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What really led to oil prices crash that hit the stock markets

In Episode 410 of #CutTheClutter, Shekhar Gupta lays out the factors that have come together to cause the current market crisis.

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New Delhi: Markets are struggling with a one-two punch at the moment: the oil war between Russia and Saudi Arabia, and the coronavirus. Apart from the virus epidemic, the crisis is also exacerbated by a global economic downturn and a strategic vacuum.

With the US withdrawing from global affairs, the centre of gravity of the strategic world has gone, making every man for himself. This is what Saudi Arabia and Russia are doing.

How did these factors come together?

Coronavirus slowed down the global economy by reducing energy consumption and driving down demand for oil. People have stopped travelling, reducing the need for jet and other types of fuel. This in turn affects the demand, which has pulled oil prices down.

Stock markets are also reacting to the declining demand due to coronavirus. The markets build a projection of global oil demand over the long term. Since things are looking grim, projections of the future oil demand curve are also on the decline.

At the root of this is a tussle between Saudi Arabia and Russia.

As demand for oil had been falling, Daniel Yergin, a sectoral expert, said a 4 per cent supply cut would be necessary for prices to be maintained. Saudi Crown Prince Mohammed bin Salman suggested a 1.2 per cent cut in supply, but the Russians refused, saying the current price suited their economy.

Since Russia didn’t agree, Saudi Arabia retaliated by launching a price war, flooding the market with oil and lowering prices.

The US too becomes a victim now.

In 2018, the US became the largest producer of oil in the world, leaving Russia behind. It would have suited Russia for the prices to remain low or go lower, because it would have rendered the prices of shale gas – in which America is a big dealer – unremunerative.

Also read: Why oil prices are going down and how it affects the Indian economy

The OPEC+ consensus

In 1973, after the Yom Kippur war in the Middle East, Arab countries that formed the bulk of oil exporters decided to cartelise and keep prices high.

Later, the Organization of the Petroleum Exporting Countries (OPEC) decided to bring things together, and became complaint to global needs, and a destabilising force for oil prices.

OPEC — which includes Saudi Arabia and 15 other countries — expanded later to include OPEC+, who are non-member states. Russia is the most important member of this because it is a big oil manufacturer.

According to Yergin, the price drop due to coronavirus is what “broke” the OPEC+ consensus.

What does this mean for India?

India is the world’s third-largest oil importer and the fourth-largest buyer of liquefied natural gas in the world. If prices remain low, India could save $30 billion a year. Every dollar drop in the price of oil decreases the import bill by Rs 10,700 crore on an annualised basis.

But India’s stock markets are still affected for two big reasons. One is that its markets are coupled with the rest of the world. The second is that the heaviest weight on the stock market indices is Reliance Industries Ltd (RIL). RIL gets a bulk of its income refining oil, and its margins also drop with the lower oil prices.

In addition to this, Saudi’s Aramco has been planning to pick up a stake in RIL. Indian markets are concerned that with the current price war, the Saudis will go back on their commitment.

Also read: India set to gain on OPEC+ deal failure after oil windfall on coronavirus

You can watch the full episode of #CutTheClutter here.

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