Sector Analysis : Crude Oil

The OPEC led by Saudi Arabia has virtually controlled the price of oil since the 1970s. Russia and Kazakhstan(along with eight other countries) also jumped on the bandwagon to form the OPEC+.It is a cartel of major oil-producing nations acting in collusion to control oil production thus, oil prices across the globe. It started in 2014 Technological advancements like Fracking and in drilling led to the U.S. companies going deeper underground in the quest for oil. It reduced the U.S. demand for imported oil and turned the U.S. into a net exporter.At its peak, the Permian Basin region of Texas and New Mexico produced more crude oil than most OPEC nations. Saudi Arabia faced a dilemma. It could decrease its oilproduction and lose market share to the U.S. or increase oil production to drop the oil price. It chose the latter.

The rationale behind this decision was clear. Saudi wanted to maintain a monopoly over oil and hoped that low oil prices would discourage the companies using costly techniques of Fracking and, would drive them to bankruptcy. State-run ARAMCO could sustain such losses for a long time as could Russia, but the same could not be said for the U.S. shale companies.But some of the companies turned out to be more resilient than the OPEC had thought. The price of oil fell from $114 to $ 51 by January 2020. It was time for the Saudis to realize that this was not a game they could win and started cutting back oil production. By January 2020, OPEC+ had cut oil production by 2 million barrels per day(BPD), with Saudi Arabia making the most significant reductions in production. The result: The US is now the largest producer of oil in the world.

Covid’19 Aftermath

COVID 19 triggered a major global economic depression originating in China. Transportation demand and factory output fell, leading to a slump in the worldwide demand for oil. This led to the OPEC+ scheduling to meet in Vienna on March 5, 2020, to discuss the aftermath of the pandemic and its repercussions on the price of oil. It is important to note that 50% of Saudi Arabia’s economy is dependent on oil, and the figure is 30% for Russia. The slump in the price of oil would spell economic doom for them once again.

Saudi Arabia proposed a 1.5 million barrels per day cut in addition to the previous cuts of 2 million barrels per day. It was supposed to prop up the oil prices giving the OPEC+ the much-needed air to survive the pandemic. But surprisingly, Russia backed out of the deal. To understand why we will have to shift our focus from Vienna to Venezuela.
(The country with largest oil reserve)

The U.S. sanctioned a unit of Russia’s largest oil producer, Rosneft PJSC, for maintaining ties with Venezuela’s Nicolas Maduro and state-run oil company PDVSA(Petróleos de Venezuela, S.A). The move represents the latest escalation in the Trump administration’s campaign to oust the “supposed dictator” Maduro and rally international support
behind Venezuelan opposition leader Juan Guaido. The U.S. harmed Russia’s foreign interests as well as its economy by blacklisting Resnoft, and Russia intended to do the same.

As mentioned earlier in the article that the US is the world’s largest producer of oil, and thus thefall in the prices would affect the U.S. companies too. Cutting back production would be similar to throwing in a lifeline for the struggling U.S. shale oil companies, something Russia is not very keen on doing. Hence the fallout between Russia and OPEC.

Riyadh responded by raising production and offering its crude at steep discounts. It is said to be an attempt to punish Russia for abandoning the OPEC+ alliance. Saudi Arabia may also have wished to cement its position as the world’s top oil exporter by acquiring huge chunks of market share. Oil prices went tumbling, and the US, the global mediator it is, had to intervene. On April 2, President Trump pressured Riyadh to cut back its production and threatened to withdraw U.S. military support if the OPEC+ did not comply.

Let us tell you upfront. Oil futures crashed to -37$ a barrel for the WTI for May delivery only. As explained earlier, oil production was at an all-time high due to the fallout between the Russians and the Saudi. People who had oil futures for May delivery intended to sell their forward contract to other refineries or producers in anticipation that the market price would have risen from the time they bought the contract.

But now ever since the virus struck, producers and refineries alike have refused to buy any oil due to the slump in demand and economic activities. Thus the contract holders faced a peculiar problem of storing the physical oil upon its delivery.

As mentioned in the table below Brent Crude Oil has ample offshore storage facilities but the WTI oil being drilled in landlocked areas cannot boast of the same. The largest storage facility in Cushing, Oklahoma too started running out of storage thus exacerbating the storage crisis. Hence the contract holders were desperate to get rid of the oil and were willing to “pay” money to get it off their hands. This led to the oil
futures for WTI falling to -$37 per barrel in April 2020.

— Avichal Agrawal (Co-founder editor)