New Normal Versus Looking for Recovery
Every day that goes by we learn more and more about the decline in global oil demand. We can see glimmers of light in the country by country COVID 19 case data hinting at impending flattening of the case curve in some countries. Yet, there are still many countries early in the fight with COVID 19: India, other Asian countries, African and Latin American countries, not to mention Russia and others from the FSU. It is difficult to model what comes next in the countries where social distancing has been at work, but even more difficult to model the impact of demand in countries where these measures are just getting underway or are still not in place. Even in Europe and the United States, it remains unclear whether we will see continued social distancing or alternative measures that encourage recovery in economic activity. More widespread testing in many countries, reducing the strain on the health care sector, coupled with new treatments and continued progress to develop vaccines, can still have a profound effect on the profile of this virus, and thus oil demand.
Our modeling has pointed to multiple outcomes for global oil demand destruction for the whole year, ranging from 3.5 to 8.0 million b/d. The low end of the range focuses more on signs of recovery. The high end of the range focuses more on a new normal in human and economic activity. We have noticed increasing consensus among oil market analysts around demand destruction of 6.0 to 7.0 million b/d. The key difference between outlooks seems to be the pace of recovery in economic activity, and especially gasoline use. For the purposes of this analysis of the OPEC++ producton cut currently under consideration, we have erred on the side of more demand destruction (8.0 million b/d for the year).
History in the Making
That brings us to the impending agreement to cut production by a group of oil producing countries, chief among them Saudi Arabia and Russia. The number being discussed in the media is a cut of 10 million b/d, ostensibly in May from April’s high. That number seems to have come out of a conversation between President Trump and Crown Prince bin Salman. As such, it may not be a reliable indication of the objective of this meeting. Yet, we increasingly believe that a cut of that size would optimal and should last at least through September, if not December. This will stop the stock build, which is increasingly testing global storage capacity, and lead to a stock draw. Tanks are not full yet. The global stock build in March and April will be about 1.2 billion barrels of crude and products. There will be room for further stock build into May. At some point in May, however, storage tanks will essentially be full, except for the U.S. SPR.
What a 10 Million b/d Cut would Look Like
It is tricky to project the decisions of thirty countries. Besides the OPEC+ countries, another 10 countries have been invited to participate: US, Canada, UK, Norway, Brazil, Argentina, Colombia, Egypt, Trinidad& Tobago and Indonesia. Even so, we offer the following observations on possible production cuts. Non-OPEC countries (exc. FSU) are already responding to the lack of demand and low prices. We estimate non-OPEC countries will cut production by about 3.1 million b/d by December. However, that will not all happen in May. If you average the decline from May-December and deduct that from April, then non-OPEC will cut by about 2.6 million b/d. U.S. Shale would be about 1.3 million b/d of that volume, close to what the EIA suggested yesterday.
Brazil has already announced a cut of 200,000 b/d, but that is against production early in the year, so is already in the market. This does not include the FSU countries which we estimate could cut by about 1.2 million b/d with Russia contributing the lion’s share. So, if you combine the non-OPEC countries and Russia, a cut of 3.8 million b/d is not out of the question. Can the OPEC countries cut the rest or 6.2 to 7.0 million b/d? An OPEC cut of as much as 7.0 million b/d is not impossible, but it would have to be against the very high production levels of April, and it would take Saudi Arabia cutting from over 12 million b d to 8.0 million b/d. Recall that during the financial crisis, Saudi Arabia’s production averaged under 8.0 million b/d throughout 2009. Kuwait and the UAE would each have to come close to 1.0 million b/d in cuts. Less depending on how much Iraq is willing to cut. The chart below provides a view of the global oil market if demand destruction for the year is as large as 8.0 million b/d and if a 10 million b/d production cut took place through September. Note, if the demand destruction is less, the ending stock position would be lower.
Time is of the Essence
At this point, if a collection of countries, including some cutting for economic reasons, can reduce production by 10 million b/d or something close in May, that will have significant impact on the stock build. The longer these countries wait, the more difficult it will be to stop and reverse the stock build. We believe this is well-known in many oil producing capitals, and thus we do expect an historic production deal at some point. The exact volume and how it is divided among countries remain unclear. Following this meeting, assuming there is an agreement, we will prepare another analysis examining the implications.