Did Oil Just Get Cheaper Than Water?

Crude oil is a liquid fuel source that is found beneath the surface of the Earth, extracted by drilling and is used for the purposes of producing transportation fuels, petroleum products, and plastic. The reason why it has a major impact on the world economy is that the price of crude oil directly affects the price of the products that have been developed from crude oil. For instance, crude oil is responsible for 55% of the price of gasoline and oil and according to the United States Energy Information Administration (EIA), oil prices affect 96% of transportation. That would lead to higher food prices. It also impacts 43% of industrial products, 21% of residential and commercial use, and 3% of electric power. In conclusion, higher oil prices increase the cost of everything you buy, causing inflation.

The Organisation of Petroleum Exporting Countries (OPEC) consists of 14 member nations that account for 44% of global oil production which gives OPEC a major influence on global oil prices. The two most popular grades of crude oil are Brent North Sea Crude (Brent Crude) which is derived from the North Sea and West Texas Intermediate (WTI) which is derived from U.S oil fields. WTI has a relatively higher quality due to its low sulphur content and lightweight.

Today, the world saw crude oil prices fall below zero for the first time in history. A negative price indicates that the sellers were paying buyers to take deliveries in an attempt to avoid incurring storage costs. This was because of the drastic drop in oil demands due to the coronavirus outbreak as almost 90% of the world is under lockdown and there is virtually no demand for crude oil. This resulted in the price of WTI collapsing 300% from $17.85 to as low as -$37.63 for a barrel level in a day. The primary reason for this plunge is said to be the expiry of May WTI contracts, alongside the significant demand destruction due to lockdowns in several countries and supply glut in oil markets. It is said that the United States continued to produce a large amount of oil and refused to regulate oil production and impose mandatory cessations.

However, Brent oil was still trading at 25$ per barrel level as the OPEC and its allies implemented a record production cut by 9.7 million barrels per day at the beginning of May. Another reason for Brent oil to not receive a sharp fall was because WTI needs to be physically delivered at Cushing, Oklahoma while for Brent contract, deliveries can be done offshore at multiple locations.

Now the main question here is whether this historic price plunge of crude oil would be beneficial for the global economy or not. The answer to this question is very relative. Firstly, I do not consider this situation to be a natural one, but a trading activity in the market by vendors who were desperate to sell and buyers who were unable to take delivery. Although, it is expected that the prices will remain vulnerable until the lockdown ends. A considerable amount of profits would definitely be made by refining companies due to the increase in gross refining margins. However, Countries buying oil from OPEC members and their allies would not be saving a great amount of money owing to its meticulous efforts to stabilize the situation and minimise the losses.

Crude oil futures are agreements to buy or sell oil at a specific date in the future at a particular price. Businesses use them to fix the price of oil they need for the future. Traders never take possession, but simply sell the futures contract before the expiration date. Oil exchange-traded funds are easier to invest in ETFs than in oil futures. They follow the prices of oil futures. People or firms invest in crude oil through both of these mediums depending on their strength in terms of the amount of resources they possess. This could cause a significant amount of losses to them. Countries producing these oils will also be bear tremendous losses in this quarter, the greatest impact of which would be faced by the United States of America. Nevertheless, the entire world is experiencing a storage space scarcity which has affected almost every other sector. Saudi Arabia was able to survive the plunge with minimum damages by selling its oil when there was a demand and later introduced weighty production cuts.

Is the price drop (deflation) a good thing? No. An economy increases when its purchasing power increases i.e. a country/individual is able to spend more amount of money. A demand shock will have a humongous negative impact on the world economy. How can this be brought to a stop? The most effective measure that can be put into place is a deeper production cut.

However, as of today, we witness that oil is cheaper than mineral water.

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