Turmoil in the Oil Market, but how will it affect the consumer?

“Earlier this week, the international commodity markets were stunned by the collapse in the price of crude oil.  More particularly the benchmark price of oil measured by West Texas Intermediate (WTI) fell to -$40 per barrel.  Whilst the price of another benchmark, Brent crude, remained in positive territory, it has fallen to less than a third of the price-level recorded at the beginning of the year.  This decline has been seen in forecourt prices, which mean that leaded prices per litre currently are only a little over £1.  The result of negative prices for WTI means that the producers are actually paying customers to take the produced oil off their hands.  Of course, the customers are not going to make a profit necessarily because there is no market for this production and these buyers will have to meet the costs of storage.  WTI refers to crude oil produced in parts of the USA which are landlocked and hence higher transportation costs are incurred.  The storage facilities of the producers are full, and the purchasers will have to transport the oil to a shipping port or other storage facility until a market is found.  The same problem of over-production faces producers in other parts of the world, but the higher price of Brent crude, which is often produced off-shore, reflects easier storage facilities, such as use of super tankers.

This situation has emerged in the past two months because of over-supply of the commodity.  Supply rose in February as a result of a disagreement between Russia and Saudi Arabia.  The latter sought to reduce production to support the price which has been falling as a result of over-production.  In part, this has happened as American producers have expanded activity, but other oil exporters have played a role in increasing supply.  Russia is not part of the OPEC price-fixing cartel, but as a major player in the market, its decisions on production have a major impact on world prices.  The Saudis tried to discipline Russia by raising output in order to drive down the price and force Russia to negotiate.  Though an agreement was reached to implement the biggest agreed supply cuts ever, this came too late.  The demand for oil worldwide has collapsed in the wake of the coronavirus pandemic and the associated lockdown of much of the global economy.  America on its own is producing 2m barrels per day more than it needs.  Its refineries have more than they need and available storage cannot take the surplus.  Unless oil wells close, demand recovers, or new storage is found, the price of crude is going to remain volatile.

Are there winners and losers?  Certainly, the smaller oil producers such as Ecuador and Nigeria will be faced with falling oil revenues.  Producers such as Iraq depend on oil for virtually all export revenues and reconstruction of its war-shattered economy will be impeded.  The North Sea industry will suffer and a record number of oil rigs are already de-commissioned and lie idle in the Cromarty Firth.  There will be no benefits for the motorists.  While prices have fallen, this trend is unlikely to continue because most of the pump price is made up of taxes.  Indeed, some environmentalists might see the present situation as an opportunity to raise taxes to meet climate change goals.  The retailers are facing a significant decline in petroleum sales and they still have to meet their fixed costs.  They will be in no hurry to reduce the price further.

However, the events in the oil market this week might serve to remind us of the huge challenges that are facing the global economy.  The world economy is unlikely to return to ‘normality’ in the near future, and there must be doubt as to whether sectors, such as the airlines, are ever going to return to the situation that prevailed before coronavirus.  The fragility of the oil price serves to remind us of the great uncertainties that lie ahead.