Oil Industry in the Time of Pandemic

This blog is inscribed by Nikita Sangwan.

The countries were busy in making their nuclear weapons, training their militaries to be indefatigable & inventing new defence equipment solely with the purpose to show that they have upper hand during the times of emergency or war. But to expect almost an invisible creature as a threat to the economies was unprecedented. The present scenario where the virus has attacked the world has diversely affected the nations and has forced the complete lockdown. Almost every sector has faced its ramifications. The most astounding data was marked in the oil industry in the United States of America (USA). Corona virus outbreak has shaken the oil market fundamentals. Let’s get in the deep of how the oil industry works, what happened and what is its impact on India.

How the oil industry works and what happened?

Oil is produced by many countries in the world, among which the US tops the list. There are two most popular grades of crude oil which are Brent crude and WTI (West Texas Intermediate). Brent refers to the oil produced from oil fields of North Sea. It is the international benchmark price used by OPEC (Organization of Petroleum Exporting Countries), while WTI is the benchmark for US oil prices.

The trading of oil is done on its future price/contracts; in simple words, the contract for buying the oil of next month is decided this month. Eg: if the oil is to be bought for the month of May then the order should be placed in April with a contract deciding the price depending on various factors. The sellers have to deliver the oil at a contracted price in the contracted month and the buyers have to take the delivery at the contracted date. Speculators have to exit from their positions before the contract expiry date and if in case they fail to do so then they have to take the actual physical delivery of crude oil on the specified date. Now the investors who bet huge sums of money on May future contracts began to unravel their positions on 20th April 2020 because the future contracts for May were set to expire the next day. The need to exit the contract was due to the decline in the demand for oil in the market and lack of storage facility. Since the world was on lockdown so where are we going to go and hence the demand for oil reduced readily thus lowering the price of crude oil. To the surprise of most, on 20 April the price went even below $0 i.e. -$37.63 per barrel (1 barrel = 158.9 Litres). The price in negative indicates that oil traders in the US had to pay from their own pockets to get rid of the excess oil. It tells that expenditure is done on it but no revenue is earned as a result. At present the situation is that oil wells are producing more oil than the world is expected to consume and to even worse there is no demand of oil in the market plus the storage tanks are already full so now the glut of crude oil is a problem to be resolved in the US.

This negative oil price is a temporary situation because oil is one of the most important raw material for our economy and the lockdown will not sustain forever. For the future contracts of June, the oil price is positive till now i.e. $21.14. The reason for this difference is that oil traders expect the situation to improve as at some places lockdown is partially lifted and the economic activities have started to resume.

Is India going to benefit from this decrease in the oil price of WTI?

Since India’s 85% of the oil from its total oil consumption is totally imported from other countries, so this drop in oil price could seem beneficial to the country but the situation is not so in reality. India is hardly going to get any benefit of this decline in oil prices of WTI oil. This is because India mainly imports oil from OPEC countries (organization of Petroleum Exporting Countries) that include 15 nations and from Brent crude (extracted from the North Sea). Although the prices of oil for Brent crude have also reduced to 5% it is still around $27 and the oil price for OPEC is around $20. Both of them are expensive compared to America’s WTI (-$37.63) so there will be no changes in the price of petrol and diesel in India.

If in case, India wishes to buy America’s WTI oil now due to its very low price, even then the country will not earn profit in this. The money that will be incurred in bringing the oil back to Asia from America will not be economical. The cost of transportation of that oil will make that oil of almost equal cost as it amounts to us from OPEC and Brent crude.

Also, there is no more storage facility in India now. All of the three Strategic Petroleum Reserves(used as a reserve for oil that can be used at the time of war when no supply could be made) in India which are in Vishakhapatnam, Mangalore and Padur are already full. So even if the nation buys this WTI cheap oil, there will be no space to store it.

If India considers the WTI oil and if in case plans to build up more reservoirs to increase its storage capacity then we can consider that as a part of the long term project, so if India buys the WTI oil considering the long term benefits then this lowering of oil price can be beneficial to India. Although lockdown can be said to benefit India as it will reduce the oil import bill of the government. It will reduce the outgoing foreign policy which saves the expenditure of the Indian government.

Does reduction in crude oil price indicate reduced prices of petroleum and diesel for people?

The chances of falling petroleum and diesel prices for people are seemingly blurred even though there is a decrease in the price of crude oil in the international market. This is because these prices in India mainly constitute taxes that are charged by state and central government, the charges of middleman are also to be included while deciding final prices. The cost per barrel which is stated is the government and the oil companies cost price, it is not the amount that the consumer has to pay. After getting the crude oil, the companies will further process it and extract natural gas, diesel, petroleum from it. Then the processed crude oil is now sold to a middleman and then it further reaches to the common man. There is a long chain of people that are connected in this process which need to be paid in the form of salaries and commission. Not only this but the government charge tax per gallon. Initially, the centre government charge excise duties, then the state government also charge its VAT(Value Added Tax) on that and the commission of oil dealers is also added to this. So if the prices of oil are reduced in the international market, it doesn’t necessarily mean that the consumers will also be benefitted for sure because it is generally when government tend to increase its tax on per liters of petrol sold as it is the easiest and most profitable way of earning revenue. So even if the prices fall to $0 in the market, still the transportation charges, tax implied by govt. , and the commission of dealers is to be recovered, That’s the reason that the prices of petrol and diesel remain mostly unaffected unless the tax imposed by government are reduced. Due to the lockdown, the Indian government is already short of revenue; therefore the government needs maximum tax inflow. In short low crude oil price in the world doesn’t mean much to the Indian domestic fuel prices.

Conclusion:

The flip of the time will always be an obscure mystery. No situation persists forever and the same goes to the oil industry too. Oil experts are used to the ebbs and flows of this field. They know that as soon as the lockdown will be lifted, the demand for crude oil will demonstrate a great surge and they will be again earning huge profits. Although this negative price of crude oil was the record in itself so it gained much attention it can be predicted that as the economies are slowly coming on the path of their development, the situation will be normalized soon. Not this negative oil price of WTI affected India much but the war between Saudi Arabia and Russia regarding the production of more oil even in this abeyant situation has lowered the price of Brent crude that could be beneficial to the nation if it persists for some time.

[i] http://www.bbc.com/news/business-52089127

http://www.thehindu.com/opinion/editorial/features-shock-the-hindu-editorial-on-oil-price-fall-below-0/article31399907.ece

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