Global Oil Market Turmoil: Testing the resilience of Countries

During March 2020, an all-out war broke out between two oil-producing giants, Russia and Saudi Arabia which rocked the global markets when OPEC+ failed in their negotiations to cut production, it deepened the crisis already exacerbated by the COVID 19 impact across the world. It was widely reported that Russia did not agree to the cuts, with the strategic intention to drive prices down, gain market share and get the US Shale oil industry off the track. In response, Saudi Arabia responded with a call to step up their oil production to more than 10 million BBL/day in April and enter into a direct price war with Russia and others. The resultant price fall in oil markets was one of the most unprecedented happenings in recent decades since the Gulf war. With none of the countries in a position to face the economic backlash triggered by the meteoric price fall of oil below USD 30 /BBL,  it was not unexpected that the OPEC+ would come back to the negotiation table and rework their strategy, which they did. On the other side of the world, US shale oil and gas industry was reeling under low prices of oil with many shale companies staring at bankruptcy. Supply-side is only one side of the story. Two more things happened which is going to pose a major challenge in the coming weeks – demand slump across the world and the consequent storage crisis that is looming large.

Key Happenings:

A quick recap of what has happened in the past weeks:

  • OPEC+ led by the top producers Russia and Saudi Arabia agreed to cut the production of oil in order to stabilize the oil prices and end the price war. OPEC+ decided to cut production by 9.7 million BBL/day.
  • This production cut is the largest in the history and this received its support from the US, which shows how deep is the crisis this time and how important is a collaboration amongst countries who might have been competitors till yesterday.
  • Oil demand is reported to have fallen by 20 to 30 Million BBL/day during the last few weeks triggered by a ban on international travel, domestic travel in various countries, stoppage of logistics by road, fall in day commuting due to lockdown, shut down of industries and other factors.
  • Is this production cut really a strategic decision of oil producers in the above circumstances?. Not at all. They had no choice and further, it has not arrested the price fall and oil prices have continued to fall. OPEC countries and Russia are already facing the economic backlash. The stoppage of drilling that is happening in US in various shale basins has already led to job cuts and the situation is expected to worsen.
  • To cap it all, the US Western Texas Intermediate (WTI) fell dramatically below zero on 20th of April 2020 and sent the markets into a frenzy. The international benchmark - Brent crude closed around USD 25.37/BBL during the same day. This needs to be understood a bit better– The May futures were expiring on 21st April 2020 but the oil storage in US was overflowing and the demand for physical delivery was non-existent. With WTI index restricted to US only, the WTI fell dramatically below zero whereas Brent Crude price, which is more international, closed at USD 25.37/BBL. One can also get an insight from the WTI June futures contract, expiring on 19th May, which was quoting at USD 20.43/BBL on the same day.

Where are oil markets headed?

International Energy Agency in its report of April 2020, has forecasted that global oil demand may fall by a record 9.3 million BBL/day year-on-year in 2020 and further that the demand in April 2020 is estimated to be 29 million BBL/day lesser than the figure a year ago, down to a level last seen in 1995. The overall scenario today and during the current quarter is: Production is being cut down, demand is falling faster than production cuts and the storages are filling up. Markets have to be prepared for further pressure on oil prices and it may swing below USD 20 / BBL. At this juncture, the focus of the countries is already on and will have to be the following:

  • The focus is now on the governments and policymakers. Governments are introducing massive emergency fiscal plans to support daily wage workers, the larger working class, commercial establishments and the small and medium enterprises, which are reeling under closure and chocking of cash flow to meet the fixed costs.
  • The other focus is on financial institutions and banks which are introducing monetary stimulus programmes and certain calibrated waivers or postponement of dues.
  • Economic recovery will remain the main focus of the governments and businesses and that has a close linkage to the oil and gas markets, undoubtedly. For this to happen, the countries have to collaborate and aim to control the production and storage and sustain the situation for a couple of months. With the significant demand slump for oil expected to continue in May 2020 and early part of June 2020, this is the only option left with the oil industry with the hope that there will be a semblance of economic recovery in later part of June 2020. How the important decisions are taken by OPEC+ and the G20 nations, as a unified global strategy is what is going to determine how the nations are going to tide over the serious crisis.

Impact on Indian Economy

Any analysis and predictions done today are always subject to the assumption on how quickly the world and India would recover from the impact of corona pandemic. The longer the continuance of lockdowns, the longer will be the time to recover. Yet it would be better to stay optimistic and expect a reversal of trends from the later-half of June onwards.  On this note, let us look at a broad overview of how the Indian economy is going to be impacted in the coming months.

  • India imports 77% of its oil and therefore lower oil prices will be good news for India. The country’s foreign exchange outgo is expected to come down. With oil price recovery expected to be slow in global markets and India’s economic recovery expected to be faster, thanks to the timely and decisive steps taken by the government to control the COVID 19 pandemic, the import bill of India will definitely come down during the year.
  • India will be one of the key demand centres post-corona crisis and there will be a lot of focus on India. The country has proved its resilience once again (recall how India managed during the 2008-09 global financial meltdown). That’s again good news for India from a development perspective.
  • India’s Inflation may be under check and will continue for some time. Demand recovery may vary from sector to sector with essentials and key services recovering faster and other sectors going through a calibrated opening.
  • But the Oil and Gas sector cannot be looked at in isolation. The impact on trade and commerce coupled with slow-down in some of the key sectors of the economy will be the major challenge. The major negative impact on countries who are oil producers – like Saudi Arabia, Kuwait, UAE, US, Russia etc – can massively impact India’s trade balance and hence there could be a bigger challenge emerging.
  • The other major impact is on the oil refining and marketing companies. The demand for oil from the transport sector and airlines has almost dried up which is impacting the production of petroleum products from the companies. On top of it, the prices of petrol and diesel have come down and this has impacted the revenue of the companies significantly.
  • The Indian economy will further face a reduction in revenue due to lower receipt of taxes and duties from the oil sector coupled with a postponement of disinvestment of PSUs. There is going to be a larger fiscal impact.

The COVID Pandemic has exposed the preparedness of many of the developed and developing nations. India is standing tall against this outbreak and has put its best foot forward in terms of timely and decisive actions. Forecast and expectations in the foregoing analysis and by other expert agencies are always based on the assumption of recovery beginning to take place from May onwards. Any delay and continuance of lockdown situations, which vary across countries, would not only delay the commencement of recovery but also expand the time taken for substantial recovery to happen.

 

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