Venezuela: The Oil Problem

Venezuela: The Oil Problem

Venezuela President Nicolás Maduro‘s decision to grant pardon to over 100 political opponents and activists has drawn suspicion from critics, who have been protesting against his regime for years. The episode is a manifestation of the turnaround of the country’s fortunes, once considered the wealthiest Latin nation due to oil reserves in the country, to now being a center of hyperinflation and extreme poverty. Let us have a look at the history of Venezuela with respect to oil.

Crux of the Matter

Venezuela And The Oil Problem

  • Venezuela was the leading exporter of oil in the world before World War II.
  • It became a founding member of the Organization of the Petroleum Exporting Countries (OPEC) in 1960-61.
  • Following the ‘Arab-Israel’ War of 1973, Venezuela tripled its oil prices. Consequently, the country witnessed a booming economy in the subsequent years, as witnessed in the fact that Venezuela had the highest ‘per capita income’ in Latin America at the time.
  • Late 1970s and 80s: Oil prices fell across the world – pushed Venezuela into recession and increased inflation.
  • 1992: Lieutenant Colonel Hugo Chávez imprisoned after a failed coup attempt.
  • 1998: Venezuela was in dire straits as annual inflation reached 30%. Hugo Chávez was elected as the President that year.
  • Chávez implemented socialist policies and took an anti-US stance.
  • 2001: He implemented wealth redistribution measures in the country.
  • 2007: The nationalization of the petroleum sector was initiated by the Government, which removed US oil companies Exxon Mobil and ConocoPhilips from the Orinoco Belt (large oil source).
  • 2013: Chávez died due to cancer, after which Maduro assumed the Presidency.

Also Read: Venezuela: Election Controversy

Curiopedia
  • United States of Banana is a postmodern geopolitical tragicomedy by the Puerto Rican author Giannina Braschi. The book dramatizes the global war on terror and has Hugo Chávez as a heroic character in it. 
  • Colectivos are irregular, leftist Venezuelan community organizations that support Nicolás Maduro and the Bolivarian government. Colectivo has become an umbrella term for armed paramilitary groups that operate in poverty-stricken areas and attack individuals, engaging in “extortion, kidnapping, drug trafficking and murder”.
  • Popular Will is a political party in Venezuela founded by former Mayor of Chacao, Leopoldo López. The party describes itself as progressive and social-democratic and was admitted into the Socialist International in December 2014.

Why Are Petrol Prices Rising?

Why Are Petrol Prices Rising?

In the last few days prices of petrol and diesel have rocketed in India. Let us understand what is causing the fuel prices to rise at a time when crude oil prices are low due to the pandemic.

Crux of the Matter

Components Of Oil Price
Oil price is divided into many components. The first component is the base price at the international crude price. Then the cost of transport and ocean freight charges are added in the base price. After this, the cost of refinery transfer is added to the price of oil and is sold out to the dealers. Now the central government of India imposes central excise duty and cess on petrol and diesel prices.

Dealers add their commission in the total price of oil. Dealers will transport fuel to different states and every state imposes state-specific Value Added Tax (VAT) on the fuel. Finally, the customer pays the final price of fuel.

The central government earns 58% of excise duty and 100% of Cess. States earn 42% of Excise Duty and 100% of VAT.

Understanding The Paradoxical Price Rise
In theory, price of Petrol & Diesel should be determined by the crude price. Crude has fallen in 2020 but fuel prices have increased in India. The price rise is because of an additional duty imposed by the government. This could be to compensate for revenue loss due to the pandemic.

Curiopedia
  • The earliest known oil wells were drilled in China in 347 CE. These wells had depths of up to about 240 metres (790 ft) and were drilled using bits attached to bamboo poles. The oil was burned to evaporate brine and produce salt. By the 10th century, extensive bamboo pipelines connected oil wells with salt springs. The ancient records of China and Japan are said to contain many allusions to the use of natural gas for lighting and heating. Petroleum was known as burning water in Japan in the 7th century.
  • According to Herodotus, more than four thousand years ago natural asphalt was employed in the construction of the walls and towers of Babylon, great quantities of it were found on the banks of the river Issus, one of the tributaries of the Euphrates, and this fact confirmed by Diodorus Siculus. Herodotus mentioned pitch spring on Zacynthus (Ionian islands, Greece). Also, Herodotus described a well for bitumen and oil near Ardericca in Cessia
  • The earliest oil wells in modern times were drilled percussively, by repeatedly raising and dropping a cable tool into the earth. In the 20th century, cable tools were largely replaced with rotary drilling, which could drill boreholes to much greater depths and in less time.
  • The 2010s oil glut is a serious surplus of crude oil that started in 2014–2015 and accelerated in 2016, with multiple causes. They include general oversupply as US and Canadian tight oil (shale oil) production reached critical volumes, geopolitical rivalries amongst oil-producing nations, falling demand across commodities markets due to the deceleration of the Chinese economy, and possible restraint of long-term demand as environmental policy promotes fuel efficiency and steers an increasing share of energy consumption away from fossil fuels.

Excise On Oil Hiked Without Impacting Customers

Indian government announced an excise duty hike of ₹10 and ₹13 on petrol and diesel respectively. With this move, the government is aiming to earn additional revenue without burning holes in the pockets of the consumers. However, oil companies that earned massive margins on fuel these days, will have to lose that after they adjusts base fare of oil to prevailing crude oil price.

Crux of the Matter

Excise Duty Hike
The Indian government announced a hike in the excise duty levied on petrol and diesel. Previously, Centre had levied ₹3 additional excise on both on 14th March 2020. It had expected to earn additional revenue of ₹39,000 crores. With this increase, the government is expecting additional revenue of ₹1.6 lakh crores.

However, the incidence of the hike this time does not fall on the consumer. The government has asked the oil companies to adjust their base oil prices to the prevailing crude oil rate. It must be noted that oil companies have not reduced the base fare of fuel prices since 16th March 2020. Therefore, the prices of petrol and diesel will not rise because of the hike and will continue to be calculated as the average of the last three days’ price.

Benefitting From The Low Price
Petroleum Minister Dharmendra Pradhan said India took the benefit of low crude oil prices and stockpiled 32 million tons of crude oil. To store 1 ton oil, 7.33 barrels are required. Therefore, (32 million tons x 7.33 barrels) equals ~230 million barrels – procured by India as reserves.

India’s expected oil demand per day in 2020 is 4.73 million barrels per day. Hence, (stockpile of 230 mn barrels / 4.73 mn barrels demand per day) equals 48 days of oil demand that can be met with the current reserves. This is ~ 13% of yearly demand.

Who Gets What?

Curiopedia
  • John Davison Rockefeller Sr. was an American business magnate and philanthropist. He is widely considered the wealthiest American of all time, and the first Billionaire. Rockefeller founded the Standard Oil Company, which was produced, refined, and transported oil. Adjusted for inflation, he is considered to be the richest person in a modern post-industrial world.
  • The Organization of Arab Petroleum Exporting Countries (OAPEC) is a multi-governmental organization headquartered in Kuwait which coordinates energy policies among oil-producing Arab nations. OAPEC’s primary objective is safeguarding the cooperation of numerous members in various aspects of economic activity within the oil industry as well as maintaining strong relations among themselves. It is different from OPEC.
  • The Deepwater Horizon drilling rig explosion happened on April 20, 2010, resulting in a fire on the Deepwater Horizon semi-submersible Mobile Offshore Drilling Unit (MODU), which was owned and operated by Transocean Ltd. The explosion and subsequent fire resulted in the sinking of the Deepwater Horizon and the deaths of 11 workers and injury to 17. It is considered to be the largest accidental marine oil spill in the world, and the largest environmental disaster in US history.

COVID-19 Pushes US Crude Oil Traders to Pay to Sell Oil

The COVID-19 crisis has destroyed the global demand for energy. The US crude oil prices traded below zero for the first time in history as West Texas Intermediate (WTI) May Futures contract settled at negative $37.63 per barrel. Simply it means that the producers are paying to get rid of their oil.
Complete Coverage: Coronavirus

Crux of the Matter

How Did it Happen?
To explain in the simplest of words: Crude oil supply didn’t fall and demand didn’t rise, resulting in this historic fall. Crude oil is one of the world’s most precious commodities and price changes in it affect the economic ecosystem right from family budgets to the nation’s GDP. 

Oil futures contracts are traded by the month and have never gone into negative before. The June WTI contract, which expires on May 19, plunged about 18% to settle at $20.43 per barrel. The July contract was about 11% lower at $26.18 per barrel. The international benchmark oil price, Brent crude also has fallen to 18-year low from January 2020 but is still above $20 a barrel.

Since the coronavirus pandemic began, many governments imposed strict lockdowns and restricted travel due to which the demand for oil dropped by one-third to about 29 million barrels a day and so dropped its price. The graph below depicts the fall of the WTI crude oil prices in the past 1-month span from $40 to a negative $37 due to the pandemic and worldwide lockdowns and

Crude Oil Futures Crash

Oil prices are volatile as they’re affected by the laws of supply and demand and prices are determined by oil futures contracts on the commodities markets. This basically means that commodities traders control oil prices and they go up if traders think there will be a surge in demand and go down if traders think there will be a drop.

1-Day Percentage Drop in Crude Oil Prices (1986-2020)

Who Wins, Who Loses?
During Iraq’s invasion of Kuwait in 1990, a trader took massive positions at cheap prices ahead of the invasion and sold them when prices rose after the invasion. Oil was stored in tankers floating on the sea and unloaded at considerably higher prices. Similar to this practice, taking advantage of cheap prices, many oil-importing countries are now storing large quantities of oil as reserves. In the graph below we can see the timeline of crude oil prices from 1950 to 2020. The prices went as high as $160 after the 2008 financial crisis and after which its downfall began.

Russia and Saudi Arabia depend heavily on its oil revenues to sustain their economies as 38.9% and 50% respective GDPs comes from oil. All oil-producing nations need higher prices to balance their budget and also account for their losses too. American shale oil companies find it very hard to survive if oil prices are low.

The world’s oversupply of oil is particularly critical in the US which produces 10 million barrels a day as compared to other regions like the United Kingdom where oil prices are still above zero because they have lower transport costs and easy access to ports. The reduced prices will be a boon for cash-strapped airlines as it will make it cheaper to operate flights but due to the worldwide lockdown, all the flights remain grounded and so is with other modes of transportation.

India’s fuel demand reached its lowest in 2 decades in March and declined by 17.8%. This benefits India as the foreign currency being spent to import the oil will reduce substantially giving relief to the growing concerns of the fiscal deficit. China is historically a stockpiler of oil when prices are low. The lower price of oil can benefit oil-importing nations.

The Demand-Supply Mismatch
Keeping in mind the reducing demands, OPEC+ had agreed to cut production by 9.7 million barrels a day which still is very less as there is already a huge surplus of oil in the market with no buyers and nearly filled storage capacities.

OPEC and its members were abiding by an agreement to limit production but it expired on March 31 and later Russia refused to lower production after which the OPEC+ responded by announcing an increase in production. Oil producers continue to produce crude from their wells causing a major imbalance between supply and demand.

Storage Capacity Running Out
The oil demands have hit a 25-year low as the pandemic has devastated all areas of the economy making practically impossible to travel by road, air or water. According to energy experts, there is an estimated storage capacity for 6.8 billion barrels in the world out of which nearly 60% is filled and with increasing difficulties to find storage spaces the companies could be forced to shut down their wells.

People are concerned that we are going to see so much build-up of inventory that it’s going to be very difficult to fix in the near term and there are going to be a lot of distressed cargoes on the market.

Michael Lynch, President of Strategic Energy & Economic Research Inc

According to a report in the Wall Street Journal, hiring charges have increased multiple times as there is a growing demand for floating storage to take advantage of low prices but that too will soon run out of capacity. The floating storage has risen by 120% in the past 8 weeks to a record high of more than 120 million barrels which is more than double the seasonal norm wherein the highest growth is seen from the Asia-Pacific region.

India has been filling its strategic reserves by taking advantage of the cheap prices. India has a capacity to hold over 39 million barrels at its strategic reserves in Vishakhapatnam, Mangalore, and Padur (Udupi).

As of now, the plan is to fill the caverns by the 3rd week of May before the arrival monsoon rains. We are buying oil from state refiners.

H.P.S. Ahuja, MD Indian Strategic Petroleum Reserves Ltd (ISPRL)

Hopes Of Recovery
It is highly expected that the oil prices recover very soon as in the month of May the oil demands are expected to be lowest and supplies are expected to be highest. Soon oil traders will begin trading barrels for delivery in June and these are expected to fetch far higher prices. A significant recovery will depend on demand for transport fuels which will increase only if lockdown ends and markets open up.

Since the global economy is in a recession and a lot of uncertainty prevails it is difficult for anyone to predict the growth of the oil prices after the pandemic subsides. The longer this pandemic lasts, the greater the damage oil producers will suffer.

Curiopedia
  • Brent crude and West Texas Intermediate are the two main benchmark prices for purchases of oil worldwide. Brent is the leading global price benchmark as it is used to set the price of two-thirds of the world’s internationally traded crude oil supplies.
  • Big Oil is a name used to describe the world’s six or seven largest publicly traded oil and gas companies, also known as supermajors. The supermajors are considered to be BP, Chevron, Eni, ExxonMobil, Royal Dutch Shell, Total, and ConocoPhillips.The use of the term in the popular media often excludes the national producers and OPEC oil companies who have a much greater role in setting prices than the supermajors.
  • Royal Dutch Shell PLC, commonly known as Shell, is a British-Dutch oil and gas company. It is one of the oil and gas “supermajors” and the third-largest company in the world measured by 2018 revenues (and the largest based in Europe). On the occasion of International women’s day (8th march), Shell changed its name to “She’ll” for a day.

End to Oil Price War?

After week-long negotiations and bilateral talks, ministers from the OPEC+ alliance and the Group of 20 nations, came to the historic decision to slash the production of oil by 9.7 million barrels per day. With this decision, the oil price war that began in mid-March may come to an end.
Summachar’s Coverage: Russia And Saudi Weaponize Oil Prices

Crux of the Matter

The Energy industry is one of the worst affected industries by Coronavirus. After Russia refused to slash the production of oil to meet the dragging demand, Saudi Arabia initiated an oil price war. The whole Energy sector has experienced a nightmare because of this war as Brent Crude Oil prices nearly halved following the fallout.

After week-long negotiations, the world’s top oil producers agreed to put a curb on the production of crude oil amid a slump in the demand across the globe due to Coronavirus. The implementation of the deal will start on 1st May. Iraq’s Oil Minister Thamir Al-Ghadhban said that the global oil output cut will help stabilize the markets by declining inventories and boosting prices. The global consumption of oil is likely to fall by 27 million and 20 million barrels per day in April and May respectively.

It is decided that OPEC+ will put a cut of 9.7 million barrels per day i.e. 0.3 million less than the initial deal proposal of 10 million. The US, Brazil, and Canada will reduce another 3.7 million barrels per day in global production. G20 nations have declared a cut of 1.3 million barrels per day from their side.

Mexico was on the verge of spoiling the negotiations to cut global oil production. But due to the urgency of the matter and the threat posed by the coronavirus, it finally agreed to cut its production by 1,00,000 barrels. American shale oil companies are likely to better off with a high price of crude oil.

Curiopedia
  • In order to seal this OPEC deal, American president Donald Trump decided to help Mexico by compensating them for not reducing oil production by 10%.
  • Ecuador, Indonesia, and Qatar are the elapsed members of the OPEC. OPEC is often referred to as a Cartel that operates to reduce market competition.
  • Russia has the largest reserves and is the largest exporter of Natural Gas in the world. It also has the second-largest coal reserves and the eighth largest oil reserves. While it is also the 3rd largest energy consumer.