This article was published by Kallanish Energy
As the world battles an unprecedented health and economic crisis, the oil market has also seen an unparalleled event: Saudi Arabia, Russia and the U.S. coordinate a global production cut.
After a four-day marathon of virtual meetings over the long Easter weekend, energy ministers from major oil producing countries finally reached a deal on Sunday, Kallanish Energy reports.
The clock was ticking and pressure was on. A 10-million barrel per day (Mmbpd) cut had been proposed and agreed on Friday by all participants, with the exception of Mexico. The mega-deal was then stalled by a non-Opec, North American country.
Telephone discussions were ongoing to try to get Mexico to agree to the proposed 400,000 barrels per day cut in May and June. Ministers went back to the negotiating table and, in the end, accepted Mexico’s proposal to cut production by 100,000 Bpd.
The group, now known as Opec++ because it includes other G20 countries, agreed to remove 9.7 Mmbpd off the market in May and June. The agreement sees production cuts scaling down progressively into April 2022.
Production cuts are eased to 7.7 Mmbpd in the second half of 2020; and then reduced to 5.8 Mmbpd in the subsequent 16 months – from January 2021 to April 2022. The allies will review the agreement extension in December 2021.
The baseline for adjustment calculations was production volumes from October 2018, except for Saudi Arabia and Russia – which have it set at 11 Mmbpd.
That means that the two oil giants will limit their output to 8.5 Mmbpd in the next two months – a reduction of roughly 2.5 Mmbpd each. Moscow’s change of heart, going from not seeing the need for further/deeper cuts in March 6 to agreeing to slash volumes, suggests that Russia is hurting from the collapse in demand and low oil prices.
As the coronavirus pandemic spreads across the globe, it is killing off crude oil demand. There was despair amongst oil producers — big and small, national and private. International cooperation was a necessity.
“The direct involvement of President Trump to forge this historical deal is the most unusual aspect of it and reflects his visible concern for U.S. shale producers,” commented Roger Diwan, vice president financial services, IHS Markit.
The expert said that a catastrophic price scenario would have wiped out a large number of producers in the U.S., but this improved scenario will not change the fact that the production decline unfolding in the country will be in the same range as the forced shut-ins or cuts agreed by Russia and Saudi Arabia.
The deal, combined with the expected declines and shut-ins in the U.S., Canada and some other countries, could see a supply reduction of 14 Mmbpd in May and June, according to Diwan.
“This is a critically-needed relief in the face of declines in crude demand estimated at around 20 Mmbpd. Stepping away from a destructive price war, the return to market management by Saudi Arabia and Russia and backed by the United States and a very involved President Trump, marks a physical and psychological inflection point for the oil market,” concluded Diwan.
However, IHS Markit warns that the deal doesn’t solve the distress physical markets are likely to face in the next two months. The record differentials between global benchmarks and physical prices reflect the dual reality of “hope and despair.”
Brent futures are now trading around $33 a barrel, while Dated Brent trades around $24/Bbl.
Downside risks remain
Analysts at the Bank of America Global Research said on Monday that the deal should provide some support to global oil prices and reduce volatility. It also reduces the changes of a “worst case” sequential U.S. oil supply decline of 3.5 Mmbpd from 4Q19-4Q21. “Instead, the U.S. shale industry will likely see a more modest drop of just 1.8 Mmbpd over that period,” they forecast.
However, the global demand recovery path remains uncertain and there still are “plenty” of downside risks. “The Opec+ compliance excluding GCC average about 80% in the past, so there is a risk the real cut is closer to 7.2 Mmbpd,” BofA said in a report.
It also noted that spare capacity may rise to the highest levels in decades, leading to “lower for longer oil prices and a flatter Brent curve.” The bank estimates Brent to average $37/Bbl this year and $45/Bbl in 2021.
‘It will make a difference’
On a more positive note, Wood Mackenzie’s Macro Oils vice president, Ann-Louise Hittle, said that the deal will make a difference to the market “even if poorly implemented.”
“The agreement is substantial,” she said in a statement last week. “Partial compliance won’t stop this production agreement from having a big – and swift – impact on supply and demand fundamentals.”
“We expect the second half of 2020 to show an implied stock draw, in contrast to the record-breaking oversupply of the first half of 2020. That will support and lift prices significantly. The market will recognize this once the storage builds slow this quarter and start drawing down in the second half,” she added.
Prices will recover
ESAI Energy believes the drop in oil demand is so significant that this cut in supply will not begin to tighten the market until July or August. But prices should recover over the course of the summer, fall and into the winter.
“If all of these supply pledges come true or close, and if the social distancing and other measures associated with Covid-19 are eased or lifted, then oil demand will recover in the face of lower supply,” the analysts said in a Monday report.
“The global market will tighten, and prices will rise,” said ESAI, warning however that there are “several uncertainties” in terms of market perceptions tempering the price recovery.
The first is the inventory overhang, which will keep spot prices in the physical markets below futures for several more weeks, and thus attenuate the impact of recovering prices. The second is the possibility that as prices rise late in the year, some of the production restraint in non-Opec countries will diminish. The third is the depth and duration of demand destruction this year, ESAI explained.
“Even so, looking out from today, we see Brent back into the $40s late in the second half of the year,” it predicted.