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Why oil prices fell below zero?

Topics Covered: Effect of policies and politics of developed and developing countries on India’s interests, Indian diaspora.

Why oil prices fell below zero?

What to study?

For Prelims: Meaning of below zero prices, what is WTI, how oil prices are determined?

For Mains: Why oil prices are falling, Impact of the fall in prices, implications on other countries including India, measures to address the situation.

What’s the issue?

Prices of West Texas Intermediate (WTI) in the US, recently fell to “minus” $40.32 a barrel.

  • This the lowest crude oil price ever recorded (the previous lowest was immediately after World War II).
  • At this price, the seller of crude oil would be paying the buyer $40 for each barrel that is bought.

But, What Negative Oil Prices Really Mean?

Firstly, WTI oil is traded as futures contracts in the NYMEX (New York Mercantile Exchange) where traders buy and sell monthly futures such as, for instance, May futures, June futures and so on.

The contract for West Texas intermediate crude, or WTI, is the benchmark for US crude oil prices. On Monday, it crashed 300 per cent from US$17.85 a barrel to minus US$37.63.

  1. The price of a barrel of crude varies based on factors such as supply, demand and quality. Supply of fuel has been far above demand since the coronavirus forced billions of people to stop travelling.
  2. Because of oversupply, storage tanks for WTI are becoming so full it is difficult to find space.
  3. Each contract trades for a month, with the May contract due to expire on Tuesday. Investors holding May contracts didn’t want to take delivery of the oil and incur storage costs, and in the end had to pay people to take it off their hands.

 Why the oil prices are falling?

Situation prior to COVID- 19 outbreak:

  1. Even before the COVID-19 outbreak induced lockdowns across the world, crude oil prices had been falling over the past few months.
  2. The reason was too much supply and too little demand.
  3. In early March, Saudi Arabia and Russia disagreed over the production cuts required to keep prices stable.
  4. As a result, oil-exporting countries, led by Saudi Arabia, started undercutting each other on price while continuing to produce the same quantities of oil.
  5. This was an unsustainable strategy under normal circumstances but what made it even more calamitous was the growing spread of novel coronavirus disease, which, in turn, was sharply reducing economic activity and the demand for oil.

Post- lockdown:

  1. With each passing day, the developed countries were falling prey to COVID-19 and with each lockdown, there were fewer flights, cars and industries etc. using oil.
  2. This meant that the supply-demand mismatch continued to worsen right through March and April.

How will this impact India?

The Indian crude oil basket does not comprise WTI — it only has Brent and oil from some of the Gulf countries — so there is no direct impact.

But oil is traded globally and weakness in WTI is mirrored in the falling prices of the Indian basket as well.

There are two ways in which this lower price can help India:

  1. If the government passes on the lower prices to consumers, then, whenever the economic recovery starts in India, individual consumption will be boosted.
  2. If, on the other hand, governments (both at the Centre and the states) decide to levy higher taxes on oil, it can boost government revenues.

What is Benchmark crude?

It is a crude oil that serves as a reference price for buyers and sellers of crude oil.

There are three primary benchmarks, West Texas Intermediate (WTI), Brent Blend, and Dubai Crude.

WTIvsBrent

Other well-known blends include the OPEC Reference Basket used by OPEC, Tapis Crude which is traded in Singapore, Bonny Light used in Nigeria, Urals oil used in Russia and Mexico’s Isthmus.

Insta Links:

Prelims Link:

  1. Important oil and gas exploration blocks in India.
  2. Difference between WTI, Brent and Dubai Crude.
  3. Largest oil producers and exporters.
  4. India’s oil imports.
  5. How oil is traded?

Mains Link:

What do negative oil prices mean for the economy and consumers? Discuss.

Sources: Indian Express.