Essay: 2020 Oil Price Crash

Crude oil holds particular importance in everyday life. As the world has progressed, almost all
operations taking place are now dependent on oil. Among commodities, oil commodities are
considered the most important ones with changes or fluctuations being correlated with other
movements. Oil prices have witnessed tremendous changes over the years, however, the change in
the year 2020 is now given paramount importance ( Albulescu, 2020). In Apr-20, the prices of crude
oil futures expiring In May-20, turned negative for the first time in history. A number of reasons
contributed to this situation such as reduced demand, excess supply, and running out of storage
capacities. Prices of other oil commodities were too significantly impacted raising several questions
on the sustainability of the price of this precious everyday commodity (McMinn, 2020).

The ability to harness energy sources and deploying

them towards a more productive use has always
Residential Commercial Electric Power
attracted considerable attention and played a critical 3% 2% 1%
role in worldwide economic development. Europe’s
industrial revolution was due to the use of coal power
steam engines for water and rail transport, facilitating Industrial
smelting of iron, and for powering looms and other 26%
Trans-
industrial equipment (Heinberg, 2003). The use of portation
68%
easily accessible oil has always helped to fuel continued
expansion in the 20th century. Airplanes, trucks, cars are
all powered by oil products, have revolutionized
transportation goods. Crude oil forms the basis for a Fig 1.1 Total Oil Usage in United States-2019 (Million
Barrels Per Day)
number of products including transportation fuels Total Fuel Consumption Per Day (In Million
such as jet fuel, diesel fuel, and gasoline. Barrels)
Transportation 13.9672 68%
Additionally, fuel oils are also used for electricity
Industrial 5.3404 26%
generation and heating. Residential 0.6162 3%
Commercial 0.4108 2%
Types: Electric Power 0.2054 1%
Total 20.54 100%
With regards to the types, West Texas (WTI) is
Table 1.1- Fuel Consumption in U.S in 2019
perceived to be of higher quality due to its lighter Source: https://www.eia.gov/energyexplained/oil-and-
petroleum-products/use-of-oil.php
weight and lower content of Sulphur. It is also regarded
as sweet, sweet crude oil. Such properties render it
ideal for the production of gasoline. For this reason, West Texas’ oil is considered a benchmark for
crude oil in the United States. 2 nd Class of type is the “Brent Oil” which comes from a combination
of crude oil comprising of more than ten types of different oil fields in the Northern Sea.
Comparatively, it is less sweet and less light than WTI but still considered a perfect alternative for
producing gasoline. It is refined in the areas of North-Western Europe and is considered as a
benchmark for regions of Europe and Africa. The third type is Shale Oil, which rests between layers
of shale rock which is broken up for allowing access to the layers of oil. Novel technologies are now
allowing this oil to be placed on the market at a competitive price which has played a critical role in
the overall drop in prices of oil (Energy Information Administration, 2020).

Prices:

Prices of crude oil refer to the measured spot prices of barrels of oil which typically comprises of
Brent Blend or West Texas Intermediate. The Basket prices of OPEC and New York Mercantile
Exchange to are referred. WTL is sold at prices USD 3-4 per barrel discount to Brent. The OPEC
basket price is the average price of Oil from Congo, Angola, Gabon, Iraq, Iran, Libya, Nigeria, Kuwait,
, Saudi-Arabia, Algeria, Venezuela, and UAE. Price of this
basket is used to monitor world oil market conditions Fig 1.2Profit
Composition of Gasoline Prices
(Energy Information Administration, 2020). 13%

Impact of Oil Prices:

The increased prices of oil result in increased prices of

Taxes and Other
other types of fuels such as Gasoline, oils for heating, Charges
natural gas, and other products. Of the total, around 95% 18%
Oil Price
of entire transportation is influenced by oil prices, which 54%
triggers higher prices of food. Furthermore, a total of 45%
of industrial products and nearly 20% of residential usage
is impacted by rising prices of oil as well. As a
consequence of increasing oil prices, the cost of every Distribution
15%
purchasable item increases which creates inflation
(Sorkhabi, 2020).

Impact on Oil Prices in 2020

The year 2020, will be categorized as the most important year in the history of crude oil prices. The
reason is fairly simple; the oil industry was hammered in 2020 which forced the prices of oil to
reach the negative reason, for the first time. Within a short period, the prices of May-2020 future
contract prices of WTI plummeted to $-37 per barrel. This resulted in an oversupply of oil with oil
produces being plunged into a crisis of storing excess supply. The had a consequence for Brent Oil
prices as well which dropped to $9.12 a barrel around the same period, a far cry from the starting
price of $70 a barrel in the year. Factors responsible included increased supply, reduced demand,
over-exhausted storage spaces. Although the prices in the negative zone were reverted shortly,
however, a serious question was raised regarding the recovery to the original position in 2021 (Lin
et al., 2021).

Impact of General Factors on Oil Prices:

The demand for oil in 2019 was already significantly lower than expectations. This was mainly due
to preferences for highly efficient and environmental friendly vehicles. Global efforts are direct
towards transitions towards clean energy sources in order to reduce the environmental footprint.
Demand for oil till 2025 is expected to reduce as countries across the globe are expected to
implement policies for efficiency and reduced carbon emissions. However, the impact is difficult to
estimate forcing the companies to priorities projects with little life cycles.

Other factors such as additional refining capacity additions and more specifically International
Maritime Organization’s bunker rules which were brought in early 2020 are also attributing factors
that have driven the shortage of demand.

With regards to the supply side of oil, the wild card in this regard turned out to be the geopolitics.
Venezuela, Libya, and Iran reported huge production losses since the start of the previous year.
Markets were over supplied even before the start of the Covid-19 outbreak.

During the period 2019-2025 it was estimated that fuel demand would rise at a rate of less than one
million per barrel where the first drivers were petrochemicals, petroleum gas, naphtha, and
finished ethane contributing more than half of the growth. Demands to reduce emission from
plastic industries and reducing the use of plastics in developing countries will also play a role,
however, the impact will only be on a modest scale even if full bans are imposed. At the same time,
global oil production is expected to grow by 5.9 million barrels per day. Among these, Non-OPEC
demand increase comprises 4.5 million per barrel per day, while the remainder will be related with
OPEC. The statistics assume that sanctions on Iran and Venezuela would continue (Energy Agency,
2021).

The year 2020 proved to be an important year for crude oil prices. Apart from changing supply and
demand of oil, other major factors also attributed to the overall temporary transition to the
negative zone for the oil prices. The prices of lower even crossed the previously recorded lowest
prices immediately after World War II.
Researches have also used comparative
situations like the 1991 Gulf War that also
resulted in extensive volatility of oil prices.

Impact of Covid-19:

The Pandemic of Covid-19, resulted in a

sudden shock in demand for the oil
industry, as governments worldwide
imposed shutting of businesses, stay-at-
home orders, and banished traveling as
preventative measures. According to a
report of Goldman Sachs, Covid-19
alleviated the consumption of crude oil by 28 million barrels (per day). This was mainly due to
reduced economic activity that encompassed the world operations creating a serious imbalance
between supply and demand of oil (Zhang et al., 2021).

The effect of lockdowns was very much severe during the first half of the year due to persistent
market uncertainties for all energy sources of all kinds. However, with summer approaching oil
markets starting showing a certain degree of recovery with the nations starting to emerge from the
lockdowns. Brent crude oil spot prices stood at an average of $40 with an $11 increased as
compared to May-20 (U.S. Energy, 2020). The next of the year witnessed recovery of oil prices. With
the passing time, expectations regarding OPEC’s decisions began to mount.

Exhausted Oil Storage Capacities:

The mismatch of supply and demand resulted in storage capacities getting exhausted. Ships, trains,
etc, that are typically used to transport oil, were used for storing oil. The shortage of storage
capacity was the main factor that resulted in negative prices. Many decisions were considered by
the United States to use the petroleum reserve strategy as an interim measure and the use of
financial incentives to encourage operators to stop production. Several oil producers with hopes of
maintaining their market shares took measures to store oil the sea by leased tankers at
considerably higher costs. Sources quote a price of US $100,000 per day (Energy Information
Administration, 2020).

Storage of crude oil is a critical issue. Simply getting rid of crude oil like the Wisconsin Milk Strike,
is not a feasible solution since dumping of oil may have serious consequences for the environment.
This resulted in storage capacities getting overloaded. High levels of inventories also resulted in
spot prices of Brent crude oil falling from a monthly per barrel price of $64 to $18 in April (U.S
Energy, 2021).

The prices of oil at the beginning of the year were fairly strong, however, reduced economic activity
created an over-supply resulting in a dramatic plunging of prices.

Impact of OPEC decisions:

Fanning the flames of the situation was the price war between Russia and Saudi Arabia after two
countries failed to reach a consensus on production levels of oil. The price war lasted a month till
OPEC and allies decided to reduce the overall production of crude oil by 9.7 million barrels (per
day) for a time of two months beginning on 1st May. This was the single largest cut of output in the
history of oil. However, OPEC’s late decision to cut production of oil in order to adjust to the lower
demand only contributed to the volatility and declines in prices in the industry. Despite the decision
of OPEC to cut down production, prices of crude oil reached rock bottom in more than 2 decades, in
May-20 (Opec, 2020).

Conclusion:

Oil is considered as a prime commodity because of the dependence of world’s operations. Increase
in prices of oil raises the price of every purchasable item. Transportation, being the most economic
source of transferring products around the world, is the key driver behind the changing oil prices.
Among the types of oil two main classes are considered the benchmarks. These classes include
West Texas Intermediate and Brent crude oil. Prices of WTI futures expiring in May-20 created a
worldwide panic when the prices fell below zero and reached the negative zone, raising serious
questions. However, this was just a fragment of the overall worldwide crash of oil prices. Several
factors were responsible for the event. General factors included supply and demand mismatch
driven by variety of reasons such as preference for energy efficient operations and vehicles,
geopolitics, etc. Key factors caused changes in crude oil prices include the impact of Covid-19, which
has led to a global shutdown, depleted energy leading to over-supply thus reducing oil prices, and
OPEC's late decisions to reduce production to meet demand. Future of demand of oil is difficult to
predict as the world continues to transit towards more environmental friendly practices,
implementation policies focused around reduced carbon emissions, and new business models. It is
general believed that in the longer run, newer models of service adopted during the pandemic,
replacing video conferencing by transportation, continued constraints on travelling may result in
an ongoing reduction for demand of travel and fueling. Global supply chains, domestic import of
supplies, re-shore production may also contribute to overall reduced demands for oil (Lucas, 2020).

References:

Albulescu, C. (2020). Coronavirus and oil price crash. Available at SSRN 3553452.

Energy Agency, I., 2021. Oil 2020 – Analysis - IEA. [online] IEA. Available at:
<https://www.iea.org/reports/oil-2020> [Accessed 9 April 2021].

Energy Information Administration. "Another Type of Crude Oil to Be Included in Calculation of the
Brent Price Benchmark https://www.eia.gov/todayinenergy/detail.php?id=30292."
Accessed Apr. 9, 2020.

Lin, B., & Bai, R. (2021). Oil prices and economic policy uncertainty: Evidence from global, oil importers,
and exporters’ perspective. Research in International Business and Finance, 56, 101357.

Lucas B. Impacts of Covid-19 on Inclusive Economic Growth in Middle-Income Countries. (2020).

Available online
at: https://opendocs.ids.ac.uk/opendocs/handle/20.500.12413/15310 (accessed
September 20, 2020).

McMinn, D. (2020). The crash of 2020. Research Gate [2020]. Disponible en: Acceso en, 23 (04).

OPEC. "The 10th (Extraordinary) OPEC and non-OPEC Ministerial Meeting concludes.
https://www.opec.org/opec_web/en/press_room/5891.htm " Accessed Apr. 9, 2021.
U.S. Energy Information Administration. "Short-Term Energy Outlook, July 2020,
https://www.eia.gov/outlooks/steo/archives/jul20.pdf" Page 1-8. Accessed Apr. 8, 2021.

Sorkhabi, R. (2020). The oil price crash of 2020: causes, consequences and historical
context. Geology Today, 36(4), 140-145.

Zhang, W., & Hamori, S. (2021). Crude oil market and stock markets during the COVID-19 pandemic:
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