To understand how the price of oil is defined, we have to remember that it is a raw material whose price is defined by the international market in dollars, and it depends mainly on the production and consumption of oil around the world.
Despite hitting its critical point last month, oil prices have been falling since the beginning of the year, mostly because of the current health crisis made many people reclusive at their homes, reducing fuel consumption, consequently, filling up reserves to their heads, and the oil demand for production of fuel has crashed. Under the law of supply and demand, the barrel of oil had lost its value. Earlier this year, a barrel of Brent oil (a benchmark for international prices) was worth about $ 66. In mid-February, it dropped to $ 53.
Aware of the recent devaluation of oil, OPEC (Organization of Petroleum Exporting Countries) has started to consider cuts in oil production. The idea was that, with less oil on the market, the price would go back up again. Negotiations seemed to advance at first, but they didn’t end up well. Russia – which isn’t a country of OPEC – refused to support the cuts, and the organization responded by raising the bar for its own production limits.
After the agreement attempt’s fiasco, Saudi Arabia, the leader of OPEC and the largest oil exporter in the world, decided then to lower the prices of raw materials and increase its production in April. As a result, the OPEC summit managed to determine the marginal price of oil no longer by supply or cuts, but rather by demand, or by a lack in oil production.
With that said, it’s noticeable that the country is trying to take advantage of this price crisis to gain its market share. The outcome of this trade dispute between the Saudis and the Russians caused oil prices to plummet since last week, with prices dropping by 30%, the biggest downturn since the Gulf War in 1991.
As Bloomberg had affirmed: “with negative oil prices, ships dawdling at sea with unwanted cargoes, and traders getting creative about where to stash oil”, the next chapter in the oil crisis is now inevitable: “great swathes of the petroleum industry are about to start shutting down.”
To summarize, the entire oil production industry is shutting down, not by option, but by the lack of option. According to Goldman, it is expected for the next three weeks a collapse in oil storage, as he says that “there will be literally no place left on earth to store oil, and unless oil producers want to pay “buyers” to hold the oil, as it has happened on the historic April 20, leaving no other choice but to shut in output.”
Head of commodity trading giant Gunvor Group, Torbjorn Tornqvist, had expressly said that “we are moving into the end-game. Early-to-mid May could be the peak. We are weeks, not months, away from it.”
Even though there was a catastrophic price plunge a week ago, when West Texas Intermediate fell to $ 40 a barrel, the US shale patch is still leading. To catch a glimpse of how the shale industry is reacting we have to observe the sudden collapse in the number of oil rigs in operation.
Before the present-day outburst had started, oil companies ran about 650 rigs in the US. Since then, more than 40% of them had stopped working, with only 378 left, setting a four-year low last week.
Meanwhile, between the delay on total US oil production and the rig count, a perfect scenario is put together for the US production to collapse next. The co-head of oil trading at commodity merchant Trafigura, already advised that this was “the smack in the face the market needed to realize this is serious”, meaning that the output in Texas, New Mexico, North Dakota and other states will now tumble much faster than it was thought, as companies have already started to react to the negative oil prices.
Despite the search for other options, oil remains one of the main drives of global economic activity. When global economic activity collapses, it’s only natural that the huge oil production chain also collapses. In a recent update of its projections, the OECD (Organization for Economic Cooperation and Development) started to forecast a 1.5% drop in world GDP in 2020 and a 15% contraction on direct investments around the world. This current and exaggerated swing of oil prices is, above all else, a sure indicator of the critical situation of the economy in all corners of the planet.