Why Oil Prices Plummeted and What It Means

By early March, people around the world had already started comprehending that COVID-19 was something much more complicated and dangerous than “just a Chinese problem.” The exponential spread of the virus across Italy, followed by other European major countries and the United States, indicated the international scope of the challenge. As the global economy finds itself in uncharted waters — with a looming crisis lying ahead — the oil industry has witnessed an unprecedented crash in the prices of its benchmark products. Let’s have a look into the drivers that caused this sharp decline in global oil prices.

The Saudi-Russian Standoff and its Result

There is a long and undisputed history of negotiations over the shaping of global oil prices between Saudi Arabia — the de facto of the Organization of the Petroleum Exporting Countries (OPEC) — and Russia, one of the largest oil producers worldwide. Even though it is not an OPEC member, the Russian Federation has always had a strong say in the policy over oil pricing, due to its tremendous production levels and Moscow’s significant geopolitical position. Global prices are historically shaped according to the supply-demand ratio and the manipulation of the prices is established through the control of supply by the major oil-producing players.

Last March, Russia’s Energy Minister, Alexander Novak met OPEC members in Vienna. OPEC parties proposed a 1.5% cut in world oil supply: or an impressive 1.5 million barrels per day (bpd) decrease. The lion’s share of this cut would be undertaken by Riyadh, as long as Moscow would be willing to align with and back this strategy. However, catching by surprise the KSA, Russia turned down the plan for supply control. This decision backfired much worse than anyone would anticipate. Riyadh announced that OPEC was willing to boost the supply, as a response to Russian defiance, and at the same time would significantly reduce the oil price for some of the major clients of the Kingdom. These moves were enough to cause panic to the global markets and violently pushed the price of Brent crude significantly lower, with losses reaching up to 30% during the second week of March.

The COVID-19 Global Lockdown: Steady Supply, Minimum Demand and Lack of Storage

The second major shock for oil world prices has been the great uncertainty and the ensuing global lockdown imposed due to the COVID-19 pandemic. The vast upsurge in the virus threat perception came at a moment, when oil prices were already hit hard and extremely volatile; it would not be far-fetched to say that COVID-19 delivered the final blow to the oil industry at that moment. The most indicative, among the various virus consequences, has been the tremendous impact on the aviation industry. Global commercial flights decreased by almost 50% by the end of March, only to go on to report a record 70% decline in April. Such an unprecedented drop also translates into massive decline of demand for fuels and oil products. On the top of that, it has not been just the aviation sector that was impacted by the restrictions imposed almost all over the world. COVID-19 countermeasures have actually put numerous countries, worldwide, on hold, literally pausing most of the everyday life aspects for almost a 2-month period. This means that the oil demand related to any form of activity under normal circumstances, from daily transportation to electric energy consumption, has been in freefall all that time.

With global demand approaching minimum levels, oil reserves have been piling up, creating an additional problem. At some point in late March, people started worrying about the lack of storage facilities; if the COVID-19 crisis demanded such restrictions to be in place in the long run, then there would not be enough facilities to store the oil. This horrific thought has pushed oil prices even lower, causing a negative rally and creating the paradox of the negative trading of future oil contracts.

In mid-April amid the unparalleled downfall in global oil prices, OPEC members alongside Russia finally agreed on a massive 10 million bpd cut — almost ten times more than the proposed cut which Russia had formerly turned down almost a month earlier. Albeit the scope of this decisive move the markets have not reacted as one would expect. Not surprisingly the announcement of the deal has pushed prices higher, but the fears around how long COVID-19 restrictions will last, the scenario of a second wave of the outbreak and skepticism around storage availability, have created a volatile context, with trends moving up and down and panic dominating. This has been the case until the end of last month.

With Current Rally Only One Thing is Certain: High Volatility Ahead

Oil prices have seen a continuous rise since April 22, when Brent has reported historic lows, approaching, even momentarily, a shocking 15 USD per barrel. Since then, prices have almost doubled, but still are nowhere close to pre-February figures. Many analysts have warned that the rally of the last few days could be attributed to an unfounded over-optimistic sentiment. In my point of view, the rally should not come as a huge surprise, considering that the sentiment would rapidly change as the world was moving towards the easing of the COVID-19 restrictions. With May 4 being the benchmark date for the gradual return to normality in various countries — an extra reason for Star Wars fans to celebrate — this has also created a positive sentiment across the markets. Assessing the energy industry, specifically, as the world was moving towards that date, the demand for fossil fuels was also rising fast, driving oil prices higher and higher.

It is too early to accurately predict any long-term impact of the COVID-19 crisis on the world markets and the energy sector. One thing that is certain for the months to follow is that the energy market will remain extremely volatile. The possibility of a second COVID-19 wave and its potential effect could create violent downturns, while any developments on the COVID-19 vaccine front combined with some purposeful moves by the OPEC+ parties could make prices soar. A “Buy the Rumour, Sell the News” philosophy is probably the best strategy going forward.