A History of Rising and Fall of Oil Prices - Answers

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 A History of Rising and Fall of Oil Prices

Map of World Showing Oil Producing Countries
Map of world depicting oil producing countries as per the year 2019 along with the table showing top 10 oil producing countries in the world.

On April 20, 2020 (Monday), the oil price crashed to hit a new low due to excess supply, which in turn is fueled by the COVID-19 pandemic and the Russia–Saudi Arabia oil price war of 2020.

The WTI (West Texas Intermediate) crude oil futures expiring in May 2020 crashed by 321% to negative territory (to -$40.32 per barrel). This is the lowest level ever recorded. This happened because uncertainty mounted regarding the storage of excess fuel.

The WTI Crude Oil Prices reached a year and an all-time low at $11.26 in April 2020. Since then, the price has recovered a bit and is now currently trading at $29.47 per barrel (as of May 15, 2020).

A highly unusual occurrence took place during April 2020. The WTI market had entered a contango, which means that the spot prices of crude oil were lower than that of its future delivery price.

Brent crude oil price had dropped by 9.5% in April 2020 to $25.41 at intra-session lows. Brent crude oil went further down to $21.27 in April-end, the second-lowest figure in a decade. The only time, the Brent crude oil price was lower than this level back was in November 2001, when it reached $18.67.

Brent crude oil price has recovered a bit since April 2020 and is now (6.05 AM GMT, May 11, 2020) trading at $30.45. Analysts believe that by the storage capacity problem of crude oil (which in the first place triggered this crash) would go away rapidly in the second half of this year, which would help stabilize the crude oil market.

Why did Oil Price Crash and go Negative?

The first body blow to oil price took place when the demand for crude oil plummeted due to the freezing of activity world over due to coronavirus outbreak. With COVID-19 becoming a pandemic, governments all over the world had imposed lockdowns and movement restrictions. This caused a drastic slump in fuel use in cars and planes, leading to an excess supply of crude oil.

The OPEC and its allies agreed to the biggest-ever cut in crude oil production to backstop prices. However, the investors remained unconvinced that the production cut could offset the sudden collapse of demand for crude oil. Their fear is not unfounded because the COVID-19 pandemic is keeping societies across the globe from operating normally. This led to the panic among investors, leading to a historic fall in crude oil prices.

The West Texas Intermediate (WTI) crude oil future for May traded at large discounts. The main reason why the WTI future for May went negative is the fear that a key storage hub in Oklahoma’s Cushing (a major oil supply hub in North America that connects oil suppliers to the Gulf Coast) neared capacity. This has put forward an opportune moment for the bears in the market for mayhem.

Map of Oklahome Showing Location of Cushing City (Major Oil Supplying Hub in Oklahoma)
Map of Oklahoma depicting location of Cushing city – the major oil supplying hub

According to AvaTrade’s chief market analyst, Naeem Aslam, the steep fall in crude oil prices has been due to:

  • Lack of sufficient demand in the crude oil market, leading to oversupply and
  • Lack of storage place (considering the fact that production curtailing has failed to address the problem of supply glut)

A History of Rising and Fall of Oil Prices

Here are the oil price trend timeline and the reasons related to the rise or fall of oil prices:

  • 1861-1970s: Global crude oil prices remained relatively consistent.
  • 1960: OPEC (Organization of the Petroleum Exporting Countries) was formed by the first 5 member countries:

Saudi Arabia, Iraq, Iran, Kuwait, and Venezuela in Iraq’s Baghdad. The countries that joined OPEC are Qatar, Libya, United Arab Emirates (UAE), Algeria, Nigeria, Ecuador, Gabon, Angola, and Equatorial Guinea.

OPEC was formed to increase the member countries’ influence in the global oil market, which was at that time dominated by the cartel of 7 companies (known as “Seven Sisters”), out of which 5 were headquartered in the USA. These 7 companies were controlling the crude oil prices from 1927-28 (after the Red Line Agreement of 1927 and Achnacarry Agreement of 1928).

  • The 1970s: Oil crises of 1973 (oil embargo proclaimed by the Organization of Arab Petroleum Exporting Countries) and 1979’s Iranian Revolution led to a significant rise in global oil prices.
  • 1973: The Arab members of the OPEC imposed an embargo against the USA during the 1973 Arab-Israeli War for the US decision of re-supplying the Israeli military and gaining leverage in the post-war peace negotiations. The embargo was extended to other countries, including South Africa, Portugal, and the Netherlands. During this time of the embargo, the oil production was curtailed along with a ban of petroleum exports to the targeted countries.
  • 1979: The Iranian Revolution of 1979 constrained the global oil supply, and the oil price more than doubled.
  • The 1980s: The average global oil price increased to $107.27 in 1980. However, due to the OPEC embargo in the early-1980s, oil prices declined rapidly. In the early 1980s (as per The Economist), the non-OPEC countries, including the United States of America and Britain, increased oil production significantly, leading to a glut in the oil market. This led to a significant fall in oil prices in the early 1980s.
  • 2008: After the US financial crisis, global oil prices increased sharply in 2008. However, it soon crashed.
  • The 2010s: The oil glut of the 2010s started with a more than 6-years of time lag after the Great Recession of 2007-08 started.
  • 2011: Oil prices again reached a record high level in 2011. The situation was significantly different from that of the recessionary cycles since the start of the First Persian Gulf War of 1980. However, there was no guarantee that the prices will remain at such high levels in perpetuity.
  • 2014-16: The OPEC members exceeded their production ceilings consistently. At a 2014 meeting in Vienna, the OPEC countries decided not to cut oil production. This led to one of the sharpest drops in OPEC’s benchmark crude oil (by a whopping 50%). A significant slowdown in economic growth was experienced by China.
  • In 2016, the price drop continued and reached a year-low at $26.19, one of the lowest crude oil prices in the history of West Texas Intermediate (NYMEX) Crude Oil.
  • 2018: Late-September and Early-October of 2018: The crude oil price increased to a 4-year high to more than $80 for the benchmark Brent crude index in late-September and early-October of 2018. This price rise was mainly because of the investors’ concerns regarding the constraints present in global supply.
  • 2019: September-October 2019: The USA’s petroleum (both crude oil and products) exports exceeded that of the imports in two consecutive months of September and October 2019. The monthly values since 1973 show that this is the first time ever that the US exports of petroleum have surpassed the imports.
  • 2020: Crude oil prices have decreased significantly in 2020. The main reason behind this drastic fall is the COVID-19 coronavirus pandemic. It caused a sharp fall in the stock market too. The HIS Market said that the contraction experienced by the market due to “COVID-19 demand shock” in 2020 is bigger than that experienced during the Great Recession of 2000s as well as 2010s.
  • March 8, 2020: An oil price war started on March 8, leading to a 30% drop in the price of oil prices later on the same day. This is the largest one-time price drop, the petroleum market experienced since the Gulf War of 1991. The oil was trading at $30 per barrel. At such a low price, it is difficult to produce oil. It was especially tough for the countries whose production costs were high such as Venezuela, the UK, Canada, Nigeria, and Brazil. In fact, it was even not viable enough for the oil-producing nations having the lowest oil production cost (such as Iraq, Iran, and Saudi Arabia) to keep producing oil.
  • April 20, 2020: The Bloodiest Day when the Market Went Negative

On the fateful April 20, 2020, the demand for storing the large surplus of oil produced increased excessively. This led to the uncertainty in storing the surplus oil, making the investors fearful of future prospects.

As the major oil supply hub in North America, Oklahoma’s Cushing neared storage capacity, the investors panicked. This led to the bloodbath in the market, making the West Texas Intermediate (WTI) crude oil futures of May to go into the negative territory (-$40.32 per barrel), which is the lowest level ever recorded in the history of oil prices. In fact, this is the first time ever that the oil price has gone negative (since the New York Mercantile Exchange started trading in 1983).

  • April 27, 2020: The current WTI crude oil price reached $11.26, which is lower than the 1999’s low of $11.38 but higher than 1998’s low of $10.82 (a historical low since 1987).
  • May 15, 2020: The current WTI crude oil price recovered a bit but still was trading below $30 ($29.47 per barrel as on May 15, 2020).

Oil Price Going Negative: Can it Happen Again?

Brent Crude index, the more widely used oil index, has moved downwards slowly than that of WTI. Nonetheless, it too moved downwards. The Brent Crude index contract had also fallen to a 21-year low level in April 2020, but its performance was not as bad as WTI. Almost a month has passed since that fateful crash day. Despite news of US stockpiles nearing full, the oil price has seen a slow recovery in the last one month.

The US CFTC (US Commodity Futures Trading Commission) has warned the traders that the WTI Oil index’s June contract can again go negative as it nears its expiry. In a letter, CFTC has warned the investors that the “registrants should remain vigilant and prepare accordingly” one month after the first nosedive to the negative region.

Experts say that the traders are investing cautiously this month because of the bloodbath last month. As on May 12, 2020, investors were holding contracts worth 155 million barrels of oil, a sharp dip from the 232 million barrels of oil in contracts at the equivalent time last month. However, this level is still way above the average level in the short run.

Former BP CEO John Brown has said that as the global demand for oil remains low and their storage remains at a near-full level, the risk of going negative again remains unavoidable.

Though the oil prices have increased slowly, the risks of falling remain high. This is because the chances of storage level getting back to lower levels are highly unlikely.

The surplus oil supply hasn’t gone yet despite losing a few thousand barrels this week. The market is long away from getting balanced and it will take some time to reach that level. Therefore, no one can rule out the chances for the oil price to go negative again.

Is there any Advice for the Investors after the Oil Price Crash?

Yes, there is some cautionary advice for all the investors who are in two minds about investing in oil after the oil price crash last month.

#1 Don’t Lose Sight of the Basics

Per barrel cost of shale companies is around $50. However, the WTI oil price is hovering around $30, almost half the per barrel cost of oil production. Therefore, for each barrel of drilling, the shale companies are making losses of around $20 per barrel.

In addition, there is almost no demand in the global market as the world is going through the lockdown phase amidst the COVID-19 coronavirus crisis. The lack of global demand has maintained a consistent oversupply of oil, keeping the storage to the near-full level.

Most experts believe that the oil price will remain low for months, if not years to come. Until and unless the oil producers are able to answer how they are going to produce oil below the selling price (after factoring in overhead, taxes, and everything else), it is certain that you’ll lose money by investing in oil.

#2 Don’t Chase the Dividends

The oil stocks are also on a declining spree, thanks to the uncertain situation in the oil production market. To entice dividend investors, many companies are offering dividend yields. Some companies are paying out as much as double-digit dividends to the investors. Though some of them are worth buying, most of them may turn out to be yield trap.

Most of the oil producers are not making money because of the low oil price and are currently making a loss of around $20 per barrel. With the weak global demand for oil, the scenario is likely to continue for months, if not years. Therefore, it is likely that the sector’s payouts won’t survive this downturn.

If you are a dividend investor, you should focus more on the ability of the dividend this storm rather than the yield size.

#3 Prudent to Wait for a Better Opportunity

Oil prices are at their all-time low levels. The shale companies are making a loss of around $20 for each barrel of oil production. With every barrel of oil produced and sold, the oil companies are losing money. Therefore, it is very important for oil companies to survive this onslaught.

If you invest now and hold it until the dust settles, it may rip you immense benefit. However, it is more important that the company you are betting on survives this trying time. If your speculative bet goes wrong and the company you have bet on doesn’t survive, your portfolio is going to have a gaping wound that would take a long time to heal.

So, there is no harm in waiting for the dust to settle, and the scenario gets clear who the survivors in the market are. This will at least save your portfolio from getting worse.

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