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Why Oil Prices have crashed?

Posted on 07-Feb-2020 Comments  0

Oil Prices

Why oil prices crashed by 20% in the last 2 months?

Most people did not realize that the price of crude oil had touched a yearly low at $54/bbl and had fallen nearly 20% in a span of just 2 months. Here is why the oil prices cracked.

Chinese pandemic fears

The Chinese Coronavirus fears may have abated but the quantum of hit has been huge. For example, it has already left nearly 700 persons dead and close to 1 lakh affected by the virus. Even the WHO has declared it a pandemic and that has resulted in international airlines cancelling flights to China and also other nations putting trade and commerce embargoes on China. Even Chinese production has been badly impacted in the Wuhan region and beyond and these regions will take a long time to come back to normal. Till then, the overhang on oil demand will continue.

China is a swing consumer

We normally hear of swing producers but in the last few years China has become the swing consumer of oil. In fact, China consumes 13 out every 100 barrels of oil consumed in the world. That shows how critical Chinese demand for oil is to global oil prices. It is estimated that Chinese demand has fallen by nearly 20% in the last two months since the Coronavirus pandemic first broke out. Factories have been shut and auto sales have plummeted leaving a structural problem for oil demand.

Risk of US oversupply

For the last five years, the upsurge in shale production has ensured that the US has become the swing producer of oil and is able to dictate terms better than the OPEC. US oil bankruptcies have been on the rise with over 208 bankruptcies in the last 5 years. US shale companies realize that they need to sell oil aggressively without impacting price too much. US shale cannot be sold below $45/bbl as it is unprofitable for them and cost of funding has gone up. That means; the US must sell oil aggressively to the world. The IEA now estimates that US shale output could cross 20 million bpd by the end of 2020 and that is also depressing oil prices.

Finally, OPEC is losing clout

The limitations of the OPEC as a price influencer became obvious when the crude prices continued to fall despite Libya’s daily output falling by 1 million bpd. Between 2017 and 2018, Russia had collaborated successfully with OPEC to keep oil prices at elevated levels. However, with the swing producer and the swing consumer veering towards lower oil prices, there is only so much that OPEC and Russia can do. That possible explains why Russia has been reluctant to commit itself to additional supply cuts beyond this level. OPEC and Russia cannot afford to look half baked in their efforts to swing prices. Their silence is pushing prices lower! 

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