Why oil will no longer be expensive (ENG video)

Oil now costs what it did back in the 1990s – $20 a barrel. High prices for hydrocarbons have allowed the Russian, Azerbaijani and Kazakh economies to grow rapidly in the last twenty years. Will they survive this period of the cheapest oil ever? How long will it last? Why is black gold no longer gold?

April 20 went down in New York Stock Exchange history. That was when 325,000 barrels of American oil (roughly 600 rail-tanker cars) were sold at minus-37 dollars a barrel. In London that day, Russian Urals oil was going for just $12 a barrel, like during the 1999 crisis in Russia. To explain how the oil price fell like this, we must explain how it is fixed.

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How is the oil price fixed?

Let’s say you are an oil-company director. You agree to deliver 100 barrels of oil to a refinery in six months. The plant agrees to pay you exactly $3,000 in six months’ time. This is known as a futures contract. Thanks to futures, you can plan your income for the months ahead, and insure yourself against falling prices, while the refinery can plan its expenses. Futures dominate the oil exchange, but 97% of buyers are speculators, not refineries. They buy futures, hoping to resell them at a profit.

These hopes are what determine the oil price. At the first hint of a crisis, speculators’ hopes evaporate and prices drop sharply. OPEC tries to keep them high – this cartel of 13 oil-producing countries keeps stock exchanges calm by announcing cuts in oil production.

The 9/11 terrorist attacks, the American banking collapse of 2008, and reports of US oil production doubling in 2014 had already halved the oil price. But the world has never seen a threefold drop in such a short time.

Why have prices collapsed?

Oil prices have fallen because a third of the world’s population have stayed at home due to the lockdown caused by the COVID-19 pandemic. They dropped so fast that stock-market players panicked – and with good reason: petrol, diesel, and aviation kerosene account for 83% of all oil products, but people have stopped buying them. In April, the global demand for petrol almost halved, while demand for aviation fuel fell by 60%.

On January 21, Brent crude was at $64 a barrel. That day, the World Health Organization called the COVID pandemic an international emergency. By March 5, the oil price had fallen to $54. That day, the oil market was hit again after the epidemic: Russia refused OPEC’s offer to cut production, and Saudi Arabia started a price war. By April 1, the price had collapsed to $14 a barrel.

That day, Moscow resumed its negotiations with OPEC, and a week later the oil price rose to $25. But on April 20, world prices plummeted to $9 a barrel. This time it was due to overflowing American oil-storage facilities. Rather than fret over where to store the oil, traders started selling off their May futures, and contracts for June deliveries froze at $20.

Who will be affected by cheap oil?

Oil is the main export commodity of post-Soviet countries such as Azerbaijan, Kazakhstan and Russia. Profits from sales make up between 6% and 18% of those countries’ GDP. That revenue will be lost if the price of Russian, Kazakh or Azerbaijani oil remains at $20 a barrel. At that price, average Russian oil wells are no longer profitable, while in Kazakhstan they will make losses, as production costs are one-and-a-half times higher there.

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Additionally, all three countries will face problems with state spending. Their budgets were drawn up based on projected oil prices being double or triple that amount. If oil fails to reach the expected price, Moscow, Nur-Sultan and Baku will face a choice: to cut spending, take loans, or tap into their reserves.

Moscow has accumulated the most impressive international reserves. Russians have $3,883 per capita, while Azerbaijanis have just $606. Yet Moscow will find it harder to ask for loans, as it is subject to international sanctions.

With the Russian oil price at $20, the National Wealth Fund will be enough for five years, pledged Russian finance minister Anton Siluanov. If Urals oil rises to $30, the funds will last for six years. But at a price of $15, those funds will run dry in just two years, Deutsche Bank economists estimate.

When will oil prices rise again?

Transportation, along with demand for fuel, will start to recover in May and June as Western countries ease the lockdown. The price of oil will not stay at $15–20 for long. The US Energy Information Administration and the International Monetary Fund expect Brent to cost $35 a barrel, which will rise to $45 in a year, and $64 in five years’ time. But no one believes that prices will return to the $100 level of the noughties and early 2010s. What will prevent oil from becoming expensive and oil powers getting rich again?

Firstly – competition. The US and Canadian shale-oil industry has been developing, which caused prices to collapse by half in 2014. Shale-oil production becomes profitable if the price is above $25 a barrel.

Secondly – the global drop in demand. China’s growth is slower than it was. The lockdown has proven that many business trips are simply unnecessary. Matters can be solved via videoconferencing, and people can work from home. Finally, even cheap oil has not forced the European Commission to abandon its plans to cut greenhouse-gas emissions and develop “green” energy and electric transport.

What is the result?

The COVID-19 pandemic and global lockdown have erased demand for petrol and aviation fuel, causing a panic on the oil market. Prices are at an unprecedented low and, unless they rise, Kazakhstan and Azerbaijan face an economic recession and budget cuts. Russia is still protected by its impressive reserves.

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The oil price will return to pre-crisis levels in a couple of years, although it is unlikely to be as high as in the early 2000s. Developing shale deposits, reduced transportation, and developments in electric transport will lead to a glut of oil on the market. As the former Saudi Arabian energy minister Ahmed Zaki Yamani warned: “The Stone Age didn’t end because we ran out of stones”.

The explainer was part of Belsat TV news show That Way/Vot Tak on 6 May 2020.

Alyaksandr Papko

Photos for collage: kremlin.ru; mnpz.by