The
COVID-19 pandemic has left businesses and markets across the world in a
shattered state. However, the first wounds of the coronavirus outbreak were
felt by the oil economies of the world as the major oil producers were
grappling to find a sustainable solution to the diving oil demand. This post I try
to navigate the oil economy through its history to the current situation, highlighting
the concerns and the potential solutions
Oil
price is known to be an important metric governing the economic and financial
health of the countries and corporations. Fluctuations in the oil prices are
hugely influenced by the supply & demand dynamics and speculations in the
financial market. Throughout the early 1900s, oil has proved to be an important
resource to suffice the increasing demand for power and automotive industries.
Its presence can, however, be traced back to 600 BC when oil was first noticed by
Chinese as a valuable fluid seeping out of the ground. Back then, Chinese used to transport the oil
with the help of bamboos. With newer technologies entering the landscape,
drilling techniques caught momentum as wells as deep as 800 feet were dug to
extract oil. The first such oil well was dug by Colonel Edward Drake in
Pennsylvania in the year 1859. Two years later, Spindletop, Texas had its first
oil field in the state which previously depended on farming, lumber and cattle
ranching to fuel its economy. These discoveries invited a rapid revolution in
the corporate world as companies started to look at oil as a potential form of business.
Vital additions to technological breakthroughs led to oil emerging as a major
energy source with Standard Oil controlling 90% of the refining capacity of the
United States in 1904. These were eventually succeeded by Exxon Mobil, Shell
and BP.
These
oil majors made numerous discoveries of oil reserves in the Middle Eastern
countries: Kuwait, Libya and Saudi Arabia. After demand for oil gained steam,
companies realized that controlling strategic oil reserves is the route to
gaining dominance over the world. With this, seven companies formed a cartel in
order to collectively take constructive decisions regarding oil and thus the
alliance named Seven Sisters came into existence. By end of 1960s, Seven
Sisters controlled 85% of the global oil reserves. The leadership in Middle
East observed Western influence in the region as an act of aggression and began
asserting their authority over oil reserves. Post renegotiation of business terms
with the Seven Sisters, an alliance named OPEC was formed to enhance
policy-making regarding oil reserves and provide financial aid to set the stage
for the member countries. The year 1970 saw huge energy crisis with countries
like US, Canada, Europe, Australia and New Zealand faced petroleum shortages
and elevated prices. This warranted a restructuring activity to the oil markets
and the first energy derivative trading emerged as an investment alternative on
the trading platform.
Cut
to the present scenario, oil markets in 2020 have faced a serious damage due to
the coronavirus outbreak. On Thursday 30th April 2020, West Texas
Intermediate (WTI) fell to USD 17.20 per barrel and Brent Crude fell to USD
24.30 per barrel. At the commencement of the year, both these prices were
around USD 60 per barrel figure. The rapid collapse in the prices is attributed
to lowering oil demand coupled with an increased inventory. Russia and Saudi Arabia,
two leading behemoths in oil industry, had locked horns in a price war in March.
Furthermore, Saudi Arabia engineered a collapse in their prices when Russia
rejected its proposal to slash production output in order to bring a balance to
the plunging oil prices. With manufacturing operations across the world at a
standstill, the oil demand is not expected to pick up anytime sooner. Reacting
to Thursday’s numbers, traders dumped their June contracts for oil futures
sighting a bleak future ahead. On the inventory front, the global conventional oil
storage having combined capacity of 3.4 billion barrels will be exhausted by
May end. Besides, the major delivery point in Cushing, Oklahoma in United
States has filled up to 2/3rd of its capacity amounting to ~59.7
million barrels. The United States’ Strategic Petroleum Reserves along the Gulf
coast also has filled up to 89% of its capacity (613.5 million barrels of oil
in 713 million barrel reserve). With empty
storage spaces heading towards exhaustion, major oil producers are looking at
other alternatives like supergiant tankers, rail freight carriages and salt
cavern to store their oil barrels. They
have even considered the option of buying ships in order to fulfil their
storage capacity. With a dark and bumpy road ahead, oil producers have reached
an agreement to slash the production output by up to 9.7 million barrels per
day in May and June.
The energy markets showed its excitement to the piece of
news with WTI and Brent posting a weekly gain on Friday closing. With
no certainty to when the pandemic will see it closure, it is apparent that the
oil markets will continue to observe volatility. However, there is light at the
end of tunnel as low prices will help rebalance the markets when stronger
demand ushers in after global operations resume.
* The opinions expressed in the article are personal and do not represent the opinions of the organization I work for *
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