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Friday, May 29, 2020

Vikram S Mehta on crude oil price dive: ‘It’s the death knell for the oil industry’

The fundamentals of the oil industry are not just determined by demand and supply, they are also determined by geopolitics, by the paper trader, said Vikram S Mehta.

By: Express News Service | New Delhi | Updated: April 28, 2020 11:58:39 pm
Vikram S Mehta, Chairman of Brookings India and Senior Fellow, Brookings Institution.

On Monday, crude oil prices in the US became negative. Vikram S Mehta, Chairman of Brookings India and Senior Fellow, Brookings Institution, spoke to Anant Goenka, Executive Director, Indian Express Group, and Udit Misra, Deputy Associate Editor, The Indian Express, about what caused it — and what the outlook is now. Edited excerpts:

Goenka: Vikram, it’s certainly something that is going to happen just once in our lifetime, isn’t it?

Mehta: Yeah, what happened is a technical issue … related to the May Futures contract from WTI (crude oil) and basically, you know, all the traders who were holding on to that derivative paper, needed to offload it. They couldn’t find anyone to roll it over because of the shortage or constraint on storage. So rather than taking the delivery of the product in May, they just bid low the price, desperate to get rid of that paper. And as you know, normally these sort of contracts get rolled over pretty easily because the differential between, let’s say the May Futures and the June Futures, is not that great. But this time around, June Futures was trading at $20 a barrel and May Futures crashed to -$37. So the differential was such that no one was actually able to roll it over.

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But this technicality reflects a fundamental reality of the market. And the reality is that it’s a hugely oversupplied market.

Goenka: Is it correct that there are certain type of oil producers who are producing at around $10 a barrel; others, like shale producers, at around $30 a barrel; and there are some who are producing at less than $5 a barrel?

Mehta: You’re absolutely right. Some of the fields, the giant fields that have been producing for the last God knows how many years, you can produce at a few cents a barrel.

But I think one has to go one step beyond the marginal cost of production and ask what is the budget requirements of the oil producers. I am going to take a slightly macro view. What is the oil price that oil producers need to break even, to balance their budget?

You’ll be amazed, Saudi Arabia needs a price of $82 a barrel, and the lowest, the most robust of the oil producers, Qatar, requires a price of around $40 a barrel and, Algeria, at the other end, over $100 a barrel. So the Saudi oil company ARAMCO might still be generating a profit. On a standalone basis, its balance sheet is not going to go under. But since Saudi ARAMCO contributes 80 per cent of the revenues to the Saudi exchequer, the fact is that Saudi Arabia will have to very quickly draw down from its sovereign reserves if it wants to meet its social and economic commitments, and that’s the big issue.

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At the industry level, you have the NOCs, the National Oil Companies and then the private companies, and if you were to order the oil companies by size and indeed profitability, you’d find that, probably of the top 20, 16 are NOCs. And then the four like, Exxon and Shell and Chevron and maybe Total; the rest have dropped off that list. Occidental, for example. It’s share prices are below value and that’s unique. That I think is the reason for saying, you might well have sounded the death knell of the oil industry.

Goenka: Am I wrong in my understanding that nobody is producing less because of the fear that if they do they will be forced to not produce at all, or will never be able to go back to the original volumes?

Mehta: The fundamentals of the oil industry are not just determined by demand and supply, they are also determined by geopolitics, by the paper trader — yesterday was all about paper trading. They are also determined to some extent by the exchange rate.

Demand has fallen by such an extraordinary level — this quarter, some estimates say it will fall by 30 million barrels a day, which is the entire production of OPEC.

Now against that kind of a demand destruction, a 10 million barrels a day supply cut, which is what Saudi and Russia have agreed to, is not making any difference.

Point number two is that, if you do reduce supplies, some fields, some reservoirs could get permanently damaged.

Goenka: So are we (India) going to see a major reduction in our annual oil bill?

Mehta: Oh yeah, I haven’t done the numbers, but there will definitely be a significant reduction. But on a per unit basis obviously, because the price has fallen. But our demand has fallen as well. The big question is: What are you going to do when the economy starts to pick up again?

Misra: As oil prices fall, should the government raise taxes and boost its revenues, or pass on the lower prices to consumers to boost consumption?

Mehta: I would do the latter, I would actually look to reducing the prices. And I am not saying that initially it will boost demand because that depends very much on economic resurgence. But I think it will be politically foolish, frankly, for the government to continue to charge all of us the same price when the world price has collapsed.

Goenka: Is the whole cause of renewable energy, especially in India, a hopeless cause, at these prices of oil?

Mehta: It’s not a hopeless cause because it cannot be and must not be a hopeless cause. So let’s hope that no one in government says that. It’s going to be complicated by the price of oil, of course, but more by supply chain issues.

The China supply chain is broken. That’s back to my earlier point that we will have to take a slightly longer-term view of all these issues. If you take a short-term view, you are going to say, yeah, okay, “forget about renewables”.

But you’ll wake up, two years, five years, from now and you’ll find yourself living in a hell-hole once again. (Transcribed by Mehr Gill)

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