Since the Covid-19 pandemic is the principal reason world oil price are spiraling down, the global crude oil market can only recover to normal, or a “new normal”, when SARS-COV 2 viruses are effectively controlled. Once mass lockdown bans are lifted, the global economy can rumble back to its normal conditions, resulting in increased demand for crude oil.
The article below summarizes a policy webinar conducted by Dr. Le Thai Ha, Director of Research and Senior Faculty member at Fulbright School of Public Policy and Management (FSPPM) on the topic: Oil Price Crashes Amidst the Covid-19 Pandemic.
Dual fists
Crude oil is an essential commodity among the most traded in the global market. Oil price swings have hit the economic health of many countries, including both oil importers and exporters. In her presentation, Dr. Thai Ha first reviewed historical occurrences of collapsing oil prices over the past 50 years to contextualize and better understand the underpinning reasons governing current price shocks.
Dr. Thai Ha first explained some basic characteristics of global crude oil management, and explained why the West Texas Intermediate (WTI) plays a more prominent role in the global crude oil market. In 2015, after heavy investment in infrastructure and record highs in U.S. production output, the U.S. lifted its 40-year export ban on crude oil. When U.S. oil output kept rising, the role of WTI gained increasing importance in the market.
The webinar was grounded on the empirical research conducted by Dr. Thai Ha and her two co-authors on the factors fueling the most recent oil price collapse. Using econometric approaches and quantitative models to analyze time series data from January 17th to April 30th, research findings revealed that uncertainty in U.S. economic policies (as indicated by EPU index) have exerted a long-term negative impact on WTI crude oil prices. According to authors, the more uncertain economic policies are, the higher the risks incurred, precipitating the downturn of economic activity and decreasing demand for crude oil and lowered oil prices. Besides, bad sentiments and the volatility on U.S. financial markets (as indicated by VIX index) are also found to significantly affect WTI oil prices. Dr. Thai Ha and her co-authors concluded that plummeting world stock indexes also take a great toll on crude oil prices long term (see Figure 1).
Figure 1: Correlations between WTI oil prices and uncertainty of U.S. economic policies (EPU index), volatility of U.S. financial markets (VIX index) and world stock market index (MSCI). Data of these indexes are collected from 17th January to 30th April and scaled. Source: Dr. Thai Ha et al.
In addition, the Saudi-Russia oil price war also negatively affected the price of WTI oil. Empirical evidence by Dr. Thai Ha demonstrated that the Covid-19 pandemic contributed significantly to oil price crashes and exerted long term negative effects (see Figure 2). In fact, global oil demand has come under an unprecedented shock due to travel restrictions between countries intended to contain viral spread. Meanwhile, oil supply had surged dramatically as a consequence of Saudi Arabia’s oil price war with Russia on March 8th. Fr Dr. Thai Ha, those were the “dual fists” pounding oil prices downward in a very short timeframe.
Dr. Thai Ha emphasized oil speculation on world financial markets was believed to be a major factor in sending WTI to sub-zero lows for the first time in history. Specifically, futures contracts for WTI oil expiring in May have fallen 300% to negative 37.63 per barrel on Monday (20th April 2020).
Figure 2: Correlation between WTI oil prices and impact of Covid-19 are measured through four indicators: number of new infected cases (NCASE), total infected cases (TCASE), new death cases (NDEATH), and total death cases (TDEATH). Data of these indexes are collected from 17th January to 30th April and scaled. Source: Dr. Thai Ha et al.
Consequences for Vietnam’s economy
Vietnam is both a crude oil exporter and an importer of petrochemical finished products. For Dr. Thai Ha, this means the price crisis might exert both positive and negative effects on the economy.
Decreasing oil prices might have positive effects on manufacturing firms, cutting production and transportation costs. Transporters and freighters may stand to benefit most, as fuel and energy account for the largest share of their cost structures. Reduced production costs also improve the competitiveness for goods made in Vietnam, especially as many recent multilateral and bilateral trade agreements provide our more open economy further advantages. Furthermore, reduced oil prices help citizens save transportation fees, stimulating stronger domestic consumption and boosting the economy. In addition, inflation rates are controlled at low rates, stabilizing the macro economy and attracting greater FDI. Dwindling prices also reduce foreign currency spending in exchange for oil and gas imports or other petrochemical products and increase the foreign exchange reserves held by State Bank of Vietnam. However, Dr. Thai Ha cautioned that these benefits are realized only if Vietnam successfully ensures the continued safe operation of the economy amidst the pandemic.
As Dr. Thai Ha argued, detrimental effects of decreasing oil prices include the reduced revenue for the country from crude oil exports. Although it must be noted oil exports from Vietnam have been on a declining trend, leading to diminishing shares of revenue from oil exports to tax revenue (see Figure 3). As a result, negative effects are expected to be somewhat mitigated. The stock market might be affected as stocks of fuel and oil companies show bearish signs (capital flows to oil & gas sector may be falling).
Figure 3: Percentage of crude oil exports on public revenue from 2006 to 2019. Source: Dr. Thai Ha et al.
Dr. Thai Ha explained depressed oil prices may threaten the stability of oil industries –a sector essential not only for the economic health of Vietnam, but of the entire globe. Considering this analysis, Dr. Ha put forward some policy recommendations on how to mitigate the current historic price crashes.. Thai Ha emphasized that although some policy measures can lessen the effects of oil shocks to a limited extent, special attention should remain on the prevalent reason for the collapse: the COVID-19 pandemic. Since the pandemic is the principal reason world oil price are spiraling down, the global crude oil market recovery to normal, or a “new normal”, is conditional to the effective resolution of the pandemic. Once mass lockdown bans are lifted, the global economy can rumble back to its normal conditions, resulting in increased demand for crude oil.
Dr. Ha also evaluated the possibility of oil prices going sub-zero again. Specifically, our researcher argued that the underlying causes behind the fall of WTI are shifting dramatically. On the supply side, OPEC+ efforts to stabilize oil prices are showing early signs of success, while the Russia-Saudi price war has come to an end. Official deals to cut productions among OPEC+ members have reached impressive milestones. Consequently, oil prices have increased 60% during the past three weeks. Regarding demand, transportation and transport constraints are being gradually removed in some countries, while some economies have already observed a return to normal operation, leading to increased demand for oil consumption. Speculators in futures market are more cautious in their investment decisions compared to a few months ago. It is very unlikely that futures contracts will be traded as aggressively as in the late April period.
Indeed, sub-zero oil prices are unlikely. But our researcher outlined two caveats. Firstly, another outbreak of Covid-19 is a reasonable possibility. In such a case, restrictions on economic activities would be imposed again, reducing the demand for oil. Secondly, increasing global oil storage capacity is a slow process. Without currently negotiated deals to reduce production among OPEC+, world storage capacity would only take a few weeks’ time to saturate. OPEC+ commitments to reduce output cannot solve the problem immediately, only slow down the process of eventual saturation until storage capacity increases.
Finally, Dr. Ha noted that the price fall to negative only lasted one day. After the historic dip (over 300%0 on Black Monday, oil prices have reverted to positive numbers the following day, Tuesday April 21st. In fact, WTI futures contracts expiring last May closed at 10.01 USD per barrel, equivalent to a 126.6% increase after one day, the largest daily price increase ever. This indicates that traders and investors still deem crude oil as an attractive commodity to hold and trade, as its nickname “black gold” suggests.
