For decades, every American president has pushed OPEC, the oil oligopoly, to do everything necessary to bring the price of oil down. President George W. Bush, campaigning for the U.S. Presidency, made a strong case that as an oil man, he would help Americans spend less in gas stations. The strategy has been this: push OPEC to pump more, and by doing that boost supply. Of course, from elementary economics, other things being equal, when supply increases, price drops, as new equilibrium points emerge.
But that is changing. Now, America wants OPEC to reduce production. It could be confusing – why would the nation which has castigated OPEC for cutting production volume suddenly wants it to pump less? Why should cheap oil be bad in a period when people are losing jobs? It comes down to third party externalities.
Coronavirus pandemic has decimated demand – that is not news. And if that is the only reason, cheap oil would not be a bad thing. But it goes further. And that’s where President Trump is going. Simply, as oil price drops – “West Texas Intermediate (WTI), the benchmark for U.S. oil, dropped 39.09 per cent to $10.98 a barrel on Monday”, a 21 year low, the president is concerned that the U.S. energy sector could be rattled. Yes, huge distortion in banking and asset quality due to exposures to the sector.
The price of West Texas Intermediate (WTI), the benchmark for U.S. oil, dropped 39.09 per cent to $10.98 a barrel on Monday.
Lack of sufficient demand and storage place is the likely cause of the steep fall in price.
“It hasn’t taken long for the market to recognise that the Opec+ deal will not, in its present form, be enough to balance oil markets,” BBC quoted Stephen Innes, a chief global market strategist at Axicorp as saying
Nigeria’s benchmark crude oil grade, Bonny Light, slumped significantly earlier last week, trading at $12 and $13 per barrel.
Also, the benchmark used by Europe, and the rest of the world, Brent oil, as at the time of this filing is down 6.55 per cent to $26.24 a barrel.
Already, most U.S. shale gas producers are already out of the breakeven price. Largely, the further the price drops, the more the paralysis is, as most of them would go under. And if they go under, banks which had lent them billions of dollars would have underperforming loans. If you scale that from Texas to Oklahoma, balance sheets of banks would take serious hits. One thing the president does not want now is deteriorating assets in banks’ balance sheets!
So, he has a big job: make sure the price of oil goes up, irrespective of his promises during the campaign to keep it low! This is war and closing the flanks is important.