The COVID 19 pandemic has forced countries to impose lockdowns, travel restrictions, and halt ongoing immigration decisions and processes. Retail is closed, people whose citizenships are pending are waiting for the situation to get back to normal, and above all, there’s a steep decline in the demand for oil.
As demand continues to fall down, oil prices are expected to turn negative in some parts of the world. According to researchers at Goldman Sachs, it is also anticipated that in areas where preserving oil wells no longer seems profitable, producers could even be urged to pay to dispose of their oil as this would be better and less pricey than closing down wells.
Oil producers all over the world are trying to reduce the production as there is nowhere they can send their oil to. Also, the storage capacity is full and the overall oil demand has been wiped out due to lockdown and social distancing measures to fight with the spread of the COVID 19 outbreak.
According to analysts, “The ultimate magnitude of these shut-ins, which is still unknown, will be likely to permanently alter the energy industry and its geopolitics.”
This massive hit to the oil industry would eventually bring about an inflationary supply shock as a huge quantity of oil production will be enforced to shut down.
All in all, the oil industry has to confront three basic challenges.
- As international travel and trade has been restricted, the oil demand has also be reduced significantly
- The oil supply exceeds demand
- Last but not least, the storage spaces are already filled and the oil must be secured properly until demand resumes
These three challenges have pushed Brent crude to reach $23 a barrel which is the lowest recorded price since 2002. The massive reduction in prices has also forced producers to close down rigs as the overall cost of delivering a barrel to an oil refinery becomes greater than the cost of the barrel itself.
Now the question is why is the world flooded with oil at a time where there are travel restrictions and lockdowns? Back in March, informal collaboration between the world’s two leading oil producers failed. Yes, you guessed that right. Russia and Saudi Arabia had collaborated since 2017 to raise oil prices by reducing their share in an alliance. Due to this move, there was a noticeable shortage in the market and customers were forced to raise the price. But, this alliance collapsed when Russia refused to make additional cuts recently, engendering a battle in which both countries raised production in an attempt to get market dominance.
The disagreement between Saudi Arabia and Russia led to the massive drop down in oil prices. The problem is that the crisis began when the world is already battling a war against the spread of the deadly Coronavirus pandemic. The current quarantining and isolation measures are now impacting 92pc of international GDP. Analysts believe that the current situation is the biggest economic shock of our lifetimes and each one of us will be affected in one way or the other. Since oil is one of the biggest factors behind social interactions and international traveling, both of which are currently halted due to the pandemic the demand for oil continues to decline.
Oil giants including BP and Shell are also expected to lower down their prices by 20pc in 2020, although these plans are yet to be finalized and announced to the general public. This massive decline in the oil industry will also impact the job market in the UK. According to analysts, more than one million jobs will be lost in the current year. Also, an overall economic recovery around the globe is likely to slow down, and with the rate of unemployment highlighting the real consequences of the pandemic on the oil sector may not be noticed for some time.
As far as storage is concerned, it is expected that there will be no space to store oil in the coming days. Interestingly, there are only 1.6bn barrels of storage tendency available around the globe and it is projected that inventories will hit 1.8bn barrels by the end of June 2020, leaving oil producers with no other option other than reducing output.
So, is the only solution a return to the alliance between Saudi Arabia and Russia? Well, it depends. A balanced market today would need a coherent international production cut.
Also, the companies must look for better ways to store the surplus oil that could be used once the demand regains. While the COVID 19 outbreak is highly contagious and expected to harm the global economy in every possible way, it also provides opportunities to various sectors and a learning curve that will help countries plan and prepare for other upcoming challenges in the future.