Share trading in Kuwait was suspended, after stocks plunged on the news that OPEC had failed to make an agreement on how to deal with the coronavirus outbreak (Photo: Getty Images)

Why the oil price is crashing, and what it will mean for New Zealand

The price of crude oil is absolutely tanking right now, because supply is being ramped up at a time when demand is unusually low. What’s going on? Here’s a cheat sheet explaining all.

What’s all this then?

Russia and Saudi Arabia, two incredibly large producers of oil, have basically declared economic war on the rest of the world, using oil prices as their weapon. It’s basically a massive gamble on being able to put other producers out of business, but in the mean time will have profound ripple effects through the global economy.

Define ‘tanking’ when it comes to the oil price?

It’s dropping rapidly right now, to the point where Brent Crude (a pretty good benchmark) is now about $36 a barrel. If that sentence is incomprehensible to you, put it like this: On this week last year, it was up at $67 a barrel. And moreover, the price has fallen off a cliff too – in the past week, it has come down from a high of around $52 a barrel. Those sort of rapid drops are really unusual – in fact, as of today Brent Crude dropped at the market opening by 30%. The last time a drop like that was seen was at the start of the first Gulf War in 1991.

What on earth is going on to make all this happen?

Basically, it started with the Covid-19 coronavirus. Because heaps of flights aren’t being taken, and heaps of economic activity that otherwise would have been powered by oil is on hold, demand is way down. That means that with existing production levels, there was a lot more supply – and in the cartel-like operations of the oil industry, having this sort of situation means that oil producers have to trust each other. But like participants in other cartels, like cocaine dealing for example, the participants really tend not to trust each other.

So at an OPEC meeting last week Saudi Arabia asked other producers to join them in cutting production, so that the price of oil would stay high. Russia was a notable refusal to that, in part because they’re able to survive economically with lower oil prices. Saudi Arabia, on the other hand, is absolutely not equipped to deal with a low oil price, given their economy is entirely dependent on the stuff. So instead they launched a massive production drive to swamp the market with so much oil that the price will collapse entirely, in an effort to drive other producers out of business.

For other oil-producing countries, such a price war could absolutely devastate economies that are already shaky. There is evidence already that it’s going to have a depression effect on the USA’s economy, as their major oil-production format (fracking for shale oil) is much more expensive to produce than conventional sources. But that’s nothing compared to what it will do to Venezuela and Iran – two countries who aren’t exactly on good terms with much of the rest of the world, but who have been able to maintain their ability to fight back through the production of oil. If the price stays down for a long time, their economies will collapse.

Just quickly – what is OPEC?

It’s the Organisation of Petroleum Exporting Countries, and they operate as a cartel to control the supply and price of oil. There are 14 member countries, and they account for about 44% of global oil output.

So this is all bad for producers – but what about consumers?

It could mean some major drops in price at the pump for drivers, and that could have positive flow-on effects for businesses that use a lot of petrol in the course of their operations. Think, for example, about a hypothetical small plumbing company. Because of the shortage of skilled plumbers, they’ll always be busy, with vans driving all over the city to get to jobs. Those trips will happen regardless, but the price of petrol determines how much of a cost that will be. So if it drops rapidly, all of a sudden their costs will have gone down.

Great! What’s the catch? 

The thing about price wars is that people tend to buy and use a lot more of the stuff. So a prolonged crash in the price of oil could send the market terrible signals about the value of investing in renewable energy and greener infrastructure projects. Each individual project will vary, depending on a country’s tax settings, the type of renewable energy and so on. But the bottom line is this – one of the strongest business arguments that has driven the growth of investment in renewables over the last several decades is the idea that over time, they’ll simply start to make more economic sense. But what if a low oil price makes that argument wrong? And if so, what will that mean for the climate? From a carbon emissions perspective, it doesn’t really make a difference what price the oil was sold at when it gets burned.

The AA’s Mark Stockdale says with the commodity price falling last week, petrol prices should also go down. He says the national fuel price has already dropped about 4c a litre in the last week, and further drops should flow through to the pump. “Logically, the commodity price is likely to fall further, and that should result in the national fuel price being reduced.” Since the start of the year, the national price has fallen 16c a litre for petrol, and diesel by slightly less. That won’t necessarily apply to every pump across the country, says Stockdale, because some regions are underpricing due to competition.

Could this cause a wider economic downturn?

It’s very difficult to make predictions like that, over and above saying it certainly could. But put it like this – the sharemarket is having a horror day in Australia, the NZX50 is having a bad day so far, and stocks are tumbling in the US as well. That’s probably not ideal at a time when investors are already jittery about the impact of Covid-19.

How about this as an idea: I buy up all the petrol now, and stockpile it for when the price goes up again, and then profit handsomely.

That won’t work, sorry. Even if you store petrol properly, it only has a shelf life of about six months before it goes stale.


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