US crude oil prices slumped into the negative after a free fall. The prices crashed by USD 55.9/ barrel and settled at a discounted rate of USD 37.63/barrel, a negative rate as confirmed by key U.S. oil benchmark, West Texas Intermediate (WTI). The brent settled at USD 25.57/barrel.
Why did the US WTI crash?
One simple reason offered is the lack of storage space in various facilities in the US. It needs to be clarified here that oil is a future contract and these rates are reflective of what will be sold in the month of May.
The June rates are still at around USD 20/ barrel.
Another reason why these the international crude oil prices have crashed is because of the deadly Coronavirus.
With over half of humanity in a state of lockdown, international borders shut and all air travel coming to a grinding halt, the demand for oil is at an all time low.
This is a situation where the supply outstrips the demand and hence the prices are at an all time low too.
This is the Theory of Demand at work.
Will the prices continue to crash and never recover?
Yes and no. As indicated before, oil is a commodity which is a future contract. It is sold in advance. For example, the demand for the month of May is estimated and sold in April. That is precisely what has happened in the present case as far as the US WTI is concerned.
The prices for the month of June is presently being traded at USD 20/ barrel.
As far as recovery is concerned, it all depends on the extended period of lockdown. The international crude oil prices have crashed by more than 2/3 since January of this year.
The leaders of OPEC have got together and decided to reduce the rate of production. All oil producing nations except Mexico have consented to this demand.
However, with access to ports and storage facilities available in many of the Middle-East nations, the prices will continue to be stable, though they will continue to remain subdued for the time being.
What does this mean for India?
Last month, Minister for Petroleum and Natural Gas, Dharmendra Pradhan, said that India is in the process of negotiating cheaper oil prices with certain oil producing nations who will be selling it to India. The rates are being negotiated.
A far as the Balance of Payment situation is concerned, India which is facing an export slump (according to an RBI announcement), will not be further overburdened by an increase in the import bill.
The depreciation of the Rupee has no connection whatsoever with the crude oil prices in this context. People are wanting to purchase a currency which is considered to be secure in the world.
India has established certain ‘strategic reserves’ in Vishakhapatnam (Andhra Pradesh), Paddur and Mangaluru (Karnataka). Plans are afoot to set up similar facilities in Odisha and Rajasthan.
These reserves will act as a reserve and prevent 1991 Gulf war type situations when India’s oil reserves completely ran out during the gulf war.
This presents an opportunity to store more oil which can act as a buffer in emergency like situations.
In recent times, the energy trade between India and the US has increased and this will present more opportunities for projects related to joint exploration and import-export.
What does this mean for the common man on the street?
To answer this question, we first need to understand the concept of upstream and downstream.
For example: India is procuring crude oil from say Iraq (upstream). This has to be brought to India (downstream) and this involves some transportation charges, insurance etc.
Once it is brought to India, the refineries in different parts of the country, refine the oil from where the distributors sell it to the sellers. It is from here that the consumer gets to use it.
Petrol and Petroleum products are out of the ambit of GST. Hence, different states have different tax rates and different aviation turbine fuel rates. The government also subsidises the end consumer.
Hence, the rates are different for each state.
Whether the rates will fall and benefit the common man is a question that the state governments will have to determine. Nothing can be speculated at this stage.