For the first time in history, the US oil prices turned negative as the coronavirus pandemic halts economic activities. Prices of benchmark U.S. oil dipped negative last week, falling as low as minus $37.63 per barrel.
Why did the prices drop so low?
The price of crude oil is decided by a number of factors. The primary factor being the global demand and supply. Currently, there is a glut of oil in the market. From January 2020, countries began limiting travel and temporarily closing businesses to curb the coronavirus pandemic. This led to the beginning of the fall in demand for oil. The fall was worsened by excess supply. Russia and Saudi Arabia, two of the world’s largest producers of oil, flooded the market with crude oil before finalizing an agreement to cut production by 9.7 million barrels per day (bpd) for May and June.
The lack of storage facilities is another major challenge. On 20th April, the price of oil in the U.S. went into negative, meaning that sellers were willing to pay buyers money to take possession of oil that was supposed to exchange hands the next day. Oil price went as low as minus $37.63 a barrel.
What does negative price mean?
The supply of crude has been far above its global demand. Because of the oversupply, traders have run out of space to store the oil. Not everybody dealing in oil contracts has the infrastructure to pick it up or store it, leaving paper traders struggling to find buyers capable of storing oil. The negative price reflected traders’ willingness to pay others to take their oil contracts and figure out what to do with the product.
Are the prices expected to fall again?
The 9.7 million bpd cuts pledged by OPEC+ for May and June may not completely offset the fall in the global demand of crude oil. The International Energy Agency has estimated the fall in demand to reach 29 million bpd in April. Even if every producer in the OPEC+ group fully complies with their quotas it, will not be enough to prevent oil inventories in the U.S. and the world from overflowing within weeks.
The price of June crude contracts is trading at around $20/bbl, however, we could see negative prices again since storage space is still limited.
Does the fall in crude oil prices imply cheaper petrol in India?
There are three major oil price benchmarks- Brent crude, West Texas Intermediate (WTI) and Middle East crude. Brent is the most widely used benchmark. Brent Oil Prices have collapsed around 60 per cent since the start of the year. India’s major imports are from OPEC which uses the Brent crude benchmark. On 22nd April, Brent crude prices fell to a historic low of $16 per barrel.
However, crude oil forms only a part of the overall prices of petrol and diesel in India. The price per litre includes a number of other costs, including refining, freight, logistics, etc. By far the biggest component of the per litre cost of petrol and diesel are taxes. Nearly 60% of the cost of petrol, and 50% of the cost of diesel are central and state taxes. These taxes have been increased over several years consistently with the fall in crude oil prices, such that the retail prices do not vary nearly as much as crude oil prices.
Further, the price of oil is usually measured in US Dollar. Therefore, the USD/INR exchange rate also plays a role. With India being an importer and the bill being in dollars, a weaker rupee may offset some of the gains from lower oil prices.