A few weeks ago, a school teacher in the US state of Missouri was dreaming of becoming a billionaire overnight. Convinced by the market theory of ‘buy on dips’, the elementary school teacher placed an order for 10 million barrels of oil at the Western Texas Intermediate (WTI).
In theory, it was a great idea. At the beginning of 2020, crude was trading at nearly $60 per barrel at the WTI, the benchmark bourse for oil in America. So, when it fell below $10 per barrel, the teacher thought he could be the next Warren Buffett by buying low and selling when the price goes up.
Two nights ago (April 20), while the eastern world was sleeping, the teacher’s dream turned into a nightmare. Not only did the price crash to zero, he was forced to take delivery of the barrels he had purchased. Now, with no space to store these barrels, he is looking for someone to stash them away, for a price, of course, till he is able to find a buyer.
Nobody knows what he teaches at Missouri’s Sherwood Elementary School, but the hapless man would have learnt a big lesson from the trade: sometimes you have to actually pay the buyer to purchase your stuff, and the price of a commodity can actually turn negative.
Many Indians may be aware of this concept. We have often heard stories of farmers dumping their produce — mostly onions — on the road after their price turned negative and the cost of transporting the stock or storing it became prohibitive. But this lesson did not help some Indian traders who, like the Missouri teacher, bought crude on the WTI and found its price turning negative. Last heard, their combined loss was estimated to be in excess of ₹500 crore.
But the real oil story isn’t about Missouri farmers and Indian traders. There are much bigger players involved. At stake are several trillions of world currencies — dollar, rouble, riyal — and the destiny of many countries.
To understand the oil game, bear a few things in mind.
One, oil is called black gold by traders who think it is the most precious liquid commodity in the world. But unlike the yellow metal, the black gold is a sine qua non for survival of every country. And since no country can live without it, oil prices make and break trade account deficits (the difference between money paid for imports and earned from exports), and thus, the balance sheets, of every country, including India. Basically, countries that import oil struggle to keep their trade accounts in the profit zone and those who export it start with a surplus. But this advantage is premised on one thing — higher oil prices.
Two, there are three main players in the oil game: the Vienna-based OPEC comprising the Gulf countries and Venezuela et al; the so-called western bloc led by the US; and the former Soviet countries like Russia. In the before-COVID age, the new BC of our era, oil prices helped the OPEC countries. When prices shot up, they ramped up production and gained from the rally. When the prices went down, their competitors suffered more because of the high costs of production.
Till a few years ago, the US relied heavily on oil imports. But since 2010, it started relying heavily on its own oil produced from shale — different from naturally occurring crude — and even became a big exporter. According to industry estimates, from 2005 to 2015, the US petroleum imports fell from 60% to 25% of the total consumption while exports increased by over 300%. Since 2015, imports have remained fairly steady at approximately 10 million barrels per day, but exports have continued to increase, from 4.7 million barrels per day in 2015 to 7.6 million barrels daily in early-mid-2018.
But the problem with the US shale oil industry is its high cost. A barrel of shale oil costs between $35 and $70 depending on the site of extraction and production. In contrast, the Saudi oil wells churn out a barrel of crude for around $10. So, as a rule of thumb, if prices fall, the US industry gets shellacked more than the crude sellers in other countries, especially in Asia.
In February, the fall in demand for oil because of the worldwide lockdown triggered by the new coronavirus threat should have ideally been countered by a cut in production. But Saudi Arabia and Russia continued to pump crude into the market, bringing its price down to a level where the business became unviable for the US shale industry. Other oil producing countries were, of course, hit by the fall, but the US shale industry got literally destroyed because of two reasons — the high production cost and a steep fall in domestic demand. In addition, its storage capacity got exhausted — since nobody had imagined a scenario where oil consumption would be just around 30% of production — making the prices turn negative (the seller had to actually pay for storage.)
All this might appear to be a logical outcome of a black swan event — a worldwide shutdown because of a health emergency. But many analysts believe this is classical game theory in action where every player is taking steps to guard their own interests — retaining market share and profits, even when a collective strategy — keeping production down — could help everyone.
Conspiracy theorists believe that Russia and OPEC both believe they can bring their rivals to their knees by destroying their oil industry. And their initial decision to ramp up production may have been a calculated ploy to hit the US.
According to the Financial Times, the sell-off will bring Moscow and Riyadh long-term benefits. “With their low costs and vast financial reserves, the two can withstand a loss of oil revenues better than most producers,” the newspaper argues. The endgame could be the taming of the US, its accession to the OPEC and financial ruin of the other major oil player, the sanctions-hit Iran.
The timing of the sell-off is ominous for the US. It is already pumping in a lot of money to save its economy from a corona-induced meltdown. Analysts believe its budgetary deficit is now almost 15% of the GDP because of the money it has spent on corona packages. In this milieu, the oil sell-off and potential demise of the shale companies is a big threat to the US. In the post-corona world, the US may find its stature diminished in geopolitics.
PS: Many readers would be wondering why petrol prices have not been cut in India even when a barrel of crude is worth nothing these days. This is because India buys crude oil mainly from the Gulf countries, where the prices — benchmarked against the Brent index — are still fluctuating between 15 and 30 dollars per barrel. Also, in spite of the sell-off, Indian oil companies have not passed on the benefits to consumers. To keep them at the pre-corona level, the government has also increased the VAT on petroleum products.
Maybe, some intrepid Indians can cut a deal directly with the Missouri teacher, who has so much oil in his stock that he’d be willing to pay a fortune to anybody willing to buy it.