Do you know about the time when the oil industry faced a huge setback? The time when the oil prices made history? When the oil prices went negative for the first time on record? Why did it happen? What was its effect on India? Did it scar the global oil industry forever? Let’s find out!
The COVID-19 pandemic had a huge impact on the overall health of the world economy and it didn’t spare the oil industry as well. The impact of the pandemic hammered the oil industry in 2020, forcing the oil prices to show a drop of 150% and go negative for the first time on record. The price of oil was above $60 per barrel at the start of the year. But when lockdowns were imposed in the entire world due to COVID-19, the oil demand went to an all-time low and by mid-April 2020, the prices had dropped to a negative $38 per barrel.
Factors leading to this drop in Prices
It’s the basic law of demand, in economics, which states that whenever the demand for something increases or its supply falls, its price will go up. And when the demand falls and supply increases, then its price will go down. This can be true for nearly everything and quite the same happened with the oil prices.
The factors that contributed to the drop in price:
- Effects of the pandemic: The COVID-19 pandemic was the major factor leading to this price drop as it was the pandemic that triggered the unprecedented demand shock in the oil industry. The governments around the world shuttered businesses, issued stay-at-home directives, and restricted travel. The aviation and transport industry halted; the demand fell and the supply had become more regulated due to significant disruptions, the oil price dropped rapidly.
- The Russia-Saudi Arabia war: US, Russia and Saudi Arabia are among the top oil producers in the world. On 8 March 2020, after the coronavirus had spread across a large part of the world and the oil demand had already started falling, Saudi Arabia initiated a price war on oil with Russia, facilitating a 65% quarterly fall in the price of oil. This price war was triggered by a break-up in the dialogue between the Organization of the Petroleum Exporting Countries (OPEC) and Russia over proposed oil-production cuts amid the COVID-19 pandemic. Russia had walked out of the agreement, leading to the fall of the OPEC+ alliance. Oil prices had already fallen 30% since the start of the year due to the drop in demand and this price war further worsened the demand situation which reduced the oil prices even more.
- Production couldn’t be stopped: Oil production can be slowed down, but it cannot be stopped completely, as the costs for shutting down the oil wells temporarily are very high and the producers might be required to invest even more money to get it started again. So most producers decided not to shut down, and instead keep their businesses running at a loss. At that time, even the lowest possible production level resulted in a greater supply than demand. The producers were not able to incur the storage costs and so they were forced to pay the consumers for buying oil from them.
The Result on the Oil Prices:
After the huge price war, in early April 2020, Saudi Arabia and Russia agreed to oil production cuts. But the oil prices crashed to such an extent that the prices went below zero on April 20, for the first time. The price went from $18 a barrel to -$38 in a matter of hours. Of all the prodigious swings in the financial markets since the Covid-19 pandemic broke out, none had been more jaw-dropping than the oil price going into the negative domain.
Effect On India
India’s Crude Oil Basket (COB) reached $19.90 per barrel in April 2020, the lowest since February 2002. For the fiscal year 2020-21, the average annual price of India’s COB was $42.72 per barrel. This is 30% less than the average COB price in 2019-20 and the lowest since 2004-05.
Many countries which imported oil gained from the negative pricing but the Indian consumers did not. This happened because instead of letting the Indian consumers enjoy the benefit from the negative price, the government of India enjoyed a gain in taxes. The pandemic’s economic disruption had led to a sharp fall in the tax collections of the government from regular sources and to make up for this loss, the government did not pass on the benefits of cheap crude to customers and increased the taxes on petrol and diesel sharply.
The data provided by The Petroleum Ministry shows that the tax component of both petrol and diesel prices increased significantly in 2020-21. Government taxes accounted for ₹37.8 and ₹28 per litre in petrol and diesel prices, respectively, on April 1, 2020. And this increased to ₹85.19 and ₹77.44 by the end of the year, respectively. As a result of this, the Union excise duties collection (the bulk of which are from taxes on petrol and diesel) for 2020-21, has increased by around 35% from its initial budget estimate.
Oil In 2021
After the huge drop in the prices in 2020, the price of oil increased sharply at the beginning of this year. The price of petrol in India was over 100 Rupees/litre whereas, in the neighboring countries, the price was much lower. For example, in Pakistan, it was 50 Rupees/litre. In Sri Lanka, it was 60 Rupees/litre and in Nepal, it was almost 70 rupees/litre. The condition was so bad in India that people in the parts of Bihar bordering Nepal were smuggling petrol. They were bringing petrol from Nepal to India because they were still saving a lot of money if they bought it there instead of buying it here in India.
According to reports, Brent crude oil price is $78.65 as of now and is expected to average around $62.26 per barrel for the year 2021. In India, the 2021-22 Budget has targeted a significantly higher level of Union excise duty collections than 2019-20, and the petroleum minister has declared, in the Rajya Sabha, that the government does not plan to reduce the duties on petrol and diesel. This means that any increase in crude prices will only increase the prices of petrol and diesel further, for the consumers in the country. Although, the government for its part, has blamed the continuing production cut by OPEC+ as the biggest reason for the rise in petroleum prices.
The Road Ahead
The last year was like no other for the oil prices. A global pandemic had such a huge effect on the industry that the prices slipped into the negative domain. It was a dreadful situation playing out in the oil market.
And to add to this misery, according to the reports, the pandemic is also expected to have a lasting impact on the consumption of oil as it is forecasted to remain well below its pre-pandemic trend for the next few years. This effect in the consumption of oil is expected because of the shift in people’s behavior. Air travel could see a permanent reduction as business travel is curtailed in favor of remote meetings, reducing the demand for jet fuel. A shift to working from home may reduce the demand for fuel which would have been required for the everyday travel to the offices, and many more such changes in the day to day lives. While the overall impact is difficult to quantify, the future oil demand in the world is in a huge cluster as well.
– Jhankar Agrawal
ECONOX 