How do oil prices affect the price we pay for petrol and diesel?
Two key points are important when it comes to the price of fuel at your local service station.
First, if we didn’t have to pay for oil itself – if it just magically appeared in our pumps – then Irish consumers would still have to pay 74 cent for the privilege of putting a litre of petrol into their car and 63 cent for a litre of diesel. This is because the Government adds on a raft of excise duties, including the carbon tax.
Second, the price we're paying today reflects the price the market was charging about five weeks ago, not five hours ago. This time lag means that even though oil prices turned negative earlier this week, nobody will be paying us to fill up our cars today. The negative movement should, however, translate into a saving over time, according to David Horgan, chief executive of oil exploration company Petrel Resources.
What sort of savings are we taking about?
At this stage, you’ll likely have heard news of a crash in the price of oil on Monday. The importance of that has been overstated but we’ll get to that later. Even so, because prices on the market are down, we can expect the price of petrol and diesel at the pumps to fall by about 17c, in maybe five weeks’ time. That is contingent, however, on refiners and retailers passing on the savings and assuming that the Government doesn’t step in with extra taxation.
Why do I keep hearing about Brent and WTI?
Brent is a tradeable index based on the production of four oil fields in the North Sea and it's what speculators and traders follow in the markets. WTI, meanwhile, is a grade of crude oil traded out of Cushing, Oklahoma and, as a result relates to the north American market where it is more commonly traded. WTI, which stands for West Texas Intermediate, typically trades at a lower price than Brent.
I heard WTI prices were negative on Monday. So would the market really have paid me to take a barrel of oil?
The short answer is no. When we saw the market price for WTI turn negative on Monday, there was a common misconception that, in effect, the markets were paying traders to take oil off their hands, explains David Horgan.
The reasons for this are complicated, but essentially for every barrel of oil consumed in the world, 30 are traded. This means that financial institutions and hedge funds are speculating now on the price of oil that will be delivered in May. Contracts for May had to be settled by April 21st, and with a raft of traders left with oil contracts on their hands in the face of extremely low demand, they were forced to offload their contracts at negative prices.
Who sets this price?
The price isn't set by the oil producers, the refiners or the likes of Shell or BP – it is set by speculators. The vast majority of prudent traders, Horgan explains, would have offloaded their contracts up to two weeks in advance of the April deadline. When many didn't, and despite the Covid-19 pandemic suppressing demand, they still had to fulfil their contractual obligations. Because none of these traders can ever take delivery, they usually offload their positions early, but this wasn't possible on this occasion due to a perfect storm.
Horgan notes that the weight of speculative money is greater than fundamentals, meaning that the speculators aren’t paying a whole lot of attention to production volumes or delivery schedules. They’re merely trying to make money by buying oil low and selling it higher before they ever have to look at a single barrel. What happened on April 20th is that these speculators were squeezed when rumour spread in the market that there would be nowhere to store oil.
What does that mean for prices in June or beyond?
Futures prices, at the moment, appear much less affected, says Horgan. “Though it’s hard to know if anybody is trading,” he adds. This situation was a “contango”, where future prices are higher than present prices, which, Horgan explains, is normally a strong Buy signal. While the June contract for American WTI is around $21, a similar storage squeeze could recur and, as such, that price seems unlikely to be sustained. If prices do stay very low, supply in the US could start to be shut down on a large scale, a time-consuming and expensive prospect.
What started this whole thing?
A price war been Saudi Arabia and Russia is at the heart of this problem. When the Saudis tried to get they Russian colleagues to cut production, the latter wasn't all that fazed about the spread of Covid-19 and the resultant impact on oil consumption. So, Saudi Arabia deeply discounted its product. The Kremlin eventually backed down, but it wasn't until around April 13th when the deal was closed.
And then they cut production, right?
That's right, at least temporarily. It's worth noting that last year, just more than 100 million barrels of oil, natural gas and biofuels were produced every day. The biggest cut in history was in the aftermath of the 2008 collapse of Lehman Brothers, when producers culled production of 2.9 million barrels per day. This month, however, producers agreed to cut 10 per cent of production.
Why didn’t that steady the ship?
Because of the collapse in global aviation, and the fact that the majority of us aren’t using our cars, Wall Street had been expecting a cut in the region of 20 per cent.
Could this cut allow the Government increase the carbon tax?
There’s no guarantee that prices will remain depressed when the global economic returns to relative normality. But if they do, it would be logical to think that it will be an opportunity for the Government, which will have large tax revenue gaps to fill as a result of Covid-19, to add on a few more cents at the pump.
