Brent Crude’s slide into the negative territory triggered a whirlpool of speculation, causing chaos amongst stock market players. As the economics of crude oil became the talk of the town, investors were unwilling to accept the physical delivery at the time of settlement which forced them to dump their contracts at all costs, resulting in the negative pricing.
In our Special Report this week, we have focused on how crude oil price gets impacted, the economics of production cost, the impact of crude oil price on gas price, impact on India’s economy, and sectors and stocks in focus due to crude oil.
Oil slides down the slippery slope U.S. oil’s slide into the negative territory triggered a flurry of speculation, sending market participants across the world into a tizzy. Economics of crude oil turned into the talk of the town as the world gauged the impact of a historic crash in WTI crude oil prices on the global economy. The unexpected turn of events unfolded after technical factors got triggered in the face of May futures’ expiry. Unwillingness among investors to accept physical delivery at the time of settlement forced them to dump their contracts at all costs, resulting in negative prices. It was the lack of inventory to store crude that investors embraced the idea of paying to get these front-month contracts off their hands. In the preceding three weeks, crude oil inventories at Cushing, Oklaho-ma had surged 40%, according to consensus, and were forecast to hit the peak of ~78mb by the end of May.
One pertinent question was, why were June futures priced at $20 a barrel when May WTI futures turned negative? This could be due to a couple of reasons:
1. Demand may recover by June as lockdowns are lifted across the world, and economic activity resumes.
2. Consensus expects that storage space to be freed up as existing inventory draws down.
Now, let us try to understand how crude oil price gets impacted, the economics of production cost, the impact of crude oil price on gas price, impact on India’s economy, and sectors and stocks in focus due to crude oil.
What drives crude oil prices?
Oil production: OPEC and Non-OPEC
Organization of the Petroleum Exporting Countries (OPEC) contributes ~40% of the world’s crude oil produc-tion. OPEC manages production in its member countries by setting production targets according to demand and supply. OPEC’s production decisions affect crude oil prices globally. Historically, there has been a signifi-cant increase in crude oil prices, with OPEC cutting production targets. Among OPEC, Saudi Arabia, being the leading producer, has a significant impact on changes in oil price
Non-OPEC’s Oil production
Oil production from countries outside the OPEC accounts for the other 60% of the world’s oil production. North America, regions of the former Soviet Union, and the North Sea are some of the leading producers. There is no central coordination among non-OPEC producers. The decision related to oil production is taken independently. There is one more major difference between OPEC and non-OPEC. In OPEC countries, oil production decisions are mostly taken by national oil companies, while investor-owned oil companies are the decision-makers in non-OPEC countries.
Economics of production cost:Generally, a conventional method of drilling oil is used by leading oil producers like Saudi and other middle eastern countries. For a conventional method, the set up needs a rig, drill stem, casing, the crew, and all the other pieces that go into a vertical well. The shale oil production in the U.S. and Canada is different. Instead of drilling just past the target deposit, the wells will take a 90-degree turn in the deposit and run alongside it horizontally. These types of well take more time to drill and more basic inputs like drill stem, increasing the overall cost of drilling.
Also, once a well is drilled and perforated, a lot of water, proppants, and chemicals are pumped down the hole to fracture the formation and allow the oil to flow back into the pipe. All of this adds to the cost of the well. That is the reason that shale oil wells may have a break-even of more than $40 a barrel, and it makes sense for these firms to suspend drilling when crude oil price dips significantly.
In conventional oil production, generally, a hole has been drilled straight down into a deposit. A pump is used to pull the deposit to the surface. The cost-per-barrel of conventional deposits is generally low. Consensus estimates that Saudi produces the cheapest oil (under $10 a barrel).
The other middle east countries have a production cost of around $20 a barrel. However, economies of countries like Saudi Arabia, UAE, Iran, Iraq, and Kuwait can face serious repercussions due to lower oil prices. The governments of these countries are more dependent on oil for spending and social programs.
The Historic Crude Crash | Impact on India’s economy