We discussed in the earlier blog how COVID-19,
also known as coronavirus has made global markets come to a standstill. We see
the effects of coronavirus on Indian markets, or for that matter, on any market.
This has greatly effected the 4th quarter of the financial year
2019-2020. But the virus started spreading in China since November 2019. The
ever-spreading virus started showing its effects in China in no time, as shown
below.
The above image shows the amount of destruction, the virus has caused in the country of its origin.
Various other countries, too have been affected badly. A country which was
called the superpower, is now weak on the knees, due to the virus. Italy has
recorded the highest number of deaths and Spain is breaking its own COVID-19
death records every day. India, too, is on lockdown for 21 days. Since the
virus has stopped the production and businesses worldwide, the demand for one
main raw material, i.e. oil, declined since the beginning of 2020. The demand
fell by a whopping 30%. This caused the price of the oil barrel to reduce from $65
a barrel to $30 a barrel.
But there’s more to the
story. The coronavirus isn’t all to be blamed.
There was one particular disagreement amongst the oil-producing partners
that caused a further decline in oil prices.
Back in 2014, these two
partners/countries signed an agreement to use their collective power for
controlling oil prices by limiting their oil production. These countries are
Saudi Arabia, a member of the OPEC (Organization of the Petroleum Exporting
Countries) and Russia, a non-OPEC member nation. This created an informal
alliance between the OPEC member countries and the non-OPEC member nations
which was called as ‘OPEC+’.
But in 2020, a disagreement
took place between these 2 oil-producing countries. The slowing demand started
bothering Saudi Arabia, as the oil price had marched down 30% due to the
pandemic threat. Due to the shortage of demand, the production of OPEC+ was cut
by 2.1 million barrels per day (BPD). In March 2020, to control the prices of
oil, Saudis asked Russians to decrease the production further to stabilize the
prices. Russian president, Vladimir Putin disagreed with Saudis, as Russians
wanted to increase their production. This is when the disagreement happened and
chances of oil price war were suspected. This price war is also one of the main
reasons that caused the global crash of various stock markets.
Since the request of
Saudi Arabia was declined, they tried to come up with a plan that would make
the Russians accept their request for a reduction in production. Saudis tried to
take an aggressive step forward, while gaining control of Russia’s main oil
markets, namely Asian and European countries. The largest oil-producing company
Saudi Aramco and the crowned prince Mohammed bin Salman together broke the deal
made with Russia and captured its markets by selling oil barrels, at $25 per
barrel, a rate lower than Russia’s. This move increased the market share of
Saudi Arabia dramatically.
But Mr. Vladimir Putin,
did not change his decision, even after Saudis move as the Russian economy is less
dependent on oil reserves and exports, as compared to Saudi Arabia.
To sustain having the
largest market share, in the words of Saudi Aramco CEO, Amin Naseer, "In a
nutshell, Saudi Aramco can sustain the very low price and can sustain it for a
long time." Oil
production in Saudi is very cheap, as per its IPO (Initial Public Offering)
prospectus released last year.
But how does this affect India? While the decrease in consumption of oil
might result in a contraction of the global market of oil reserves, the slicing
prices can help India. The increasing tension in the Middle East increased fuel
prices in India, but later Saudi Arabia assured India of uninterrupted LPG
supply. The Indian economy is already facing a widening fiscal deficit. In such
a time, of fiscal deficit and deteriorating Rupee value, the actions of Saudi
Arabs have worked in the Indian economy’s favor. This can help to reduce currency outflow and also support combatting inflation and economic
slowdown.
With all of this, a potential cold war has been
announced, even though none of the countries agree to be in a situation of
such a war; and if not dealt
with, the largest producer and market shareholder, Saudi Aramco may also mark
the end of the life of long-running union OPEC. Thank you,
Regards,
Nishi Sanghvi,
Kautilya,
IBS Mumbai.
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