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2021 | OriginalPaper | Chapter

COVID-19 and the Big Oil Price Crash: Exploring the Anatomy

Author: Kaushik Ranjan Bandyopadhyay

Published in: Sustainable Development Insights from India

Publisher: Springer Singapore

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Abstract

Crude oil prices have fallen drastically since the beginning of 2020 driven by the lethal double blow of economic contraction caused by the 2019 novel coronavirus disease (COVID-19) and suspension of an OPEC-NOPEC (OPEC+) deal due to defection of Russians. Eventually a price war got waged by Saudi Arabia and led to a protracted disequilibrium and volatility in the world oil market. The worst fallouts could be observed when Western Texas Intermediate, the benchmark crude oil futures price plunged below zero for the first time on 20th April 2020 and made it a Black Monday. The huge volatility made energy companies file for their bankruptcy; the shale in the US and the much-hyped American energy dominance got severely battered; caused huge job losses; and bruised the financial institutions that have been backing these industries. The coupling of unprecedented demand and supply shocks tested the oil market and its storage capacity to the limits. To gauge these issues and the imbalances that has been building in the system more carefully, the chapter examines the changing dynamics of oil markets in the COVID-19 affected world in deeper details.
Footnotes
1
Implied volatility measures an asset’s expected range of near-term price changes. OVX measures the implied volatility of oil prices and is calculated using movements in the prices of financial options for WTI, the light, sweet crude oil priced at Cushing, Oklahoma. VIX measures the implied volatility of the Standard and Poor’s (S&P) 500—a stock market index of 500 large companies listed in the United States. Crude oil volatility is typically higher than the S&P 500’s volatility, generally because OVX represents changes in one commodity and VIX represents changes across a diverse group of 500 companies (see EIA, 2020).
 
2
The behavioural psyche of the dominant producer within OPEC like Saudi Arabia who waged a price war could find explanations with the recent advances in game theoretic approach to model behaviour of oil producers. The recent advances known as mean field game theory has been advocated and applied by French mathematicians Pierre-Louis Lions, Jean Michel Lasry and Olivier Gu´eant in their recent paper focusing on oil production (Lions et al., 2020).
 
3
Stranded assets are “assets that have suffered from unanticipated or premature write-downs, devaluations, or conversion to liabilities” (for more details on different perspectives on stranded assets see Caldecott 2017).
 
4
I have argued earlier that it is not correct to think that Saudi Arabia, the dominant producer within OPEC always act as a residual swing producer and respond to the call or the amount of oil demanded from it (after accounting for NOPEC production and inventory adjustment), unless doing so serves its interests in the best possible manner (see Bandyopadhyay, 2008).
 
5
International Energy Agency (IEA) and Energy Information Administration, Department of Energy, USA (EIA) tend to assume the existence of an equilibrium price path. After calculating the world oil demand and non-OPEC output, the latter is subtracted from the former after allowing for stock adjustment. This gives the oil demanded from OPEC (often referred to as “call on OPEC”). For more details see Bandyopadhyay (2008).
 
8
 In addition to futures contracts, another way for market participants to invest in crude oil is through the buying and selling of options contracts. Options allow for investment exposure with limited potential for losses and provide an insurance-like instrument against adverse commodity price movements. See https://​www.​eia.​gov/​finance/​markets/​crudeoil/​financial_​markets.​php (accessed 28 August 2020).
 
9
The contango gets deepened when the near-term futures prices are way lower than longer-dated ones.
 
12
The explanation and illustration draws largely on the information and details contained in https://​www.​eia.​gov/​petroleum/​weekly/​includes/​analysis_​print.​php (accessed on August 20, 2020).
 
13
In case of a failure to accept physical delivery the specific costs that an owner of crude future has to incur depends on the specific contractual arrangements entered into by the contract holder and the Futures Commission Merchant (FCM)—the entity responsible for executing the buying and selling of futures contracts on behalf of a client. The possible costs may involve a combination of direct monetary penalties, reputational consequences, the liquidation of the collateral deposited by the client in the margin account with the FCM, the revocation of trading privileges, and the costs of any legal settlements resulting from the breach of contractual obligations. (see- 7/200422/includes/analysis_print.php (accessed on 05 September 2020).
 
14
The second wave of infection could actually be more deadly as evinced by the experience of Spanish Flu, see https://​www.​miamiherald.​com/​news/​coronavirus/​article242371006​.​html (accessed on September 2, 2020). For an illustration of impact of second wave of infection please see: https://​www.​wsj.​com/​articles/​why-a-second-wave-could-be-even-worse-for-sports-11587117600 (accessed on September 2, 2020). Also see an excellent commentary that came out in The Guardian on the lessons that we can apply for the current pandemic from Spanish Flu https://​www.​theguardian.​com/​commentisfree/​2020/​apr/​29/​us-responses-1918-flu-pandemic-offer-stark-lessons-coronavirus-now (accessed on September 2, 2020).
 
Literature
Metadata
Title
COVID-19 and the Big Oil Price Crash: Exploring the Anatomy
Author
Kaushik Ranjan Bandyopadhyay
Copyright Year
2021
Publisher
Springer Singapore
DOI
https://doi.org/10.1007/978-981-33-4830-1_12

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