After one month of a dramatic break-up and a beginning of an oil war between Russia and the Saudi Arabia, history was made last Sunday with a renewed agreement achieved by OPEC + of 9.7 million barrels per day (mbpd) oil output cut.
A 10 million bpd oil reduction is the biggest cut ever agreed in the history of OPEC and the amount is equivalent to 10% of the world oil supply. However, is it enough to rebalance the oil market and help the producer economies to avoid problems?
Oil cut deal explained
As you know, agreements like this were made in past occasions and were referenced in one of our previous articles. To know more press here. However, this one is special due to the volumes, the urgency and the importance of it.
After four days of marathon talks, the 10th (Extraordinary) OPEC and non-OPEC Ministerial Meeting held on the 12th of April via videoconference culminated with the Participating countries agreeing on the following reductions
- 7 mb/d, starting on 1 May 2020, for an initial period of two months that concludes on 30 June 2020.
- 7 mb/d, from 1 July 2020 to 31 December 2020
- 8 mb/d adjustment for a period of 16 months, from 1 January 2021 to 30 April 2022.
- The baseline for the calculation of the adjustments is the oil production of October 2018, except for the Kingdom of Saudi Arabia and The Russian Federation, both with the same baseline level of 11.0 mb/d. The agreement will be valid until 30 April 2022 however, the extension of this agreement will be reviewed during December 2021.
Table 1 – Cut levels per country (mbpd).
Impact on current market
Oil prices fell to historic lows in March after Saudi Arabia and Russia fail to agree on further oil output cuts and started a volume war for market share dragging Brent oil prices to as low as 22,76 $/bbl, a 68% fall from the maximum levels registered in January.
Figure 1 – Brent M+1 Prices ($/bbl). SOURCE: MTECH
Despite the volume war between the second and the third world top producers, the World is currently facing a greater battle against the COVID-19 pandemic, which has spread all over the Globe and is responsible for more than 1.8 Million people infected (registered) plus 115 thousand fatalities in four months.
The current pandemic forced governments to advise up to 40% of world population to stay at home causing important reductions in tourism and travels as well as a great impact on industrial activities in most countries with consequently waves of firings and layoffs. The latest forecast from EIA shows a significant fall between March and June with the bottom being reached this April at 83.61 mbpd, corresponding for a 20% fall of average demand (slightly above the 100 mbpd).
Figure 2 – World oil supply vs World oil demand (mbpd). SOURCE: Reuters
This latest report seems to have underestimated the impact of the virus and the velocity of its spreading since that, recent news from April, oil demand seems to be falling about 30 mbpd (30% of global oil supply), almost 10% more that the report recent estimations.
On the other side, oil storage is filling up rapidly across the World prompted by the shy demand and the ongoing high levels of crude production worldwide. According to recent data from the International Energy Agency, estimations point for a 2.9 billion barrels in industry storage and 1.5 billion barrels in government storage in the OECD in January 2020. Last record high was registered in July 2016 at 3.1 billion barrels, shortly after the end of the last price fall, meaning that the levels reported back in January were already 200 million above the last peak. Other sources point for a 71% of capacity worldwide already completed, with space capacity between 0.9 to 1.8 billion barrels of spare space.
Only in the US, oil stocks jumped increased 13.8 and 15.2 million barrels in the last two weeks to the impact of COVID-19 in U.S. demand.
Global output agreement in sight
One of the biggest deadlock to this agreement was the fact that the U.S. was not committing to any voluntary cuts, something that was largely demanded by Russia and Saudi Arabia and that was understandable since the three are fighting for the top spot as oil producer. Nonetheless, the agreement was reached by OPEC ++ using the global crisis as argument to encourage other non-members of the OPEC to join them the agreement and make a jointly effort to rebalance the oil market.
Among those, Norway and Canada already showed their willingness to participate by giving up part of their oil output, but official numbers were not stated yet.
The U.S. opted by keeping the same argument used during the negotiations: the national output was already expected to decline by 2 million bpd by the end of 2020 due to the current situation. But in an unexpected move, Trump said that the U.S. agreed to help Mexico to comply with an additional cut of 250 000 to 300 000 barrels a day, added to the official cut defined in the agreement of 100 thousand.
Is this deal the real deal?
Oil & gas sector is probably facing the biggest crisis ever and the OPEC ++ will rely on external factors to reach the desired impact of the agreement in place.
The real impact of COVID-19 is still a huge question mark and is hitting all the economies across the world at the same time. The way each one and everyone will respond to it will dictate the next months and how the world will be recovered from it.
If we add the expected cuts to the supply curve of EIA latest projections (in green), we could see a quick market rebalance, even pointing for potential shortage already in Q3 of 2020 (grey line against green). But is important to highlight that the current levels of low demand (30% below normal) can persist and change the evolution of the demand recovery throughout the current year.
Figure 3 – World oil supply vs World oil demand with OPEC+ (mbpd). SOURCE: Reuters
Also the economic impact of the current lockdowns and “stay home” approaches is still to be correctly accounted since we cannot forget that we just managed to avoid a recession 3 months ago, meaning that the economy was already “debilitated” before the pandemic appeared. Some sources pointed already for a Great Recession worst than 2008 financial crisis. The “v” curve (in grey) projected for the demand suggests a rapid recovery of the economy and demand from the current sanitarian crisis. But if the reality proves to be harder and the recovery slower, we could see the “v” curve turning to a “u” or even a “w” impacting significantly on the demand for oil and, consequently, on the success of the current agreement. A more prolonged period of low demand, below the levels agreed by OPEC+ would keep the current oil prices lower than desired and would keep pressure on all the countries that rely on this commodity.
More focused on the oil sector, this new deal can be important to control and manage the current oil storage situation, which could give some optimism in the oil prices and help “oil producer economies” to reach the safety net.
Opinions split about the next trend of oil prices, some are positive that the OPEC++ deal is insufficient to rebalance the current oversupplied situation and market will crash back to 20 $/bbl, other believe in the optimism of the signal of commitment of this deal and believe that market will stabilize. As for mid and long-term perspectives, more than the level of compliance of Saudi Arabia and Russia, the next steps to fight or overcome the COVID-19 pandemic will be key to give a clear signal for oil & gas markets.
There will be a different world after this COVID-19 pandemic and the impact will be vast. Besides economics and health, people might change their habits as well as the way they socialize and work which could impact the oil demand and change the current reference level of 100 million barrels per day.
Anyway, the desired levels of 50 – 60 $/bbl seems intangible in a near time.
Jorge Seabra | Energy Consultant