From UPSC perspective, the following things are important :
Prelims level : WTO benchmark, Brent crude.
Mains level : Paper 3- What are the implications of oil price fluctuations for Indian economy?
This article discusses the factors that contributed to oil prices falling below zero, and where the prices are headed in the near future. There are suggestions for India to make the most of this oil crisis. In the last week, we covered the same topic but its focus was on increasing the storage capacity. This article also covers the geopolitical implications of oil prices remaining low for long.
What negative price of the benchmark US crude WTI mean?
- The collapse in the price of WTI reflected a technical peculiarity of futures trading.
- Paper traders would normally have had two options- 1) To let their contract expire and take physical delivery 2) To pass on the contract to someone else.
- The US was running out of crude oil storage capacity and traders knew they could not “risk” taking delivery.
- There was no physical space to hold the product.
- So their only option was to sell the contract.
- On the last day before the contracts expired, the traders in desperation “paid” to offload their risk.
- There was no physical transaction of oil.
- The current future price is back in positive territory.
The world running out of oil storage capacity
- The world and not just the US was fast running out of storage capacity.
- Production in excess of demand: This was because oil production was way in excess of demand.
- The latter had crashed by almost 30 million barrels a day or mbd (the equivalent of OPEC’s entire production) because of the COVID-induced lockdown of transportation and industry.
- The price of the other crude benchmarks had also dropped but not the same extent — the North Sea Brent fell, for instance, to $15/bbl, a level not seen since 1999.
- The reason was that unlike the WTI, which is traded in the US and therefore dependent on US inland storage capacity, the other crudes have access to seaborne storage (oil tankers).
- This latter capacity is, however, fast filling up and the price of these crudes may also hit historic lows.
So, where the oil prices are headed?
- Oil prices will be volatile downwards until demand picks up and/or supply is further cut.
- Demand will depend on the curve of post-COVID economic recovery.
- Supply will rest on the outcome of further discussions amongst OPEC, Russia and, ironically, the US.
- OPEC and Russia had earlier this month agreed to cut production by 10 mbd.
- But clearly, this is not enough and further cutbacks have to be agreed on.
- Whatever the scenario for economic recovery or supply constraints, there is a slim likelihood of crude oil prices reaching the average price levels of 2019 ($64) over the next 12 months or so.
- More likely, they will be volatile downwards with $50 as the ceiling and with no floor.
- This “low for longer” price outlook raises two issues for India’s policy-makers.
As India depends on imports for over 80% of its oil requirements, oil prices have wide implications for the financial health of India. Safe oil supply lines are essential for its energy security. Both these points are important from the UPSC point of view. Following two points deal with these two factors.
Two issues that India’s policy-makers need to consider-
1. Disruption of oil supply lines and problems of diaspora
- Every oil producer with no exception will face a budgetary crisis.
- Some, like Saudi Arabia, the UAE and Kuwait will finance their social and economic commitments by cutting costs, increasing debt and drawing down on their sovereign reserves.
- Others like Iran, Iraq, Nigeria and Venezuela, who have no such cushion and whose credit ratings are junk, will confront deepening political and social crises.
- Economic plan: India should build into its economic plans the possibility that its traditional oil supply routes could get disrupted.
- And that its diaspora, whose remittances are of significance, could face disproportionate hardship as these economies retrench.
India has the largest diaspora in the world and sends as much as $80 billion back home as remittances. So, any impact on diaspora in oil economies has implication for India from this perspective as well.
2. Empower the oil traders and remove bureaucratic control
- On the day prices hit negative territory, it is unclear whether the trading experts in our oil PSUs had the flexibility to even contemplate “buying” the WTI futures contract for June, taking delivery, shipping it to India and storing it someplace.
- It is also not clear whether they had the authority to lock in low prices through forward contracts.
- Storage capacity and WTI quality mismatch: There is a shortage of storage capacity in India and a mismatch between the quality of WTI and the requirements of our refineries.
- India cannot leverage the current market conditions of low and volatile oil prices to our national advantage unless we empower the traders and leave them unencumbered from bureaucratic control.
- Most importantly, protect them from the three Cs ( CVC, CBI and CAG) in case their trade goes awry.
This oil market crisis could be made to work to our advantage. We must not waste this opportunity. There is a need to remove the bureaucratic hurdles in our PSUs, increasing storage capacity and sound financial planning by the government to make the most of this oil crisis.
Back2Basics: What is WTI and Brent crude benchmark?
- West Texas Intermediate (WTI), also known as Texas light sweet, is a grade of crude oil used as a benchmark in oil pricing.
- This grade is described as light crude oil because of its relatively low density, and sweet because of its low sulfur content.
- Brent Crude is a trading classification of sweet light crude oil that serves as one of the two main benchmark prices for purchases of oil worldwide.
- This grade is described as light because of its relatively low density, and sweet because of its low sulphur content.
- In finance, a futures contract is a standardized legal agreement to buy or sell something at a predetermined price at a specified time in the future, between parties not known to each other.
- The asset transacted is usually a commodity or financial instrument.