What explains the sharp crash in global oil prices?

Here is what is driving oil prices lower.

Feb 07, 2020 11:02 IST India Infoline News Service

In the hype and hoopla surrounding the Union Budget, rising inflation and falling GDP growth, most of us did not realize that the price of crude oil had touched the lowest point in the last one year. What is more, the price of crude oil has cracked more than 20% in a span of less than 2 months as depicted in the chart below.

Chart Source: Bloomberg
 

For a better part of the last one year, the price of crude oil was driven by two distinct factors viz. the US-China trade war and tensions in the Middle East. While the US-China trade war had the impact of depressing oil prices, the tensions between Iran and the US fuelled prices higher. However, in the last couple of months, three different set of factors have come into play in determining the direction of oil prices. The phase 1 of the US-China trade deal has been signed and tensions in the Middle East are relatively more subdued. Despite that, the price of oil has cracked in the last two months as is evident from the chart above. Here is what is driving oil prices lower.
 
Chinese Coronavirus makes a dent on oil demand
 
While the US remains the key swing producer, it is China that has emerged as the major swing consumer for oil in the last 10 years. Some of the numbers are staggering and that will put in perspective why the Coronavirus outbreak matters so much to oil prices. Just 3 weeks into the Coronavirus outbreak, Chinese oil demand is down by nearly 20% due to falling demand for air transport and road transport. The outbreak is also impacting manufacturing output in China and that is also impacting oil demand and prices. All these cues matter because out of every 100 barrels of oil consumed across the world, 13 barrels are consumed by China. In short, China alone accounts for 13% of global oil demand and that goes to underline what a 20% fall in Chinese oil demand can do to prices.
 
US supply expected to increase by end of the year
 
One of the key factors depressing oil prices in the last couple of months is that the US could become a major oil exporter by the last quarter of 2020. US producers realize that oil bankruptcies will increase and there will be greater consolidation of the shale oil business in the US. US shale oil producers need close to $45/bbl to break even so they need to sell as much as possible when the going is good. Their strategy has to be the exact opposite of what the OPEC countries are following. Since 2015, there have been 208 oil bankruptcies in the US and there have been more than 60 in the last on year alone. These bankruptcies entail a total outstanding debt of $122 billion. It is now estimated that US oil output will get closer to 20 million bpd by the last quarter of 2020 and the glut could exert tremendous pressure on crude oil prices. That has also exerted downward pressure on crude oil prices in the last two months.
 
Finally, OPEC + Russia finds itself in no-man’s land
 
For a better part of 2017 and 2018, the informal combination of OPEC and Russia managed to hold oil prices at a firm level. In the last one year, they have been less instrumental in exerting influence on prices. OPEC and Russia are now realizing that when a 1 million bpd production cut in Libya (due to political unrest) has not pushed up oil prices, any supply cuts at this point will hardly deliver the goods. Also, OPEC and Russia realize that the US as the swing producer and China as the swing consumer will have the say in marginal pricing of oil. Hence, any serious supply cuts from OPEC look unlikely, which is also pushing down prices.
 
That must be good news for India, for sure
 
If the US supply overhang exists, Indian policy makers can heave a sigh of relief. India still relies on imported oil for ~85% of its daily oil needs. Therefore, oil prices impact the trade deficit, current account deficit, rupee / dollar equation and the domestic inflation. At a time when India needs to expand GDP growth with limitations on public spending, weak oil prices could be a blessing in disguise. That could be the good news for India Inc in the midst of, otherwise, troubled times. 

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