Why has oil plummeted?

Over the past few weeks, stocks have plummeted . Along with them, so have raw materials. Especially oil, which has dropped 57% so far this year.

Due to estimates of the impact that the Coronavirus will have on the economy, stocks fell. Investors expected a drop in the companies’ expected profits and, consequently, prices fell very quickly.

Along with stock markets, raw materials also crashed. More even than the stock markets. In the following graph, we can see the falls in energy commodities.

The one that falls the least is natural gas, with a 20% drop. On the other hand, oil with a reduction of 57% in 2020. Although it is currently in the area of ​​25-30 dollars a barrel, it has reached below 20 dollars. That is, at prices that have not been seen for 20 years.

Causes of the oil crash

The oil market is complex and, therefore, all the causes that we indicate here will be insufficient to fully understand what determines the price of oil . However, since the objective of Economipedia is to make economics easy, we will summarize it in the following:

  • Conflict between Russia and Saudi Arabia:Saudi Arabia, main member of OPEC, negotiated with Russia a cut in oil production. That is, they negotiated a reduction in supply jointly to try to get prices to rise. However, Russia refused and, in response, Saudi Arabia announced that the state company Aramco would increase its production to record levels. The intention was to sow chaos in the market so that Russia, which is more expensive to produce the barrel, would be forced to comply with the conditions set by Saudi Arabia. However, despite the fact that the latter produces at a lower cost than any other country (it is profitable above $ 10 a barrel), it has a public budget that requires it to have prices higher than current prices. In any case, it is a full-blown price war.
  • Advancement of US production:In line with the above, both countries are at a crossroads since their public budgets depend heavily on oil revenues. For its part, the United States has greatly improved the technique of fracking (an oil extraction technique). Although producer prices are more expensive than in other countries, not taking advantage of the production cuts agreed by OPEC + (OPEC and Russia), has made it gain market share.
  • Fall in demand for oil:The Coronavirus crisis has resulted in a very drastic reduction in global demand. Not to mention the slowdown suffered by a large part of the planet’s economies.
  • Excess supply:Finally, excess production causes the price to fall. That is, if in the face of the same demand, supply increases, prices fall.

Also, another problem of the current situation is the lack of storage. Producers are looking for exceptional ways to store that excess. Some analysts claim that the oceans are full of oil and ships are full of oil. Many operators, taking advantage of the contango situation, are currently buying oil.

by Abdullah Sam
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