Pandemic's second wave and oil markets

'For an industry still heavily scarred by the events of March and April, when prices went into free-fall as widespread lockdowns cut global oil consumption by around a quarter, the second wave of coronavirus restrictions has left many shuddering. Brent crude, the international marker, fell 10 per cent this week to just above $37 a barrel.' - 'Oil traders tear up demand forecasts as Covid lockdown returns' by David Sheppard, Energy Editor, Financial Times

With the coming of winters, Covid-19 has seen a rise globally to the extent that it is now being called the 'second wave' of the pandemic; with England already going under a nationwide lockdown. This, along with the surfacing phenomenon of 'long Covid' whereby symptoms of the disease continue to affect a proportion of patients many months beyond the actual culmination of the Covid attack itself, and in turn the additional negative impact this is having on economic activity. Resultantly oil prices, which were seeing a rising trend since start of May till end of August, have since then been hovering around the $40 a barrel mark since then for both Brent and WTI (West Texas Intermediate). Since October 27 though, as the Covid cases started to rise sharply more recently, as the winter-effect kicked in, prices started to fall significantly - the last week of October, for instance, saw around a 10 per cent decline in prices of Brent, which was the biggest drop since middle of April whereby, by end of October, prices for Brent and WTI had come down to $37.94 and $35.79, respectively.

A quick look at the journey for the crude oil prices may help understand the likely fall in prices during the second wave. From the high of $68.91 a barrel for Brent, and $63.27 a barrel for WTI on January 6, the 'first wave' of the pandemic took the prices all the way crashing to $19.33 for Brent, and $11.57 for WTI on April 21. As the cases went down and more control was achieved over the pandemic, and as lockdowns were removed country after country, oil demand started to gain momentum. Hence, prices of crude oil made a comeback to soar up to $46.16 for Brent, and $43.39 for WTI on August 26. But since then, prices started to fall, with new cases continuing to appear in countries, and with it rose the need for more focused 'smart' lockdowns because in many countries nationwide lockdowns had affected economy quite badly and with it levels of poverty.

To give stability to this dramatic free-falling of crude oil prices in March and April, a strong need was felt to cut on supply of crude oil, which nevertheless was not an easy task given both the technical aspects of production, and years of heavy investments in production infrastructure to meet increasing energy demand needs. According to a recent Wall Street Journal (WSJ) article 'Saudis, other OPEC producers consider deeper cuts amid pandemic' by Benoit Faucon and Summer Said, 'In April, OPEC, a 13-member cartel led by Saudi Arabia, and 10 Russia-led producers agreed to carry out record production cuts of 9.7 million barrels a day.... The accord called for producers to return that production gradually, in stages of two million barrels of added crude a day, every six months.... Last month, The Wall Street Journal reported that Saudi Arabia and other producers had started debating whether or not to delay opening up the spigots by three months. Such a scenario, at a minimum, is now increasingly likely, OPEC officials said. Amid increasingly bearish oil prospects more recently, Saudi Arabia and other oil producers in the OPEC alliance are also now considering new cuts as one of several options to deal with lackluster demand, officials in these countries said. Deeper curbs "is now an option," said one of these officials.'

For such a bearish scenario for oil prices, and if the extent of crude oil price fall during the first wave is any indication - with the caveat that the second wave is expected to be lesser in intensity - it is important that countries like Pakistan, which are net importers of crude oil, should try to lock in early futures contracts to take advantage for their balance of payments. The government in Pakistan should learn from its lack of proper hedging planning in the oil sector during the first wave, where together with the reportedly 'collusive games' of domestic oil suppliers, artificially impeding supply in turn, proactive and more efficient planning should be adopted.

The related authorities in the country should avoid repeating mistakes of the sort, some of which were highlighted in this writer's June 19 article 'Fragile oil markets' in Business Recorder as 'Unfortunately, Pakistan as a net oil importer, and whose energy production relies heavily on furnace oil, has not been able to take any significant advantage of the crash in oil prices, where the fall began as far back as three months ago. Firstly, there was an issue of appropriate storage capacity to cash in on the windfall gains in the wake of the pandemic. Secondly, the government reportedly delayed moving towards a hedging policy to obtain insurance that helped lock-in better futures.... Thereafter, rather than passing benefit of oil price crash on to masses, petroleum levy was significantly increased.'

The reason, in addition to the second wave and 'long Covid', whereby prices may continue to drop quite significantly over the winters even as OPEC tries to adjust supply, is higher supply from both Norway and Libya. A recent WSJ article 'Oil prices close higher after volatile session' by David Hodari highlights the following: 'In Norway, an end to the labor dispute at the country's vast Johan Sverdrup field means production there could hit a record high of 470,000 barrels a day this month, according to Eugen Weinberg, head of commodities research at Commerzbank. That is in addition to Libya's rapidly recovering supply. After negotiating an end to an eight-month blockade on its oil, the North African producer's supply has recovered to 800,000 barrels a day-already above the 700,000 barrel figure the International Energy Agency forecast for the end of 2020. The country's national producer expects production of 1.3 million barrels a day by early next year, according to Bloomberg.'

(The writer holds PhD in Economics from the University of Barcelona; he previously worked at International Monetary Fund)

He tweets@omerjaved7

Copyright Business Recorder, 2020