Crude Prices: Rude Awakening

Products require resources for its manufacturing and thus all the varied costs incurred at different stages of the value chain should be considered. These costs could be direct – material, labor and other direct expenses together with a portion of overheads across administration, selling, and distribution. The final product price should cover all these costs for the producer to generate a surplus.

Logically, we would presume that a valuable product would never ever be priced below $0 looking at it from the supply-side. More so when it is a FMCG like crude oil which lubricates the global industry, we would expect a high price as a strong oil cartel called OPEC controls the supply in an oligopoly market.

According to a 2016 report published by the International Energy Agency, the cost of producing a barrel of oil ranges from a low of $8.98 (Saudi Arabia) to a high of $44.33 (UK). This aggregate cost takes into cognizance capital expenditure, administrative/transportation costs, production costs and gross taxes. Hence, the break-even price varies across OPEC and non-OPEC countries. As of April 2020, the OPEC had around 80% of the proven oil and gas reserves globally, held 40% world market share and around 60% of its oil crossed national frontiers.

On 20th April 2020, crude oil prices collapsed in the US oil futures market. The price for May(2020) futures contract nosedived more than 300% during day trading to hit an all-time low of -$40 per barrel as sellers paid buyers for the privilege of buying crude oil.

The reasons for oil price crash were not far to seek:

• Glut in oil supply globally as producers did not anticipate the impact of coronavirus pandemic. OPEC could not arrive at a consensus to even cut oil output by 10 million barrels per day.
• Demand for crude oil plummeted as 90% of the world was under lockdown. Demand was destroyed by almost 30 million barrels per day.
• Fund manager of the largest exchange traded fund for oil in the US – United States Oil Fund chose to rollover its positions to the subsequent settlement cycle(s) at low cost.
• Settlement cycle for May futures contracts expired on the same date (20th April, 2020) and these contracts suddenly became illiquid.
• There were only sellers and no buyers as investors holding a long contract refused to take delivery of crude oil and store it till the next settlement cycle.

The ministry of petroleum and natural gas tracks the daily prices of Indian crude basket with weightages of around 75% sour grade (Oman and Dubai) and 25% sweet grade (Brent). This price reflects the landed price of imported crude and hence, is the basis for fixing the domestic prices.

Crude oil is the basic input for all down-stream oil products like petrol and diesel. After sourcing crude oil from global markets, oil companies refine and distribute petrol and diesel through the fuel stations. In India, 75% of this price at the pump is in the form of taxes. In May 2020, central excise duty on petrol and diesel stood at र 32.98 and र 31.83 per litre respectively in Delhi which also levied a VAT of र 16.44 per litre on petrol and र 16.26 per litre on diesel. While oil producers continue to struggle with soft prices, consumers are not celebrating.

Global ranking of India ($0.98) was 96^th amongst 165 nations in fuel prices as on May 11th, 2020. However, neighboring countries like Myanmar ($0.38), Pakistan ($0.51), Bhutan ($0.65), Nepal ($0.79), and Sri Lanka ($0.85) sell fuel at more competitive prices. Venezuela the most oil-rich country in the world offered petrol free of cost as the State has monopoly over fuel distribution and subsidizes it. On the contrary, Hong Kong ($2.13) was the most expensive nation because of huge land cost associated with building a fuel station.

DISCUSSION QUESTIONS

1) Can negative crude oil prices mean free petrol, diesel, and cooking gas in India?

2) In an oligopoly market like oil do you think the global demand-supply imbalance will continue?

3) Why do you think India is not passing the benefit of lower crude prices to end consumers?

4) Why do you think land locked countries neighboring India are able to charge low fuel prices?

Dr. A Srihari Krishna

Dr A Srihari Krishna holds dual master’s degree in business administration as well as in finance & accounting.

He started his career as business journalist with ICFAI in 1993 where he tracked capital and currency markets for reporting in the ANALYST magazine.
Subsequently, in 1995 he joined Swell Financial Services – a merchant banking firm as a equity research analyst where he managed IPOs and structured venture capital/private equity deals.
In 1999, he joined academics and served institutions like Siva Sivani Institute of Management as an associate professor.
After submitting the doctoral thesis on “Monetization of Shareholder Wealth” in Osmania University during May 2006, he joined GE Money Servicing as a learning manager. He had trained credit underwriters on risk management practices across India and partner sites in the USA. He left GE in 2011 and since then remained a freelancer involved in teaching, training, and consulting.

Currently, he is an advisor with Engineering Staff College of India, visiting professor at Amity Business School, Narsee Monjee Institute of Management Studies, Galgotia University, ITM Vocational University, and Symbiosis University of Applied Sciences.

He also provides academic support to varied learning products of IFHE for their executive MBA program in the capacity of an adjunct faculty.

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