Unprecedented global oil market turmoil and Pakistan

Global lockdowns have resulted in a drastic reduction in oil demand. A long and painful deliberative process to cut the global supply of oil by OPEC+ group of major oil exporting countries, each vying for greater oil revenues and lesser proportion of cutting down supplies, could only manage to reach consensus on cutting around 9.7 million barrels a day of oil supplies. By the last week of March, however, the consumption of crude had dropped by between 15 million and 20 million barrels a day from the normal level of 100 million barrels a day.

Hence, a lack of needed response in oil supply cuts resulted this week first for the WTI (West Texas Intermediate) futures for May, which went into negative territory for the first time in history, selling at negative $40 a barrel, indicating the biggest intraday decline on Monday in WTI since 1982, according to Bloomberg – the last time there was a global oil crisis. For the same reasons, the Brent crude oil dropped to below $20 a barrel for the first time in 18 years.

According to Wall Street Journal, “US crude-oil futures for delivery in June rose 19% to $13.78 a barrel, extending a series of chaotic moves. The most heavily traded U.S. crude benchmark on Tuesday collapsed to a 21-year low, with supply overwhelming demand and storage in many parts of the world full. On Monday, a U.S. crude futures contract turned negative for the first time ever, effectively meaning sellers were paying buyers to take away oil due to a lack of storage. The contract that turned negative early in the week expired in positive territory on Tuesday. Brent crude futures, the global benchmark for oil markets, climbed 5.4% to $20.37 a barrel on Wednesday but also remained near a multi-decade low.”

There is just very little space to store oil, and that is the main reason behind the crash in both WTI and Brent. And the situation of some form of lockdown is likely to continue as even some of the optimistic scenarios about Covid-19 are indicating that it is still yet to peak, and that it may come again at least once during this winter, and a vaccine could at least take another 12-18 months. This means oil demand is going to show weak signs for many months.

Storage tanks and even floating storage for oil have almost reached full capacity. In fact, the build-up in oil storage has already increased a lot in the last three years. According to ‘Orbital Insight’, a company that according to Bloomberg “uses optical and radar satellite observations to estimate crude in floating roof tanks, which it estimates covers approximately 70% of total on-land storage,” pointed out that on April 19, 2020 crude that is placed in oil tanks had already surged to a three year unprecedented level of 3.2 billion barrels; when at the same time it stood at 3 billion barrels in 2019, and 2.9 billion barrels in 2018 and 2017 each.

This means that the current crash of prices will continue for at least some months. According to Amrita Sen, who works at Energy Aspects Ltd. as chief oil analyst, “We’ve been calling for $10 Brent for a while, and we’ve absolutely looked at single digit prices.” At the same time, it appears that even if OPEC+ group continues to cut supplies in a big way, which it has to anyways (drilling is already halting and wells are being shut in US, which is the biggest producer of oil) since storage is running out a lot faster than very weak expected demand build-up, at least in the short terms and probably which will weaken cyclically for some time on the back of probable Covid-19 rounds and with it lockdowns, supplies build-up will not allow prices to rise in any quick way in the coming months.

While this means revenue losses for oil-exporting countries, it brings a much needed air of ease in terms of oil-related balance of payments pressures for most of Asia – especially the developing countries here – except for Malaysia, which is the only net exporter of oil, while the rest are net importers of oil. For countries like Pakistan, where a significant portion of import bills is based on oil imports, and where there is a big hit on export earnings in the wake of the pandemic, the falling oil prices should allow it to manage its balance of payments in a better way in the coming months.

At the same time, Pakistan produces a significant amount of electricity based on furnace oil. Now falling oil prices and the same trend in the coming months overall should mean that electricity tariffs would actually fall in a significant way for both household and industrial consumers, which means benefit both in terms of safeguarding depleting household incomes, and in turn aggregate demand in the times of lockdowns. In other words, historically lower oil prices can help boost aggregate supply and inject much-needed competitiveness into our exports.

What the government should not do is try to keep the price of oil relatively high, and not transfer the pass-through of oil prices internationally to domestic consumers, mainly to earn revenues for the treasury. This may very well prove to be a wrong strategy, because power sector is stuck in an unprecedented circular debt crisis, and any revenues made by the government will in a significant way go towards keeping the power sector afloat through heavy bailout with no benefit to the end-users of electricity, and at the same time this will not help bring inflation down or help boost exports or foreign reserves already hurting from falling exports, a decline in remittances and a lukewarm debt moratorium response from the international community up till now.

Rather the cost of production of electricity should be allowed to go down on the back of much-reduced oil prices domestically, which will remain possible for many months, especially if a proper strategy is adopted to lock in better futures for Brent. In this regard, the related government authorities should think about engaging international insurance companies to obtain future Brent prices. A floor is kept on prices just above the single digit, and a floor of not more than $20 a barrel, at least in the short run. Our policymakers should think of ways of creating greater storage capacity to cash-in on this unprecedented fall in oil prices.

That the prices are showing declining signs going forward is a fact that has found its best expression from the following Bloomberg insight: “The Dated Brent benchmark, a global reference almost two-thirds of the world’s physical flows, plunged to $13.24 a barrel on Tuesday, the lowest since 1999, according to price reporting service S&P Global Platts. On Wednesday it was assessed at $14.21 a barrel, Platts said. With the price so low, key European and African crude streams including Urals and Bonny Light will now sell under $10, as they trade at a discount to the marker.”

(The writer holds PhD in Economics from the University of Barcelona; he previously worked at International Monetary Fund)

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