A Brief Account of the Oil Crisis And Future Implications

A Brief Account of the Oil Crisis And Future Implications

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Krutika Patil and Rahul Jaybhay

Oil is the new Data: cheap and abundant. In the second week of April, both International Energy Agency (IEA) and Organization of the Petroleum Exporting Countries (OPEC) estimated that there will be a drop in demand for crude oil by 6.8 to 9.3 million barrels per day (mbd) in the year 2020 due to the COVID-19 pandemic that has grappled the world. To make things worse, on the 20th of April, the price of West Texas Intermediate (WTI) went negative for the May futures contracts, costing the producers minus $37.63 a barrel. This meant that the seller had to pay the buyer to get rid of the oil because they didn’t have adequate storage.


The Brent crude futures, which are the benchmark for India didn’t witness such a sharp fall in their prices because the production and transportation supply chain mechanism for Brent crude is more robust. Even though the lockdown has cut down India’s energy demand by 30%, India can benefit from the fallen oil prices in two ways: fiscally and strategically.


The fiscal year will have a lower oil import bill which might take some pressure off the account balance considering that the COVID-19 situation is harming the economy tremendously. India will also benefit by filling up its strategic reserves (In Visakhapatnam, Mangalore and Padur) that have a capacity of over 39 million barrels. This will help the economy to jumpstart, once things are normalised.


WHAT LED TO THE SUB-ZERO CHILLS?


The black gold's ubiquitous presence has ripped its value to historical lows. How did this happen? The answer lies in the demand and supply of oil in global markets. Any imbalance in either causes the prices to fluctuate. The demand for oil cratered to a historic low, due to the COVID-19pandemic. The shutting down of major economic powers like China has crippled the demand, as economic activities have halted. The global movement of human and capital dwindled as restrictions were imposed by states to counter the pandemics' effects. As business activity collapsed, the shock shattered the aviation and transportation industry, which are the biggest consumers of oil. In short, people are not consuming as much as they are expected to, thus dramatically reducing demand. As the corona effects abate, the prospects for demand recovery remain sanguine, though not immediately. The skepticism over supply-side correction remains the major concern for energy scholars. The issue is more political than economic. One of the reasons for the sliding oil prices is the ongoing price war between Russia and Saudi Arabia. In the recent past the surge in oil production, thanks to the US shale oil fracking technique, led to a price crash in 2014. To offset the effects of shale oil suppliers, traditional suppliers of oil (OPEC members) collaborated with non-OPEC members to give birth to OPEC+. The institution established the new Russia-Saudi rapprochement with the promise of cuts in production from suppliers to stay in business. The problem started in March 2020, when the COVID-19 aberration forced OPEC+ members to find a remedy for foreseeable fall in global demand. The negotiations over supply cuts failed to reach any conclusion between Russia and Saudi Arabia, forcing the latter to increase its oil supplies. Since global demand halted, the additional supplies found their way into storage capacity. As found by IHS Markit, the storage capacity will reach its limit by late April or early May, forcing producers to ship their oil in tankers, which are found stranded in watersaround the world. In short, the price collapse resulted from "a massive demand shock and a huge supply overhang" simultaneously.


THE WORLD THAT IS


The recent fall in oil prices has global implications. The utility of international institutions to navigate through diverse problems within the member nations will be questioned. The inherent weakness remains an anarchic ordering principle, where states shelf-help themselves against the collective good. Credibility of the OPEC+ in solving problems through collective means will remain doubtful in years to come.


In the domain of international relations, we can expect the worsening of relations between the US and Russia. Russia's decisions to not cut oil supplies were directed to hurt shale oil producers in the USA, the initial grudge being a reaction to the US sanctioning of Russian energy projects and companies,especially against the Nord Stream 2 pipeline project and a trading arm of the Rosneft. The future of US-Saudi relations seems pessimistic, as 13 Republican Senators have written to the Saudi prince asking him to maintain "oil market stability". Moreover, the senators expressed concerns over a surge in production causing undue damage to the American Oil industry, which might affect the US-Saudi defense relations. American oil producers wanted a ban on oil imports from Saudi Arabia, which might just aggravate the worsening conditions. For the US, the economic costs are huge. The debt-ridden shale gas companies will eventually run out of business, bankruptcy creeping in and consolidating the bigger players, wiping out smaller enterprises. Unemployment could then become a major issue in the upcoming US Presidential elections. Saudi-Russia relations will take a major hit, as Russia can survive on lower prices per barrel of oil, but Saudi cannot. It will be fiscally more challenging for Saudi to manage their budgets. From the business point of view, the oil companies will diversify their investments in the renewable energy sector, but such investment will be delayed until the effects of the COVID-19 recede. In the realm of consumers, it could be a jackpot for countries like India, though the benefits must be weighed against the costs. India will lose substantial remittances coming from the Gulf region due to low oil prices and lower demand. Thus the current global implications provide opportunities to some, while losses for others. The world will be better off if the current economic imbalance gets resolved through political will and diplomatic channels.


FUTURE OF THE CRUDE POST LOCKDOWN


Even though the May WTI futures went negative, the June futures prices are still $20.43 a barrel. This is because the traders are optimistic about the dilution of the lockdowns in June and hence some normalcy in the market is expected that will increase the oil demand. Because of the contango trades in the oil market, the price of the crude oil in the futures market is expected to be higher than for immediate delivery. For example, the November futures were sold at a somewhat stable price of $31.66 because buyers speculate that market conditions in November will bring demand. Mohamed Arkab, Energy Minister of Algeria (currently presiding over OPEC) said that the oil prices will be $40 per barrel,starting from the third quarter of the year 2020,when the oil prices recover due to OPEC+ production cut along with a gradual lifting of the lockdown. The situation, however, might not stabilize for millions of energy sector workers who have already lost 303,000 jobs due to the pandemic. BW Research estimates that around 30 % have lost their jobs in the first quarter of 2020 and many will lose them in the future. The damage to the oil sector is, thus, irreversible and is slated to change the world’s consumption patterns forever.


The free market system has forced the energy sector to think about ways to switch to renewable sources of energy that would guarantee some stability in terms of storage capabilities. Renewable energy is expected to grow by 5% this year, according to Birol and would catch up with the reduced demand for electricity. The governments should include the agenda to promote clean energy by providing the sector with some financial stimulus packages to bring clean energy into the mainstream and eventually replacing fossil fuels.


The IEA has already announced that the COVID-19 crisis has caused a decline in energy demand that is seven times greater than the economic slowdown. A post-COVID-19 scenario looks grim but is also an opportunity for states to recognize the faults and fractures in the system and to replace it with a system that serves all the stakeholders. After all, nothing is more expensive than a missed opportunity.

The authors are postgraduate students of Politics and International Studies at the Jawaharlal Nehru University, New Delhi.