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By the end, it is all about the (oil) market, and it moves on

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Luky Yusgiantoro, BSc., MSc., Ph.D

Oil prices recently plummeted by around 60 percent and are beginning to rebound with intervention from big oil producers. The sharp decline was the confluence of two major events, which are the COVID-19 pandemic, and the long-smoldering deterioration in relationships between countries, such as Saudi Arabia, Russia, the United States, and, now, Mexico.

The pandemic started in China, a country that accounts for about 20 percent of the world’s gross national product. Massive health concerns quickly boiled over into unprecedented drops in energy demand – a pattern that has repeated itself around the world. In this setting, the major oil producers choose, under a multitude of plots and subplots, to produce at unrestricted levels and crystallize diplomatic positions.

The spread of the virus to other countries outside China worsened the global economy. The almost uniform policy of social distancing, or even lockdown, in virtually all countries, brought the economies into a crawl. Globally, including the transportation and electricity sectors, oil contributes about one-third of primary energy consumption. Economic activities declined and continue at nearly a standstill around the globe – resulting in the further fall of oil demand and price. The pain and necessity to adapt to the current economic situation has driven governments to review and adjust their strategy and policy in conducting social and economic activities. In the quest for adjustment, what have we learned from the past when low energy prices were experienced?

Ever since the energy crisis in the early 1970s, oil price has been volatile. Global energy markets have experienced the fall of oil prices in the past. The Asian economic crisis in 1998 caused the oil price to fall. Another significant drop of oil prices occurred in 2008, when oil price collapsed from around $140 per barrel in June 2008 to about $40 per barrel six to seven months later, driving a recession in the industrial economies of the United States and Western Europe.

The most recent significant drop in oil price occurred in 2016 when oil prices declined from $105 per barrel in June 2014 to $33 per barrel eight to nine months later.

Historically, when oil prices move rapidly and steeply down or up, there has been intervention from OPEC, the controller of about 30 percent of global market supply, leading to either cuts or increases in production.

However, these days OPEC is not the only major oil producer. Russia and the US are big producers fighting their way to gain market share of the global energy market. Russia was sanctioned by the US and Europe in 2014, causing the Russian economy to only grow at an average of 0.5 percent annually after the sanction, less than 15 percent of past growth rates.

This sanction was one of the major factors that compelled the Russians to gain an increase in oil market share. With the rapidly increasing production of shale oil, the US also attempted to increase its share of the global oil market. Thus, in the unprecedented conditions experienced due to COVID-9 overlaid with an already aggressive swing to renewal energy sources, the major production sources, each for their own reasons, are chasing a dramatically reduced market for crude oil.

No one has crystal balls and markets prefer stable and non-volatile prices to support growth. The oil market is inelastic, where it is difficult for consumers and producers to rapidly change the quantity they demand and supply in the face of price changes. The wait-and-see decision by oil market players exacerbates the importance of having storage or inventory.

Although oil markets appear transparent, in reality, especially during the unprecedented current conditions, oil producers have incorporated eclectic information into their analyses and decision- making. In the face of the pandemic, and its unknown resolution, low energy prices, governments must act and plan to ensure sufficient energy sources to stimulate their economies and support growth once again.

The manufacturing industry has played an important role in Indonesia’s recent economic growth, which has hovered at around 5 percent per year. The government has been trying to further accelerate the manufacturing industries by providing stimulus packages. However, the manufacturing industries are exposed to risks.

The industries obviously impacted by COVID-19 in many ways and face difficulty in operating at maximum production capacity. Therefore, to support the recovery and growth of the manufacturing industries in Indonesia, there must be a policy that allows industries to acquire competitively priced energy resources, provided that low price energy resources are globally available. This policy is intended to promote production at maximum capacity and the associated creation of maximum employment opportunities resulting in a trickle-down effect on the economy.

Aside from the benefit of low price energy resources, manufacturing industries can minimize their risks by adjusting to economic conditions. Manufacturing industries in Indonesia have some advantageous flexibility through expanding its own strategic energy storage or inventory to have stability of their needs and minimize the exposure of global uncertainty, such as the volatility of oil prices. In the long term, the utilization of energy storage and options optimized through forecasting by manufacturing industries using the available parameters can create financial protection from the price volatility of a commodity. However, a policy is needed to regulate the utilization of energy storage.

We have discovered that low oil price and COVID-19 are in fact affecting our lives, both society and the economy. We have the choice to ponder our current faith or to think long-term. Insightful strategic policy decisions will affect the economy for decades. The timing of comprehensive planning and implementing the right policy is crucial in expediting the recovery period of the economy.

When the pandemic is globally contained and world economic performance returns to equilibrium, oil prices will return to an increased level of stability, supporting efficiency and growth. COVID-19 will eventually be the pandemic of the past as will the current low oil prices.