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The Game of Oil

On April 21, 2020, the world witnessed an unprecedented swing in the financial markets since the COVID-19 pandemic broke out, and nothing else has been more jaw-dropping than the West Texas Intermediary (WTI) trading at negative $37.63 per barrel. That’s right, sellers are paying buyers to take the stuff off their hands! The main reason for this? Probably the coronavirus. This pandemic has ravaged global economies, bringing all industrial and economic activities to a halt. As billions of people were advised to stay put at their homes to slow the spread of disease, the physical demand for oil had dried up. And on top of it, airlines and industries weren’t helping much either. Thereby, we can say that the demand was close to nil. But coronavirus might have decreased the prices by a lot, though not to the extent of it trading at a staggering negative of $37, right? So, what caused it then?

Amidst the coronavirus pandemic, came the unexpected oil price war between Russia and Saudi Arabia. Oil prices were already tumbling due to scarce demand. Taking into account the plummeting demand, the Organisation of the Petroleum Exporting Countries (OPEC) nations decided to cut the production by 1.5 million barrels per day (BPD), on top of the existing cuts. However, to everyone’s surprise, Russia backed out of the deal. This move was a response to the declining share of OPEC+ countries (OPEC + Russia) to the US shale producers; supposing OPEC+ reduced their supply, US shale producers would step in and rope all the customers of OPEC+.

Russia’s response agitated the oil-rich nations and the repercussions involved an announcement to flood the market with oil by producing 12.3 million BPD. Thereby, almost all the nations went on the offensive and ramped up their production. The story seemed interesting until now, to see how the two countries fought with each other through crude oil. But as countries’ production ascended, the storage avenues started to fill at an unprecedented rate and this was when the real problem came to light. The prices dipped below zero not because of scarce demand and excess supply but due to ‘oil futures’.

Let’s understand the concept of ‘oil futures’. To put it simply, a future means deciding the price for a commodity now but delivery and payment at a future pre-determined date. Let’s say you have futures of crude oil worth $40 and the delivery is anytime between May 1 and May 31. You need to get rid of the futures contract by April 20, according to the rule by the New York Mercantile Exchange, otherwise, you end up taking the actual delivery of goods. As a futures dealer, you might have thought that as the price of crude oil will rally, it would be profitable to sell them at a discount on current market price and earn a hefty profit later on. But the situation turned upside down and there was no taker for the futures contract. And your heart started thumping heavily, suddenly you see the futures chart falling to zero and as the time started to come closer, the price decreased as there was anxious selling.

You’re in a dilemma about your course of action: either you take actual delivery of crude oil or you sell it at a negative price, in either case, you suffer a heavy setback. Now, we cannot just think of storing the oil in our garden as it is a bare minimum requirement to buy at least 1,000 barrels, or if you’re thinking to store it in the shipping yard, we’d have to shell another set of dollars, but the shipping yard was almost full and on top of it, they were charging exorbitant prices for it. Therefore, it was better to tick off the former option. Being left with the latter, we try to sell it at the least possible price, just to get rid of it. Due to panic selling, the prices dipped below zero which thereby caused a once-in-a-lifetime moment.

As we write, crude oil prices have registered three weekly gains in a row, amid efforts by top producers to cut production due to concerns about recovery from the damage caused by the coronavirus pandemic and resultant lockdowns. Saudia Arabia has a history of waging oil price wars that have created ruckus all around the country. Increasing or decreasing production of oil might seem like a pinch to the Saudis but the repercussion is that various companies are filing for bankruptcy. The oil price war is rather synonymous with an actual war: wherein valiant soldiers die. But in this case, hard-working businessmen are turning bankrupt, just because they have to give in to the conditions dictated by the big and mighty, which causes them to incur losses. This puts up a very important question: is it the time to decentralise this power?

aditya.khandelwal

Aditya Khandelwal

A happy person with the desire to enchant everyone with a smile. Pursuing Bachelors of Commerce from Hindu College. In his free time, you can find him reviewing new gadgets or cars.

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