- Crude Oil has an impact on all walks of our lives. The ‘vaseline’ that is used as a lip balm to the Aviation Turbine fuel used in an aircraft originates from the Crude Oil.
- Crude Oil has a significant impact on the GDP of countries. It is usually a substantial component of the Balance of Payments.
Understanding Crude Oil: Types and Pricing
The naturally occurring Hydrocarbon deposit found several miles beneath the earth’s surface is deeply intertwined with our daily lives. There are many different classifications of Crude based on several parameters. The main benchmarks are, however:
- West Texas Intermediate (WTI)
- Brent Blend
- Middle Eastern Crude
- Crude Oil pricing is governed by Supply and Demand.
- Its pricing is also controlled by a cartel of the major Oil-producing nations.
Importance of Crude Oil in Financial Markets
It is one of the largest traded commodities in the Financial Markets. It is traded in the spot market as well as via derivative contracts.
Lately, Crude Oil prices have been very volatile. It has dropped more than 65% in just the last three months.
Jan 1: Crude traded at $66.31
Apr 1: Price was at $25.22
Why are the Crude Oil prices dropping?
- The COVID-19 pandemic has forced many businesses to shut down.
- Nationwide lockdowns mean people are not taking out their cars. Thus, the demand for fuel has reduced.
- Many of the Aircraft carriers have grounded their fleet as there are no travelers now.
- Finally, Oil prices are also impacted by the trading that happens in the Financial markets. Investors are currently rushing out of the markets amidst fears of losing their capital.
Let us understand why such a huge price drop of Crude is not a good sign.
A massive and sudden drop in prices of Crude Oil has a profound and lasting impact on the economies of several countries.
- Exploration of Crude Oil is an expensive affair. Drilling thousands of kilometers into the earth’s surface requires high-performance machinery. Companies engaged in Oil production won’t be profitable if Crude starts getting cheap. Stopping all exploration and production would result in a shortage of Crude. Petrol, diesel, gasoline are all end products of Crude. Thus, the deficiency of Crude translates to a lack of fuel for cars, buses, and even aircraft! No to any travel, then!
- Economies of countries such as Saudi Arabia, Iran, which are strongly dependent on Oil exports, would crumble.
- Now that the global level of Oil is decreasing in the Oil reservoirs found beneath the earth’s surface, unconventional methods of oil recovery are adopted. This is known as Shale Oil. The extraction of Shale Oil is a much expensive ordeal that won’t be viable until unless Oil prices are way above what they are right now. Cities such as Texas, in the US, has lost millions of jobs owing to this price drop.
Is there a silver lining to this price drop of Crude?
- Industries such as Paints, Tyre manufacturing derive a large amount of their raw material from Crude. These industries would massively benefit from the price drop.
- Countries such as India, which imports 80% of its Crude requirements, would rejoice a price drop. This would improve the state of the Current Account Deficit (CAD) of the country.
Despite all these pros of a drop in Crude prices, there needs to be a balance in the pricing. Otherwise, production and exploration won’t sustain, leading to a massive shortage of Crude. Recently, US President, Donald Trump had a meeting with Russia and Saudi Arabia to consider resorting to production cuts to stabilize the Oil prices. Crude Oil prices jumped 35%, just following the announcement.