Last Updated on Apr 23, 2020 by Aradhana Gotur
Folks, today we will discuss the historic plunge in WTI oil prices.
Had you ever imagined a time when oil sellers would pay buyers to get rid of their stock?
Eh, how’s that even possible?
But, hey it is happening now and we aren’t kidding!
Remember when OPEC declared a crude oil production cut to boost prices? If you don’t know about it, you may read here for a better understanding of what’s happening and why.
Coming back to the point. Just over a week before, both OPEC and non-OPEC members agreed to cut oil production to prop up falling prices on account of the dampened demand for crude oil triggered by COVID-19.
Well, turns out, it did not help.
On Mon, the 20th Apr 2020, something historic happened in the oil market so much so that it startled producers and investors alike and sent global benchmark indices diving.
The May futures of West Texas Intermediate (WTI), an American benchmark for crude oil, fell 305% and closed at -$37! (we had given you a spoiler just in the beginning).
Table of Contents
How can the WTI price touch negatives?
No one has ever heard of the oil price dipping to negatives. Then, what explains this unprecedented behaviour now? Let us examine the reason for this oil market crash.
1. Ever since COVID-19 set foot, the demand for crude oil was plummeting. What can you expect when people across the globe are locked down and industries are shut? With no to low demand for oil, the prices plunged significantly.
2. A dampened demand for oil due to coronavirus’ impact created an oversupply of oil in the world. Now, it’s not like oil is air, right? Meaning, it needs storage space. And when millions of barrels of oil are accumulating because of low demand and consumption, oil needs more place to be stored. But the US has so much oil now that Cushing (Oklahoma) is running out of storage space. And tankers are charging a bomb, if at all they are willing to house the barrels. Literally, the entire world is facing storage woes.
3. The WTI futures for May were set to expire on Tue and investors who held the contract were to take physical delivery of oil barrels. They simply can’t hold on to the WTI futures and refuse to take physical possession, right? But with no place to store physical barrels, investors were at their wits end, which forced them to go on a selling-spree. This means investors literally sold their WTI oil futures contracts to avoid storage and price issues. No wonder why WTI oil futures contracts fell below the zero level and touched -$37!
What does the historic decline in crude oil prices mean to India?
Now, you may think that such a plunge in oil prices is good for India, given we are the world’s 3rd largest crude oil and 4th largest liquefied natural gas importer (we import ~80% of our crude oil needs). Note this, every $ rise in the price of oil adds ~Rs 11,482cr to our import bill, results in a balance of payments, and lowers the value of the rupee. Ultimately, fuel-dependent companies transfer such high costs to end consumers.
But what happens when prices fall? With every $ drop in the price of a crude oil barrel reduces our import bill by Rs 10,700cr yearly. Now, if fuel companies transfer high prices to consumers, they should ideally be transferring the benefit of low prices as well, right? But as you see, it is not happening. Here’s why.
Why are fuel prices not falling in India?
Yes, on the face of it, a lower price of crude oil prices in international markets would ideally translate to a drop in prices in domestic markets as well. Also, the government is looking to fill its strategic oil reserves to benefit from the low prices. However, the benefit of low prices will not be transferred immediately. Let us see why.
A weak rupee against a strong USD
First, the rupee has been plunging compared to the USD. Our import bill is in dollars. This means that we still have to make up for the difference between the rupee and the dollar. Naturally, the gain from a lower oil price will be absorbed by a strong dollar value.
Brent crude price is stable against the WTI price
India majorly imports Brent crude oil and not WTI. Further, Brent crude prices are not as volatile as the WTI. So, a fall in the WTI may not help us a lot.
Oil prices consist of additional costs
You may be familiar with the fact that in India, the government controls the oil prices. Also, the centre gives subsidies to state-run oil companies, which adds to its total cost. This means that the government does as required, meaning it may reduce prices, increase them or keep them unchanged according to what the economic situation demands.
Now, you saw that India has one massive import bill to pay every year. Plus, with the economy falling out due to COVID-19, the government’s revenues are impacted significantly. Therefore, the low oil prices are likely to be policymakers’ instrument to meet the fiscal deficit. This means that any benefit passed on to us may not be significant and immediate.