Oil prices have crashed drastically worldwide A few months prior, the price of crude oil was 60 dollars per barrel Today, it has fallen and has touched almost 20 dollars per barrel A huge reason behind this is the ongoing price wars between three countries- USA, Russia and Saudi Arabia Such a huge crash not only has a great impact on the global economy but it also has a vast effect on climate change and geopolitics Why exactly did this happen? What are these price wars ongoing amongst these countries? How will this oil price crash affect India? How will it affect the rest of the countries?
Come let us see…
Economic of Oil
First of all, a small, basic economic concept that most of you would already know that the price of anything in a free market depends on demand and supply If the demand of something is more while the supply is less, then its price will rise The same is with oil. If the demand of oil is less and the supply is more, then its price will fall The top three oil-producing companies of the world in USA, Russia and Saudi Arabia All the three countries all the oil-producing countries would want for themselves that they sell the most possible amount of oil at the highest possible price so that they incur the most amount of profit possible.
Generally, what would happen in a market is that the countries that buy oil would look for the cheapest option of buying oil and buy from there And a competition between the oil producing countries would be maintained they would keep the price at the lowest amount possible so that oil is bought from them and they make profits and this would drag down the profit of all the countries An alternative is that they altogether decide to control supply and decide the price concertedly which would enable all of them to earn a respectable amount of profit All would be benefited Therefore, an alliance exists between some of the oil producing countries which is named OPEC Organization for Petroleum Exporting Countries 13 countries are a part of OPEC , including Iran, Iraq, Kuwait, Libya, Nigeria, UAE, Venezuela, and Saudi Arabia is also a part of OPEC But USA and Russia are not a part of OPEC OPEC is basically an agreement between these countries where they sit together and decide what the price of oil should be and how to control supply, which would prevent the fluctuations of price and ensure profits for everyone In December 2016, OPEC signed an agreement with some non OPEC countries that they would, together, increase the oil production upto 1 million barrels per day to keep the market stable The real reason behind this was something else. I will explain that later in the video So, basically, an agreement was reached upon between 13 OPEC countries and 10 non-OPEC countries and these 10 countries included Mexico, Kazakhstan and even Russia So basically, there was an alliance between Saudi Arabia and Russia This agreement was named OPEC+ Together, these were 24 countries and altogether, they were controlling 55% of the world’s oil supply So, together, OPEC+ exerted a huge influence on the world economy USA was still not a part of OPEC+. USA was a competitor of the OPEC+ countries.
What is happening today is that due to this widespread virus, schools and colleges have been shut down. Factories have been shut down People are not moving out of their houses because the cities have been locked down- which is a good thing and has been done for their safety. So because of these things, air travel and shipping have declined due to which users of oil has also reduced The demand of oil has fallen due to which the price of oil is declining This is one reason But if the demand of oil is falling, we reduce the supply as well then the price can be kept stable
Therefore, on 5th March 2020, OPEC convened a meeting in Vienna and together they decided that they would reduce the oil production by 1.5 million barrels per day so that prices remain stable and all oil-producing countries can earn profit OPEC communicated this to the non-OPEC countries as well, including Russia This was told to the OPEC+ members as well and requested them to curtail their production so that everyone can earn profits But Russia refused to do this, In fact, Russia further raised its production What this led to- the demand was already low, the supply rose even further and oil prices crashed drastically as a result and the alliance of Russia and OPEC came to an end An obvious question that arises here is why did Russia do so? because if oil prices fall then all the oil-producing countries would bear the brunt be it USA, Saudi Arabia, or even Russia Russia would harm itself by doing this So what is the logic behind doing this? The reason behind this is that Russia wanted to attack the USA’s Oil industry Not an actual attack It wanted to attack the US industry in the form of prices and Russia wants to destroy it.
Russia and the USA
Although the enmity between Russia and USA has been ongoing since the 1950s, in the aspect of oil it began around 2014, 20- 30 years before today, the USA had been an oil-importing country It did not produce so much oil on its own but imported it from the other countries Around 2010 -14 there was a revolution in its oil industries due to which USA became an oil-exporting country The name of this revolution is Shale energy revolution They discovered a new technique of oil drilling It was a combination of hydraulic fracturing and horizontal drilling which is called Shale oil due to which it extracts more oil from the existing oil fields in a more profitable way The shale oil turned out to be so revolutionary that it made the USA the world’s number 1 oil producer It left Russia and Saudi Arabia lagging behind the USA snatched away the market share from Russia and Saudi Arabia.
Due to the production of Shale oil, the supply of oil increased and the oil prices fell This meant that the profit of the OPEC countries and Russia began to dwindle Initially, when the shale energy revolution commenced, then the OPEC countries thought that they would have to destroy the USA’s oil industry and keep their market share maintained if they wanted to keep accruing profits in the future In order to do this, the OPEC countries decided to increase their production due to which the oil prices worldwide would fall and due to this fall, it would no longer be profitable for the USA to produce shale energy And so they would stop production and so later they would become the sole oil producers later Interestingly, the oil drilling in USA is done by private companies if the private companies of USA would go bankrupt, then the USA government would not intervene to save them But in countries like Saudi Arabia and Russia, the oil companies were nationalized companies So the government directly controlled them So the government could keep funding the companies to keep them running SO every one was facing losses but the OPEC countries were hoping that the USA private companies would face losses and shut down The competition would get ruled out. And they would compensate their losses from the governments and then they could maintain competition But the plan wasn’t so successful Not all of the private oil producing companies of the USA shut down- only some of them did But overall, they were able to keep themselves sustained when the oil prices were falling.
But even today, Russia feels that it can root out the USA private companies from the competition and can capture back its market share in oil production And so Russia increased its supply and kept the prices low if the prices remain low for a long time, the private companies of USA would not be able to make profits they would become bankrupt and would have to shut down ultimately and Russia would be able to get back its market share Basically Russia is frustrated with the USA because of several other reasons because there are the Crimea and Ukraine issues USA has imposed sanctions on Russia which is already having a lot of effects on their economy So they thought that they would bear the losses for the time being During this time, they would indeed face losses but the USA companies would shut down And later when the USA companies would shut down, their market share would increase and then they would increase the oil prices and earn profit Russia feels like it might be able to do what OPEC failed to Alexander Dynkin- President of the Institute of World Economy and International Relations in Moscow It is basically Russia’s think tank He said that Russia has decided to sacrifice OPEC+ top US Shale producers and punish the US for messing the Nord stream 2 project Nord stream 2 was another project in which USA imposed sanctions due to which Russia had to face losses Ofcourse, to upset Saudi Arabia could be a risky thing but this is Russia’s strategy at the moment flexible geometry of interests Russia knows that upsetting Saudi Arabia and OPEC is actually fighting a war on two fronts in a way On one hand, the US is being angered and so is the OPEC on the other hand But at this time, Russia has taken this decision because It wants to target the US more and hence it decided to ignore the OPEC’s decision So what is the impact of this decision?
Impact of this Decision?
What Russia wants will happen to some extent If low oil prices stay maintained over a sustained period of time, there are a lot of small oil drilling companies in the US Not all the companies in the US are huge companies, there are some small businesses indulged in oil drilling They are going to face huge losses They are going incurring huge losses because the demands have been low So some companies might actually become bankrupt But some big companies like Exxon and Chevron They have enough money in their balance sheets that they wouldn’t incur losses But small companies might definitely get harmed The US government is planning on giving government assistance to these oil drilling companies in order to prevent them from becoming bankrupt Russia has enough money to bear these losses in the short term but in the long term, the Russian economy would be adversely impacted because the Russian economy is dependent on oil-exporting in a major way In response, Saudi Arabia has also increased its production because why would it be left behind? They too, want to maintain their market share They too can sustain losses for some time easily And they are gauging that if the US companies shut down, they’d be benefited and if Russia is unable to sustain, then too, it would be benefited because everyone would come to them to buy oil The maximum brunt of this entire situation would have to be faced by small oil-producing countries, For example, Iran, Iraq, Brazil, Argentina Ivory Coast, Malaysia, Indonesia, Azerbaijan, Kazakhstan Because if the oil prices remain so low, they would not be able to sell oil at a profit They would not be able to earn money. And since they are small countries, their entire economy is dependent on oil Nor do they have enough money to sustain themselves in the long term on such a small profit margin.
Biggest Loser and Winner
The maximum benefit in this situation would be availed by the oil importing countries For example India, China, Japan Estimating how big of a benefit we would avail, For example in the financial year 2019, India had spent 112 billion dollars to import oil If prices remain this way, it is being predicted that in the financial year 2020 India will be spending only around 64 billion dollars It has been halved So India will avail a benefit of approximately 60 billion dollars This is quite a good news for the Indian economy It remains to be seen whether the Indian government will pass on this benefit to the Indian consumers It does not seem so because you must have seen that the government has hiked the taxes so that all the profit accrues to the government and the government would make itself economically better Unfortunately from the perspective of the environment ,the entire situation will have a very negative impact because this is the time when the entire world is making a transition to the electric cars and it is not good for the electric car industries if oil and fuel are so cheaply available and it is not good for the electric car industries if oil and fuel are so cheaply available Plus, the recyclable plastics would become costlier in comparison to manufacturing new plastic if the oil become so cheap The companies would not get economic incentive to recycle But at the same time we can hope that the situation might bring some changes in the oil producing countries These countries might think that they should not remain dependent upon oil and that they should switch to renewable energy A huge example of this is USA which could face thousands of job losses due to the crash in oil prices and the USA might decide to turn to renewable energy sector to create jobs instead of the oil sector.