The world's biggest collective oil production cut. It’s still not enough
For however historic the size of the production cuts reached the world’s biggest and medium-sized producers at the so-called ‘OPEC+’ and G20 videoconferences, the markets weren’t impressed.
Scott McKnight - April 2020
Stay at home but ride the rollercoaster
Oil prices have been extremely volatile since December 2019, when they lost about two-thirds of their value, with periodic rebounds on hopes that the major oil producers both within OPEC and without—and spurred by presidential tweets—could reach some agreement to scale back production in response to sharp drops in oil demand. This collapse in demand is the result of major parts of the global economy coming to a standstill under travel restrictions and quarantines through many of the world’s biggest and most oil-hungry economies as a result of the coronavirus.
The balance between oil supply and demand is ‘horrifying’, according to Mohammed Barkindo, Secretary-General of the Organization of Petroleum Exporting Countries (OPEC). This extreme imbalance between supply and demand prompted an emergency videoconference between the so-called ‘OPEC+’, a group that combined the traditional member-states of OPEC, along with several so-called ‘+’ members led by Russia and nearly a dozen other mid-tier producing countries. After an agreement seemed solidified in the first day (evening Thursday, Vienna time), the videoconference went into extra innings—and ultimately resembled a weekend-long cricket match—as Mexico, a large oil producer but meager and declining oil exporter (here), insisted it wouldn’t cut back production.
For its part, Mexico had hedged itself against this price collapse—brilliantly as it has turned out—as the country locked in a $49 per barrel price, which has helped the country’s oil industry find some degree of shelter among this storm. Nevertheless, Mexico’s contribution wasn’t going to matter in substance as much as in principle. But Saudi Arabia, de facto leader of OPEC and the country that fired the first shot in the oil price war in mid-March when it produced a historic 12.5m bpd last week, insisted on framing the agreement as everyone cuts or no one does. Mexico’s days-long holdout threatened to bring the whole agreement down.
The oil price war looks about over
Saudi Arabia and Russia, as the two largest producers of OPEC+ and numbers two and three respectively in world oil output, predictably and necessarily led the way in announcing production cuts. The tentative agreement of 15m bpd in cuts would also mean the month-long oil price war is over, thus effectively ending one side of the dual shock that flooded an already oversupplied oil market since mid-March. (In the meantime, a veritable ‘armada’ of Saudi oil carrying 14m barrels—compared to 2m barrels a month ago—is on its way to the US Gulf Coast).
Mexico was finally nudged out of its obstinance by the United States, and President Trump in particular, who personally intervened and agreed that the United States would reportedly shoulder 400,000 bpd of the total 500,000 bpd cuts asked of Mexico. This figure would be under serious dispute throughout the weekend, repeatedly threatening to bring down the entire edifice of the deal, which finally came into fruition late Easter Sunday (here).
These are the bizarre times we’re living in. On the following day of ‘Good Friday’, the G20 countries, the world’s largest industrialized and emerging economies—among them several major oil producers like the United States, Canada, Brazil among others—held a similar videoconference to discuss their own contribution to the cuts. Unlike the OPEC+ countries, however, these wouldn’t be coordinated and instead forced upon the myriad private and publicly traded companies by painful market forces.
Mexican president Andres Manuel Lopez Obrador and Mexican energy minister Rocio Nahle
Source: Cambio Digital, https://www.cambiodigital.com.mx/mosno.php?nota=377974
A Saudi oil tanker on the open seas
Source: https://www.aljazeera.com/ajimpact/supertanker-delivery-surge-saudi-crude-oil-armada-heads-200408142443637.html
“‘The reductions are too little, too late. In the short term, the global oil market is experiencing a vast pincer movement, with a flood oil on one hand and little demand for it on the other.’”
Too little, too late
The world’s largest ever production-cutting agreement, finally agreed to late Easter Sunday, is still not enough. The demand shock, which no tool in the OPEC+ toolbox can address, remains —and may indeed be getting sharper. With the global spread of the coronavirus through the first three months of 2020, the extent of oil demand destruction is almost beyond comprehension, in the range of 25-30m bpd or 25-30% of global oil demand. By comparison, a recent event that brought about a collapse in world oil prices—the Global Financial Crisis of 2008-09—removed 1.5m bpd in demand. Ironically, this figure of 1.5m bpd was the same amount that the Saudis proposed as combined cuts during the historic March 6 meeting, which then prompted the Russian representative to walk out and in turn prompted the Saudis to flood the market with oil, something we’ve written about here).
“‘The global oil market is experiencing a vast pincer movement, with a flood oil on one hand and little demand for it on the other. Oil infrastructure in the form of terminals, pipelines and storage—on land and sea—will experience a wave of ‘micro-bottlenecks’””
In short, the reductions are too little, too late. In the short term, the global oil market is experiencing a vast pincer movement, with a flood oil on one hand and little demand for it on the other. Oil infrastructure in the form of terminals, pipelines and storage—on land and sea—will experience what Arjun Murti calls a wave of ‘micro-bottlenecks’ over the coming weeks as the global oil industry better resembles a Legoland of almost countless parts and firms throughout the oil value chain than one holistic unit.
And this system has been pushed to its limits for several weeks now, with no relief in the short term. The collapse in demand for gasoline and jet fuel has been particularly sharp, caused by quarantines and travel restrictions, as about one-third of global oil production is dedicated to transport-related activities.
Things will take time to settle
The cuts, however large and headline-grabbing, will take several weeks to take hold. In the meantime, capacity will be ‘shut in’ and a wave of bankruptcies will inevitably sweep through higher-cost oil producers like western Canada, the North Sea, the United States, Colombia and parts of Brazil, among others. Very simply, outside the most geologically blessed oilfields ringing the Persian Gulf and parts of Russia, practically no oil production is economically viable at $15 per barrel, a price range that may become the new normal for the coming weeks.
In one of the most expensive producers, this months-long oil price collapse has pushed a barrel of West Canadian Select, the benchmark of western Canada, below the price of a McDonald’s Happy Meal. As much as one-fourth of western Canadian oil production will be shut in due to low prices, to add to the 135,000 bpd that has already been shut in, with other analysts predicting declines of 1.1 to 1.7m bpd. In the US shale industry in particular, major US banks like JPMorgan, Bank of America, Wells Fargo, among others, are already setting up companies to take over distressed assets from insolvent private companies, setting the stage for a massive and inevitable restructuring of the US shale oil industry as well as the global oil industry more generally.
When will we go back to normal?
With demand as now the bugaboo behind the current worrying state of the world oil industry, the two central questions are when and how the world’s biggest economies will reopen and what will be the nature of the recovery—one that is rapid (‘V-shaped’), slow but steady (‘U-shaped’) or long and drawn out (‘bath-tub-shaped’, in the words of Bobby Tudor). In the meantime, the pain to oil producers and refiners alike will be heavy and sustained, no matter how big the production cuts agreed to over these two days in mid-April.
