The price of West Texas Intermediate (WTI) in dated contracts fell below zero earlier this week, sending shockwaves across the world. Though prices for American light crude stabilised on positive territory the next day, they were still as low as a couple of dollars a barrel for May contracts.
Contracts for June were at around $20 a barrel, but speculative trading is continuing on WTI on May contracts, with dealers trying to clear their books due of stockpiles.
The fall in prices is not only due to a lack of storage capacity, though it is true that most consumers now have no spare capacity for stockpiling. Other factors are in play to this historic fall in American oil prices.
The market is awash with oil. Production cuts of 9.7 million barrels a day agreed by OPEC+ will only begin to make an impact next month. Meanwhile, nervousness in the energy markets has led to speculative trading, with some hedge funds benefiting from the price drops, and hopes of a quick pick up in the global economy after the coronavirus pandemic is over are rapidly diminishing.
The example of China, which is restarting its economy gradually, is not encouraging: estimates suggest that lifting lockdown restrictions on the major economies will at best lead to 50 per cent of pre-lockdown activity in the short term. Global energy demand will need many months to pick up once the crisis is over.
Saudi Arabia and Russia may have agreed major cuts in oil production given the glut in the market but the US, not wanting to lose market share, did not commit to cuts despite the fact that a major part of excess supply in the global oil market is due to increased American output. US shale oil has added four to five million barrels a day to the markets.
The markets were volatile even before the COVID-19 crisis, and will probably continue to be so until there is a clear idea of the economic fallout of the pandemic worldwide. Arguments about a quick recovery once the lockdowns are lifted, the so-called V-shaped recovery, or a slightly longer U-shaped curve, look increasingly shaky. The energy market is one of the main sectors impacted by recovery prospects, and oil prices look set to be sluggish for some time to come.
The shale oil industry in the US might be the most affected by a prolonged oil-price slump, but this does not mean other producers are immune. The Gulf region, where almost a third of global oil is produced, will also be affected. Benchmark Brent crude prices are still around $20 a barrel, half the price many producers need to break even, and countries that rely heavily on energy exports will inevitably be hit.
Many Gulf countries have adjusted their budgets to factor in low oil prices, drawing on currency reserves built up over the years to finance large deficits. But lower oil prices still represent a daunting challenge for many Gulf states. Though speculative trading cannot be ruled out, most Gulf producers have long-term commitments with Asian clients, and spot sales are not a major part of their trade. This might fend off some of the negative impacts of the current crisis, but low prices in global markets will definitely hurt the Gulf producers.
A significant negative by-product of the oil-price slump is its impact on oil companies. US companies are braced for tens of thousands of layoffs, and are likely to face financial difficulties servicing their huge debts.
The picture in the Gulf is different in that most of the big oil companies are national companies with enough cash reserves to ease the burden of low revenues for a while. Many have undergone restructuring in recent years to make them more cost-effective.
As the global pandemic accelerates, painful decisions that countries have mulled over for a long time will need to be taken, and the combination of the pandemic and low oil prices might accelerate moves by Gulf states to reduce their reliance on oil.
*A version of this article appears in print in the 23 April, 2020 edition of Al-Ahram Weekly