The Crude Oil Saga 2020-21

Even after several decades of First Oil Crisis and a lot of technological advancement … an increase in petrol and diesel prices still effects balance of payments of several nations and a common man's budget too.

“Economics is study about how to meet unlimited need with scarce resources” – Laurence J Peter.

This statement holds a lot of significance. People make a lot of money by manipulating prices (meeting their unlimited needs) via artificially adjusting demand and supply (scarce resources) be it stocks, onions or crude oil… etc. In this article we will see how demand and supply of crude oil were adjusted so as to control prices.

 

We can consider Petrol and Diesel as a relatively inelastic market in short run, which means that there are very few substitutes available so that you can shift to that substitute if prices for petrol increase.

As petrol and diesel both are obtained from crude oil, so it becomes important to understand about what happened to crude oil prices which were less than $30 in early 2020 and then it astonishingly rose to $80 and above in 2021.

Abbreviations:

1. Barrels: quantity measure of crude oil

2. All prices are in $ per barrels

3. OPEC - organization of oil exporting countries

4. OPEC+ - includes Russia and some other nations too.

1     Outbreak of Covid-19 & Saudi-Russia Dispute – A Price War

 

 

As the deadly corona virus started spreading all over the world, the nations preferred life over economic growth and lockdowns were imposed in many parts of the world. This led to a huge decrease in demand for crude oil & massive losses for the OPEC+ nations as they have crude oil as an important source of income.

On one hand the decrease in demand for crude oil was leading to a massive decrease in crude oil prices and on the other hand Russia rejected the demand by Saudi Arabia to cut oil production. This led to a price war between Russia and Saudi Arabia. As Saudis have a break even point of even less than $10 per barrel (although this led to huge budget deficits), they increased their oil production and even offered price discounts to its customers from April.

As per some analysts Russia has break-even point at around $30 per barrel, which means it can’t continue its production at a price of less than $30 per barrel. The daunting steps taken by Saudis were causing severe losses to Russia as this price war crashed the crude oil prices to around $24 per barrel.

On the other hand, White House was also suffering because USA has shale oil reserves. The shale oil has high extraction and production cost. The shale oil companies in USA can’t operate with prices less than $30-$40 per barrel. This means that if the price of crude oil will go below $40 per barrel, it will lead to shut down of America’s shale oil production in short run. One reason is that they will incur loss and the other is that shale oil is priced lesser than crude oil, so if crude oil is less than $40, buyers will not prefer to buy shale oil for a higher rate than crude oil.

 

Saudi Arabia is a good ally of USA, this was the main reason why Saudis were proposing to cut oil production so that the price of crude oil will remain higher and America’s shale oil production will continue. Russia foresaw this and rejected the Saudis demand to cut oil production. But due Saudis offering discounts and crude prices less than $24 per barrel Russia had to agree to cut oil production.

Some experts say that Donald Trump called emperor of Saudi Arabia “Mohmad bin Salman” and threaten him that if he did not cut production and continue this price war, he will impose sanctions on Saudis and withdraw US army from Riyadh.

After all this both the parties (Saudi & Russia) agreed to cut oil production and the crude oil prices started normalizing.

How cut in production effect Crude Oil prices?

A cut in production led to decrease in supply, which means shortage of crude oil as compared to its demand, this led to increase in crude prices after a sharp fall.

 

2-     Crude at its peak – Output Cuts & Demand Recovery

As the situation started getting stabilized with an increase in vaccination doses, the demand for crude oil started increasing. Now on one hand there were production cuts as decided in OPEC+ meetings and on the other hand there was an increase in demand for crude oil. This led to a massive rise in crude oil prices. This became catastrophic for nations importing oil.

Although OPEC+ decided to increase production by 400000 barrels per day but this was not enough to meet the demand and cool down the prices.

 

How increase in demand effect crude oil prices?

An increase in demand with production remaining same means there will be shortage of a product, therefore prices go up.

 

Here also America intervened because with winters approaching, the fuel demand in USA was also increasing and with elections (in some parts) being scheduled in USA in Jan 2022, rising electricity bills and fuel costs may cost Joe Biden a huge loss. Therefore, White House

asked OPEC+ to increase the oil production but OPEC+ didn’t increased production beyond 400000 barrels a day.

 

This led to one of the fanciest things, which has happened only in big circumstances like gulf war 1991 and Libya war 2011, ‘the release of oil reserves.’

 

Following is the price chart of WTI crude oil prices, I have marked three points, the first is related to our very first point i.e., Covid outbreak and Saudi-Russia Dispute. The second point in related to second point (rise in crude oil prices) and the third point is the fall in price after Reserve release by United States.

 

3-     Reserve release by Nations – Supply emergency or Political emergency?

After the 1970’s embargo, many nations started maintaining crude reserves- SPR (Strategic Petroleum Reserve). United States decided to release 50 million barrels of crude oil from its SPR and asked other nations also to release some of their oil reserves.

 

Now before going further, let us understand:

What is the affect of releasing oil reserves?

By releasing oil reserves, the availability of crude oil in market will increase. Therefore, the unmet demand or the shortage will be met and hence prices will decrease. However, the magnitude of this effect is dependent on the quantity being released.

 

US asked other nations like India, UK, Japan, South Korea and China to release some of their reserves. India has already released 5 million barrels from its reserves (India maintains a reserves of 9.5 days as a part of its SPR). Japan has agreed but it will not release its reserve for manipulating the prices as its law doesn’t allow this but they may release some part of their reserve primarily to meet the demand.  

 

Another Question here comes that:

How USA was able to take big nations on its side…. China too...?

 

One thing from my whole analysis on this topic was very clear that United States is an excellent negotiator. They are excellent politicians and they know very well how to make their nation and their people better off.

US targeted major oil importing nations i.e., China, India, Japan, South Korea etc.

 

The US shale oil, as I said has huge refining cost as compared to the traditional crude oil but it is available at a cheaper rate than the conventional crude oil. With India and China facing huge problems due to rising petrol and diesel prices, these two were the easiest ones to crack the deal. Much of the US reserve release will be going to India and China, so taking these two nations on its side became easier for USA.

In a similar fashion United States tackled other oil importing nations but having India and China on their side made them totally confident of capitalizing their motives behind reserve releasing step.

On 26-11-2021, United States released 50-million-barrel crude oil from its reserve. This led to a massive decrease in crude oil prices, or we can say the worst fall in crude oil prices from $78 to $68 in 2021 (about 13%). It fell till $65.4 on 01^st of December 2021.

 

4-     Reaction of OPEC

OPEC had all reasons to cut production after US led reserve release but US officials had met with UAE and Saudi Arabia’s officials before OPEC’s meeting on 2^nd of December 2021. The end result of the meeting was that OPEC+ sustained their decision of increasing supply by 400000 barrels per day.

 

What if Russia had demanded production cuts as it knew that high crude oil prices will affect USA?

Saudi Arabia is the “Hukum ka Ekka” for united states in middle east and OPEC related matters, well US can influence UAE too to be on their side. If Russia would have demanded to cut production, US could have simply asked Saudi Arabia to offer discounts in short run or it may have itself released more reserves (which would have led to further sharp fall in crude oil prices). Any of this step would have affected Russia.

As per analysts everything is good for Russia if prices are around $75.

 

5-     Denouement – Summing up the Events

The whole game was neither orchestrated Russia nor by Saudi Arabia… it was done by United States. When USA wanted to benefit their shale oil firms, they get their task done by help of Saudis. And when USA wanted to cool down the rising price, they get it done by their effective communication and influencing power.

United States has no doubt won in this case but the truth is that everything from here depends on how does the new variant i.e., Omicron affects.

OPEC+ may have decided to increase their production this is primarily because they assume new covid variant to be a short-term effect (as officially stated by OPEC+) but if demand for crude oil plunges OPEC+ will cut its production.

This means that if Omicron will harm the same way like 2^nd wave, Petrol and Diesel prices will soar like never before. With Crude at around $75, we are having petrol prices at ₨95 (after reduction in excise duty by Rs5) in India. If the situation became worse like it was, Crude oil may rise to $90-$100 which will lead to petrol prices in India at Rs 125 per liter or even more.

 

: Shaurya Gupta

  Bcom Hons. University of Delhi

  Financial Markets hons, Yale University

 

 

 

 

 

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