Will the petrodollar collapse happen in 2020?

On the 20th of April of 2020, at around 2pm, something historic happened: WTI, short for West Texas Intermediate, crude oil futures traded at negative prices for the first time ever. From there, everything went downhill, and oil prices reached the impressive mark of negative $37.63 a barrel, which translates to a 300% crash. For perspective, this means that if you had bought the oil contract which traded at that price, you would have been paid $37,630, as the contract entailed the sale of a thousand barrels of crude. However, as expert Neil Irwin pointed out, “that is about five tanker trucks’ worth, so any joke about storing the oil in your basement will have to remain just that”.
The immediate reaction by many economics commentators to this bizarre event was to simply shrug it off as price adjustments to the collapsed demand for oil. Some also blamed it on lack of storage at the Cushing, Oklahoma delivery point. While this certainly isn’t false, it is a very simplistic way of looking at a complex market with many strong players. American and Saudi elites, in particular, have very significant stakes in oil production and market manipulation has become, over the years, a normal practice. In fact, meddling by powerful oil players is probably why most media outlets have not been very helpful in their reporting of the oil price crash. So, let’s take a serious look at what’s been happening in the oil market for the past few months, shall we?

West Texas Intermediate is one of the three most used benchmarks in oil pricing. Together with Brent crude and Dubai crude, it provides a reference price for buyers and sellers. WTI is also called Texas light sweet, because of its low density and low sulphur content. In fact, of the three benchmarks it is the least dense and contains the least sulphur. On the New York Mercantile Exchange, WTI is used as the underlying asset of most oil futures contracts, which gives it a very prominent position in the US domestic market. Its price settlement point – what most of us would call delivery point – is the now famous city of Cushing, Oklahoma. This small settlement of just under 8,000 inhabitants is home to the Cushing Oil Field, which dominated U.S. oil production during the first half of the twentieth century. Because of this, huge storage facilities and multiple in- and outbound pipelines were built there, to the point of the city being known as the “pipeline crossroads of the world”. As the Oil Field’s importance waned, the New York Mercantile Exchange took the opportunity to use the existing infrastructure as WTI’s delivery point, instead of building huge facilities from the ground up, which would have been a major and potentially risky investment.
Since the beginning of March, oil prices around the world have been under significant pressure, not from the current health situation, but from a price war between Russia and Saudi Arabia. As demand started contracting in the early stages of the outbreak in the West, the Saudi elites sought to artificially inflate oil prices through a reduction in worldwide output. To achieve this goal, Saudi Arabia tried to coordinate with fellow member states of the Organization of Petroleum Exporting Countries, also known as OPEC, and Russia. Now, Russia doesn’t belong to this organization, but they have been cooperating since September 2016, in an informal alliance dubbed “OPEC+”. However, when Saudi Arabia tried to push further production cuts in reaction to the pandemic, Russia walked out of the agreement. The Russians’ objective was to create a price war as retaliation for the Trump Administration’s newly imposed February 2020 sanctions. Much to their joy, the Saudi’s drew on their huge reserves and started pushing down oil prices. As a result, over the course of a few week, oil prices dropped significantly, with Brent oil crashing by 24% and U.S. oil falling by a whopping 34%. The stage was set for major instability in the oil market.

It was then that Western governments started issuing stay-at-home orders and imposed lockdowns, all but obliterating 40 to 50 percent of oil demand. As you know, it is a basic economic principle that prices are set by the equilibrium between supply and demand. Hence, if demand suddenly crashes, prices will crash too. Eventually, supply will adjust to the new conditions and a more favorable equilibrium price can be reached. Depending on the market, this adjustment can be almost instantaneous, or it can take a long time. Unfortunately, the conditions faced by oil producers mean that they can’t react quickly. Some people have suggested that, given the problem is severe oversupply, oil production should be simply shutdown, thus all but making oil a very limited commodity. Read the full transcript here: https://www.epiceconomist.com

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Epic Economist

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