On March 9, 2020, the prices for oil dropped by 30%. Barrel’s cost of the Brent brand produced in the North Sea on this day was $32.83. This is $12.44 lower than the cost of the same petroleum on March 6. The US crude WTI also decreased to $28.84. Why is it happening?
The Main Reason
Last time, the cost of oil fell so quickly nearly 30 years ago when Americans launched the “Desert Storm” Operation. Current conditions are caused by the collapse of the OPEC + agreement, which Russia left on March 6 due to the impossibility to afford a noticeable reduction in rate. As a result, on April 1, OPEC member states will have no obligation to limit production. That is why Saudi Arabian authorities declare record discounts on oil and share plans to dramatically increase extraction.
The cost of oil largely depends on world economic growth. Currently, the demand for petroleum is falling in China and many other states. Anxiety due to the recession is becoming more widespread and constant fears of COVID-19 cause panic among investors. Major European stocks fell more than 7%, Japanese indices decreased by 5%, and the US ones dropped by 7%.
Key players were already in dire straits due to quarantine around the globe, because governments tried to contain the outbreak of the virus and prevent a pandemic. There is a lot of fear in the finance sector, and if the cost of oil goes down, it suggests that a decline is not far off.
Unlike the exchange rate, the data on the websites is approximately equal and correspond to Forex trading quotes. Based on this info, the situation with the price of oil is more complicated. It depends on:
- a contract for delivery in a specific month;
- the geographical location of the trading floor.
Each broker considers the reaction of the need-to-value changes in relative terms and calls it the elasticity of inquiry of trading stocks. If the cost reduction of 1% leads to a rise in sales of less than 1%, this means that demand is inelastic. In this case, the total profit that the seller receives will not rise among falling expenses. On the other hand, if a 1% decrease would lead to a realization increment by more than 1%, the total profit would rise as a result of lower costs.
Thus, the context reflects a Rialto with a high level of competition and weak consumer reaction in the short term. Even the state of technology and weather conditions affect the request for oil much more than prices.
At the same time, producers and individual countries continue to increase their income by selling even more oil. However, a decrease in values does not generate sufficient turnover growth.
The percentage of market share suggests that it is enough to reach agreements between two or three large producers. For example, Saudis and Russians, who control 10% of supplies, could stop the fall in prices. However, this would only work in the short term. When OPEC skyrocketed rates in the 1970s, it forced other states to think about alternative energy sources, which eventually led to a further drop in oil demand. This is the reason why the current crisis has enough solutions and ways how to handle it.