Negative crude Oil Price

25 April 2020

Crude oil price getting into the negative territory is hard to conceive but happened yesterday as the May contract due to be settled ended negative even as June contract retained its $ 20 plus level. The June contract expires on May 19 and is a better representation of the true oil market. Hence, this will get corrected, but the falling crude oil price is symptomatic of a deep malaise that has been brought out by the IMF i.e. recession. With overall growth expected to be negative demand for everything will be low if not drop which includes crude.

The immediate problem of negative prices is quite simple. There is production taking place and even though demand is 30% lower than normal there is no place to store oil. The land based storage is full and while sea based containers are in demand where the cost is higher, everyone knows that the situation will not improve. The futures contract to expire had holders sell off in a big way as no one wants to take delivery due to shortage of storage. Once settled deliveries have to take place in May which is not what buyers of the contracts want given this problem of storage. This has pushed prices into the negative zone.

The issue is that no one expects crude to recover given the circumstances:

1.Shutdown means demand for petrol and diesel is virtually declining progressively towards near zero.

2.Continuation of lockdown means that the other major consumer i.e. airlines will not be in the air meaning thereby demand will be very low if not nil for the next few months.

It may be recollected that Russia and Saudi Arabia had earlier flooded the market with oil causing prices to crash and also impacted storage capacities. Now with this new problem, the oil industry is in for tough times especially the shale option which is even more expensive to produce. This has also impacted the stock indices afresh and just when it looked like that the market had absorbed the covid impact, the oil shock has set in.

Low crude price is something India must leverage and accumulate stocks to the extent possible which will help to lower the trade imbalance and improve CAD. This should provide support on the fundamentals side for our currency. It should soothe inflation too – both WPI and CPI which will be useful as food prices will be sticky in the upward direction. This will not be good news for the disinvestment plan of ours’ as BPCL was to be one of the big tickets. This may have to wait till the prospects of the industry improve. Low crude oil prices is also a worry for the government as tax revenue will get affected at the state level (where it is ad valorem) and centre (lower consumption). Therefore, in short a mixed bag for Indian economy.