ⓒ YONHAP News

Last week, international oil prices plummeted below zero for the first time in history. On April 20, West Texas Intermediate for May delivery closed at minus 37.63 dollars per barrel at the New York Mercantile Exchange. Negative oil prices mean that sellers have to pay buyers to take oil from them. Prices then picked up again later. Still, ultra-low oil prices are seen as a threat to the economy. Here is Professor Kim Dae-jong of Sejong University’s School of Business Administration to discuss the repercussions of the sharp drop in oil prices. 

This had never happened before. The COVID-19 pandemic has reduced consumer demand and suspended supply, as factories stopped operation. Four billion people, out of the world’s population of 7.7 billion, have been self-quarantined. Meanwhile 95 percent of international flights have been grounded. Oil producers have run out of space to store the rising stockpiles of oil. They have even rented oil tankers, which are also filled to the brim. Against this backdrop, oil prices plunged to negative territory for the first time ever. 

The unprecedented negative oil prices show just how bad the global economy is. The historic plunge is attributable to a drastic fall in oil demand, as the spread of COVID-19 resulted in lockdowns and travel restrictions, as well as the oil storage problem. Many are concerned about the negative impact of the abnormal fall in oil prices. 

The situation is pretty serious. There are about 9,000 shale gas businesses in the U.S. major banks, including Citibank and Wells Fargo. Local banks in the U.S. have also invested in those businesses. Forty-two such companies went bankrupt last year, but more firms are expected to suffer the same fate amid low oil prices. The failure of small-and mid-sized shale gas firms may trigger a crisis similar to the 2008 financial crisis, as the banks that invested in the firms may also end up bankrupt one after another. 

At present, the U.S. is the largest oil producer in the world, as a result of the expansion of shale oil production in the country. According to the Energy Information Administration in the U.S., the country produced 2.8 billion barrels of shale oil last year, or 7.7 million barrels per day. During the good times, many shale producers took on more debt to increase production. But now, they suffer a direct hit from extremely low oil prices. If the companies fall like ninepins, a crisis may erupt in the financial market. This reminds us that the collapse of two major mortgage lenders in the U.S. in 2008 led to the global financial crisis. 

The plunge in oil prices is also bad news for the Korean economy. 

Petrochemical products make up a significant portion of South Korea’s exports. Korea imports crude oil and processes it into marketable products such as jet fuel, gasoline and asphalt pitch. China and Australia are the major customers of South Korean jet fuel. 

But the drastic decrease in the number of international flights has reduced demand for aviation fuel, dealing a blow to Korean exporters. Korea typically signs a two or three year contract when importing crude oil. Although oil prices have fallen, factories can’t stop operation because it takes a few months to reactivate the factories after a shutdown. But Korea can’t terminate the long-term import contract, either. The local shipbuilding and offshore plant industries, which play a crucial role in the Korean economy, have also seen a sharp decline in demand. In other words, those industries are in a very difficult situation.

Korea depends entirely on imports for its oil. Falling oil prices, therefore, have some positive effects such as price stability. But the industry overall will feel the pinch. South Korea’s top four oil refiners are estimated to suffer heavy operating loss of more than 2.7 billion US dollars in the first quarter. The situation is similar in the airline, shipping and transportation industries. In the first quarter of the year, global orders for ships decreased more than 70 percent year-on-year. Suffering a direct blow, Korea’s shipbuilding industry might face a liquidity crisis. While the world economy is struggling, oil prices are unlikely to rebound anytime soon. 

In late March, the Organization of Petroleum Exporting Countries or OPEC decided to cut oil production by nearly 10 million barrels per day. But demand for oil has already decreased by 30 million barrels per day, indicating an oversupply of 20 million barrels. Still, the U.S., the biggest oil producer, has not reduced output. Rather, it demands that Russia and Saudi Arabia pump less oil. But the two countries have not agreed to cut oil production. Saudi Arabia has to deal with its unemployment rate of 13 percent, while oil and gas exports account for 40 percent of Russia’s budget revenues.  

International oil prices climbed again on April 22, on the back of the market projection of a decline in oil production following a shortage of oil storage facilities. This escalates geopolitical risks related to Iran and the possibility of easing virus lockdown measures in the U.S. However, falling demand for crude oil remains unchanged. As oil-producing countries still flood the world with excess supply, oil prices may possibly fall. Of course, such a drastic decline in oil prices is extremely rare. Once the COVID-19 crisis abates and economic activities resume, oil prices will rebound. Until then, it is important to get through the current crisis properly.

South Korea is the fifth-largest manufacturing economy in the world, following China, the U.S., Germany and Japan. The Korean government needs to support manufacturers of petrochemical products, which are one of the nation’s key export items. Factories and small businesses have stopped operating, due to a temporary liquidity crunch. The government should keep them alive so the economy may grow again after a recovery. It should give full support to them in the next six months. What the Korean economy needs now is the government’s financial support for companies and people. 

On April 22, the government announced tax cut measures for the local oil refinery industry, which finds it urgent to secure cash. In addition to that, the government needs to mobilize all possible emergency measures to cushion the impact of the collapse in oil prices from the COVID-19 pandemic.