Economy

Oil Prices 2020: Supply and Demand Shocks.

How it Affected Rich Exporting and Poor Oil Importing Nations?

The world economy has become less reliant on oil as compared to what it was a decade ago. That had already pushed crude oil prices down even before COVID-19 had set its foot in the world. The onset of COVID-19 has only pushed the prices further down to the extent that it is now distorting oil-producing economies, for a significant part of their GDPs depends just on oil. Their dream of ever-expanding and eternal fortunes founded on oil appears to be changing patterns.

Their fiscal budgets have taken a significant blow as the oil market, including traders, marine, and pipeline businesses, achieve a new low. The health of these economies, which seemed accustomed to continuous GDP growth, based on oil, apparently is not immune to shocks and, on the contrary, is becoming increasingly vulnerable to it. Oil-producing nations can undoubtedly manage the impact in the short term. However, it will only become more challenging for them to uphold their economies in the future as their capacity to support their citizens during the crisis will likely collapse as a result of high levels of unemployment and even bigger revenue losses.

Backdrop

The world is simultaneously facing both supply and demand shocks, and with the appearance of new determinants, like the ongoing pandemic, things are going haywire. On the supply side, oil prices sank due to the price war initiated by Saudi Arabia on being denied a reduction in output by Russia. The proposal to slash production was put across by the former to stabilize the COVID-19 induced plunge in the oil price as a half of the world came to a standstill. It irked and propelled Saudi Arabia to take a surprisingly drastic step of instead increasing its supply of oil, causing the market to go further down and lowering the price per barrel (International Brent) by 24% then. The plummeting oil prices did not lead to an increase in overall consumer demand as it would in regular times since the gains from lower prices get offset by uncertainty accompanied by the crisis. In normal circumstances, reduction in oil prices leads to exuberance amongst consumers, which causes inflation to decrease, but pandemics are particularly dour times, with not just people’s health at stake but also their future finances. It’s easy to understand the why behind it. As fewer people demand oil due to lockdowns and decreased economic activity world over, the price of oil dived. It’s called demand shock in economics, a marked change in the price of a commodity due to increased or decreased demand. Generally, shocks are negative — both demand and supply. There’s enough evidence to indicate that the nature of shock decides its impact on prices as they both differ in their essence. Even though the price of oil decreased to an unexpectedly low point, it couldn’t get the consumers to trade-off the gains with higher spending on other goods.

Disruption of the oil industry due to pandemic prompted demand shock is so completely different and is unlike anything that the world has faced before. The world had not seen this kind of price bottoms even when it was going through the financial crisis of 2008. It’s mostly demand-driven, and therefore revival is going to be slow too. Research suggests that demand shocks are more persistent, and supply shocks, on the other hand, are short-lived. Especially if they have arisen out of geopolitical outages that the world is currently facing, that pushes oil companies to divest out their existing assets as they foresee bleak chances of them ever regaining pre-pandemic demand levels. They are required to diversify their assets as fast as they can as the investment in the sector is taking a back seat, and so is the corporate bond market.

There’s still hope while oil producers and marketers prepare to leave the “New Normal” behind safely.

The prices are beginning to stabilize at $40(WTI) per barrel owing to steep cuts in production and supply. But basing the oil price rise on outages is not realistic as the bigger haul is to catch up on demand. Though it seems like a ‘new normal’ for now as the market is displaying bullish sentiments given the rising demand, especially in China, the demand needs to shoot up higher than it already has, to reach a stable price in the long run. Because the continuance of demand lags will only mean OPEC plus its partners will have to make a tougher choice of completely giving up producing oil or speeding up their pace. However, talking about the rising oil demand, jet fuels are not yet expected to contribute much to it this year.

What could come between oil companies and the optimum price they aim to achieve?

1. The second wave of coronavirus: It will decide the time it takes for economies to rebound and create oil demand again. As the line between the first and second wave, in most countries, remains blurred, it’s the rise in the number of cases that causes oil markets to fluctuate along with more selloffs.

2. Oil refiners demonstrate pessimistic sentiments while their margins for processing crude oil have decreased quite a bit, and they don’t seem motivated enough to keep buying it, warns Goldman Sachs.

Why aren’t gains reaching oil-importing emerging nations given how cheap crude oil currently is? Why are they still facing high prices? A case in point: India

India is the third-largest oil consumer in the world with the consumption of around 5 million barrels a day and also has a vast internal production of 1 million barrels per day. It imports the rest of it. It leads to India importing around 80% of its consumption needs from outside, which makes India a very lucrative business destination for oil-exporting countries. Still, despite all of it, the gains from trade do not percolate down to the consumers in India when the crude oil price plummets. Why?

The gains from lower prices get offset by so many other drivers. What are they?

1. The price of crude oil makes up only 40% of the total retail price. There are many benchmarks in the oil market. India’s basket is dominated by Brent crude oil, so when WTI (West Texas Intermediate) is making headlines on being negative, it does not impact India as much.

2. To make up for the disrupted fiscal budgets, governments are not passing down the gains to consumers. Moreover, the percentage of subsidies assigned to petroleum products this fiscal year was the lowest of all categories so that the government can counterbalance some losses incurred during lockdowns. Facing the same direction, they also decided to hike excise duty on both petrol and diesel during the crisis.

3. Oil Marketing Companies, too, don’t want to pass on the rewards to oil retailers as they wish to counterpoise what they lost during the oil dismay.

4. Exchange Rates: Indian rupee has depreciated in the last few months against the dollar, and that gives an account for rising import bills and, therefore, higher prices.

Research also suggests that the deregulation of oil prices can lead to a significant rise in inflation, and adjustments on the part of government can worsen its finances. It’s a tight spot to be in. In the interest of its citizen and to reduce import bills, India shall embrace substitutive strategies of producing more oil and, at the same time, adopt cleaner ways to produce it.