Why are the oil prices going through extreme fluctuations?

Falling Global Oil Prices

As coronavirus is decimating the global economy, the oil and gas industry is reflecting a dramatic collapse in the prizes, plummeting to the drastic lows in the wake of the glaring gap between the global demand and supply.

The ongoing global pandemic has completely shaken the oil industry with the unprecedented changes in the prizes, owing to the halted businesses and travel bans due to the lockdowns. As per IEA, demand for oil in April was dropped by almost a third compared to the last year’s demand statistics.

Smaller industry players are heading to bankruptcy after being severely indebted due to many years of accumulated losses. For those who survive, there will be a sea change.

A backdrop of the unique and unprecedented scenario

Unlike the price of any other commodity, the crude oil price has been primarily been a function of geopolitics defined by the troika of the US, KSA & Russia for the last 47 years. Due to the coronavirus induced lockdowns, for the first time ever, supply is significantly higher than demand and countries have already notched up their strategic reserves to the maximum capacity.

To curb the falling prices, OPEC+ nations had reached a historic deal to reduce the supply to by 9.7 million barrels a day. Despite the production cuts, supply will exceed demand significantly even if the deal is implemented from May 1, 2020. Q2 demand could be lower by up to 30{4f8b3ed9fef9ea84dcab9ecab3909d1faac4098bcd4a30a2275db8b2fbfea39e}, while Q3 could see good recovery (estimated at 90{4f8b3ed9fef9ea84dcab9ecab3909d1faac4098bcd4a30a2275db8b2fbfea39e}), as per the EIA crude demand projections.

Long-term effects on the oil demands

Long term demand for crude oil will continue to dwindle due to the following factors:

•   Reduction in demand for gasoline due to a shift towards electric vehicles

A gradual transition to renewables which was already taking place in the transportation sector will accelerate, thereby having a significant impact on gasoline demand. Furthermore, the work from home culture will become more popular and will result in reduced gasoline demand and business travel.

•   Significant shift towards natural gas

LNG liquefaction plants, LNG regasification plants and gas pipelines, and consumption infrastructure has already been transpiring over the last few years and will see an increased jump in the near future

•   Probable reduction of demands for the Chinese goods due to the shift of manufacturing

The trend to reduce dependence on Chinese goods will result in a shift in energy demand to new manufacturing countries. New energy demand will be for environmentally friendly and efficient sources i.e. gas and renewables

Impacts of the recession on the crude oil demands

IMF has projected a 3{4f8b3ed9fef9ea84dcab9ecab3909d1faac4098bcd4a30a2275db8b2fbfea39e} drop in GDP for 2020 due to recession. This global recession has been described as the worst since the Great Depression.

•   Impact of COVID could be seen from a zero-based approach i.e. as if these 2-3 months are completely removed from the calendar year, we can predict the following statistics:

Q2 demand around 70 Mln BOPD – Price circa US$ 30 per barrel

Q3 demand around 90 Mln BOPD – Price circa US$ 40 per barrel

•  The oil demand is difficult to predict beyond Q3, but the price expected to remain between US$ 30 – US$ 40 / Bbl for the next couple of years at least.

• Most of the oil produced today costs below US$ 10 / barrel, hence low oil price results in reduced margins for most producers. Further, major determinants of the cost of production are fixed and cannot be controlled.

After the pandemic induced rampage will alleviate, companies will need different strategies of operations. Despite the disruptions and adversities, the oil will continue to empower human lives in various ways. In the succeeding posts, we’ll analyze impacts on the global oil and gas markets and strategies to cope with the ongoing disruptions.

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