benchmark WTI, European benchmark Brent Crude etc have also seen major upheavals in the oil prices in the months of March and April.

EXCERPT

The oil market has been witnessing a slump in demand due to global economic slowdown and the situation has been aggravated by the ongoing global pandemic. A reduction in demand and increasing supply has resulted in unprecedented reduction of oil prices at global level. Since 2014, crude oil prices have been reducing and it touched about 30 dollar per barrel in March 2020. The supply and demand shock in the oil market combined with disagreement between Russia and Saudi Arabia have been the major reasons for decline in oil prices. Oil importing countries like India stand to benefit from this price reduction as import bill will reduce but major oil producing countries like USA will suffer from this price fall.

In the month of April, more declines were seen in the oil prices when the European benchmark, London Brent North Sea Oil also witnessed similar trends in April with price per barrel of oil going down to 27.01 dollar. Later the price went below the 20 dollar mark and reached about 19 dollar per barrel on 27th April 2020. Similar trends were seen in the USA benchmark West Texas Intermediate (WTI), when it pegged the cost per barrel of crude oil at 11.31 dollar in the month of April. The prices fell further and touched 0 dollar per barrel on April 20, 2020 for the first time in history. WTI crude oil saw a negative price of about -40 dollar per barrel for May futures (contract between buyers and sellers of oil where both of them trade for future months and price for future months is decided based on different factors like demand, supply etc).

Oil Prices and How They Are Fixed

Oil prices have a dynamic nature in the global level. The top oil producing nations are USA, Saudi Arabia and Russia. The policies of these nations play a crucial role in determining the global oil prices. Organization of the Petroleum Exporting Countries (OPEC) was formed in 1960 and this group of countries of 13 countries which includes Iran, Iraq, Kuwait, Saudi Arabia, Venezuela, Indonesia etc account for about 45% of global oil production. OPEC was formed with the intention of establishing coordinated and well planned policies so as to regulate oil prices globally and in order to secure fair and stable prices for petroleum producers. In 2016, a larger group was formed by addition of few other countries led by Russia with OPEC and it was named as OPEC+. This organisation and other major oil producers like USA etc formulate policies and decide upon the prices of oil for exporters all over the world based on different factors and market conditions. As these producers account for majority of oil production in the world, hence the prices of oil as decided by them represents the oil prices at the global level.

Oil Prices and How They Are Fixed Info 1
Oil Prices and How They Are Fixed

Oil prices like any other market commodities are regulated by supply and demand. The economic concept of supply and demand which states that with increase in demand the prices of commodities increases and vice versa (directly proportional) and with increase in supply the prices decreases and vice versa (inversely proportional), helps to determine the oil prices. Oil prices are usually determined in future markets in terms of future contracts. Oil future contracts refer to an agreement reached upon by seller and buyer based on which both decide a predefined price on a predefined date in the future for sale of oil by barrel. Besides supply and demand, market sentiments also influence the futures contracts in oil trade. Market sentiment refers to mere belief that oil demand may increase or decrease in the future and based on this belief the prices of oil fluctuates even when actual demand for future in unknown. Besides these market factors, oil prices are also determined by groups like OPEC which have a significant hold on the global oil prices. OPEC uses its production capacity to regulate oil prices so that the members benefit from oil trade. With the increase in production capacity, countries like USA, Russia etc also have a significant level of influence on global oil prices.

Reasons for Recent Fall in Global Oil Prices

Oil prices fluctuate due to various reasons. In the recent past demand for oil has been decreasing. The global pandemic situation that forced almost all major nations to adopt lockdown measures has further aggravated the decreasing demand situation in oil market. Due to the lockdown major consumers of oil like travel sector (very low air, road and sea traffic), factories, refineries etc have failed to consume the oil that is already available in the global market. Major oil importer countries like China have cut down their oil imports from producers like Saudi Arabia. Economic activity all over the world has come to standstill and this has resulted in an increase in quantity of oil as reserves leading to filling up of oil storages. This decline in demand has decreased the oil prices. Further, fears of a fall in demand in the aftermath of the pandemic have given rise to demand shock in the global market and have depressed the oil prices to a greater extent.

In 2014, glut diplomacy reduced the prices of oil following which in 2016, OPEC and few other nations led by Russia formed OPEC+ to adopt coordinated measures to cut down production and steady the falling oil prices. Recently, Russia had a disagreement with OPEC in the matter of cutting down production to regulate the decreasing demand situation. After the fallout both the major oil producers’ i.e. Saudi Arabia and Russia have become free to ramp up their production and Saudi Arabia has already increased its production with the intention to force Russia to come back into the agreement, establish its monopoly and capture the oil market and to gain advantage over the U.S shale oil producers. This has led to an increase in supply of oil at a time when demand is already low and has resulted in supply shock in the market. Currently, the market is suffering from the dual issue of demand as well as supply shock and this has led to a decrease in the oil prices to unprecedented levels.

Effect of Falling Oil Prices on Global and Indian Economy

The COVID-19 pandemic has severely affected the global economy. Bringing the economy to a standstill, the pandemic has deteriorated the condition of stocks and bonds market due to the atmosphere of uncertainty created by COVID-19. The price war that has been started over oil prices by Saudi Arabia ramping up its production will make the global economy more volatile and murkier. Further if Russia decides to join the war in order to counter Saudi Arabia then it will have a drastic impact on oil prices. The fall in prices will affect big oil producing companies as they are dependent on higher prices to compensate the higher cost incurred by them for production. This decrease in price will benefit oil consuming countries and will adversely affect oil producing countries. Besides the transport sector, other sectors like cotton industries, rubber industries, oil refineries etc have also been feeling the heat from falling oil prices. Low prices have reduced the prices of cotton and rubber products as the synthetic substitutes for these products have become cheaper. Sugarcane and corn mills have also suffered as their products used to be bought by ethanol and bio-diesel producers at good prices before the oil price decrease. But due to decline in oil prices the oil companies have become reluctant to take up the produces from the mills. Oil importing countries, airlines etc will be benefitted due to reduced oil prices as they will be able to procure oil at low prices and hence decrease their expenditure on oil.

Effect of Falling Oil Prices on Global and Indian Economy Info 2
Effect of Falling Oil Prices on Global and Indian Economy

India as an importer of oil will benefit from the fall in oil prices. Firstly, as India imports a major portion of its oil requirements, the decline in oil prices will help to reduce India’s import bill significantly. Like all other economies India is also suffering due to reduced income from merchandise exports. In this situation a reduction in oil prices will help India to balance its current account deficit. Secondly, the reduction in crude oil prices will help to ease the inflationary pressure on Indian economy which will result in more funds being available for public expenditure and will also allow RBI to reduce rates for the benefit of economy. Lastly, the reduction in crude oil prices will help the government to stabilise the fiscal condition of the economy. Indian economy has been growing at a very slow pace and government has been facing difficulties to increase its revenue. In such a scenario savings from importing oil at low prices will help to increase government income and will help to settle the growing disruptions in Indian economy. However, Indian government’s plan to disinvest BPCL for increasing funds will become futile as big oil companies will avoid to bid higher for BPCL shares. The government may opt to compensate the loss from reduce disinvestment proceeds by increasing excise duties and other tax rates which will adversely affect India’s consumer middle class.

Conclusion

Oil is an essential product in today’s world as it is a major component for production of energy and energy forms the basis of economic growth of any nation. Recently, different factors like decreasing demand of oil due to COVID-19, price war between Saudi Arabia and Russia, increased oil reserves due to increase in production of oil etc has led to a dramatic fall in the oil prices at a global level. In such a scenario, the countries that produce oil will suffer due to decreasing prices and oil importing countries like India, China etc will benefit from this price decline. The oil price reduction will serve as an opportunity for India to reduce its import bill and will help to reduce India’s current account deficit. The reduced oil prices will stay in the global market for a longer period even after economies start to recover from the pandemic and lockdown situation because it will take long time to use up the oil that has been stocked up at present. The major oil producing countries like Russia, Saudi Arabia etc and organisations like OPEC must take into account the changing market conditions and must take necessary steps in order to establish a stable oil market so that all importers and exporters of oil benefit from the policies and the dual problem of supply and demand shock that has hit the oil market is dealt with in an effective manner else it will lead to dire situation like the past oil crises of 1998, 1973 etc.

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