By: Mansoor Dailami
On Thursday April 9, after much anticipation and market trepidation, Russia and Saudi Arabia ended their month-long spat and agreed to cut oil production by 10 million barrels per day (mb/d). In a historic and extraordinary OPEC and non-OPEC, Ministerial Meeting – conducted via webinar – major producers agreed to a phased out plan that would start in May 2020 and last for two months, followed by cuts of 8 mb/d for the rest of the year, and then cuts of 6 mb/d for a period of 16 months from January 2021 to April 2022. Russia and Saudi Arabia would absorb one half of total cut, with the remaining 5 million divided proportionally among other OPEC+ members and partners. Regarding the baseline oil production to calculate the cuts, it was agreed to take the October 2018 production levels, except for Russia and Saudi Arabia which would have different starting points. For the two powerhouses, the agreement is to measure their pledged cuts from the baseline level of 11 mb/d. On that basis, the real number of barrels of oil to be taken off the market is estimated to be in the order of 8.4 mb/d.
Eyes turned to the G20 energy ministers virtual meeting held on April 11. There, producers outside OPEC+, including the United States and Canada, expected a deal with an additional production cut of 5 mb/d. In days before their April 9th meeting, Saudi Arabia and Russia had signaled their agreement to scale back oil production to depend on other major producers joining in. Yet, the joint statement released by G20 early Saturday morning, makes no reference to specific oil output cuts, while recognizing “the commitment of some producers to stabilize energy markets”.
Given the unprecedented demand destruction caused by the coronavirus, even a 15 mb/d global oil production cutback would not be enough to balance the market and rally prices beyond a short-term boost. The math on current global oil market supply-demand imbalance calls for a more drastic coordinated action. As the world economy grinding to a virtual standstill, the virus has dealt a heavy blow to oil demand, particularly demand for transport fuel. Except in China, where virus-related travel restrictions are being gradually lifted, lockdowns in countries across the world have restricted non-essential travel and have left highways and streets vacant. Many analysts project world demand for crude oil to plummet in April by 30%. It would take months for demand to return to its 100 mb/d mark observed in late 2019.
For global investors, the oil sector has always presented unique challenges, requiring a deep understanding of oil price drivers and the sector’s complex geological, economic, environmental, and political characteristics. However, the current market collapse has no historical precedent. Global oil prices have plunged since early March when OPEC announced, after its March 6th meeting, that it would not extend production cuts beyond those expiring March 31. Russia’s refusal to support deeper oil cuts to cope with coronavirus ended its three-year pact with OPEC and sparked a pricing war between the two oil producers. As global demand for oil was falling due to coronavirus disruptions, Saudi Arabia announced on March 7 that its new strategy would be to protect market share by cutting its official selling price and ramping up crude production above 10 mb/d starting this month. While the motivation behind Saudi’s change of tack remains controversial, its impact on oil prices have been dramatic. By March 30, the spot price of Brent Crude had fallen to less than $20 a barrel, while West Texas Intermediate crude was trading at $14.10 a barrel, down significantly from the year’s high of $60 in January (Figure 1). Prices have gained some ground since then. In the first week of April President Trump’s intervention and apparently political pressure led markets to anticipate a truce between Saudi Arabia and Russia.
Looking at the global oil market outlook for 2020, there will be significant downward pressure on oil prices in the second quarter as concerns are mounting that the world is virtually running out of storage for barrels of crude that cannot be sold and consumed. Thus, short-term oil price dynamics will be driven by the rising costs of inventory accumulation and soaring tanker rates, as much as by demand/supply balances. By some accounts, the world is now running an oil supply glut of roughly 20mb/d which is filling up storage capacity on land and at sea. Current estimates put the size of U.S. commercial storage at about 135 million barrels of unused capacity, barely enough for ten weeks of inventory accumulation at a rate of 2 mb/d.
The implications of the current trajectory of low oil prices go beyond the unfolding debt distress of leveraged U.S. oil drillers and operators. There are also growing concerns of sovereign debt risk among emerging countries dependent on oil. Many countries in the Middle East and Latin America have planned their national budgets based on an oil price scenario of $50 per barrel or more. The reality is likely to be far lower than that. For 2020, U.S. Energy Information Administration (EIA) forecasts in its recently released March Short-Term Energy Outlook, Brent crude oil prices to average $43 per barrel, down from an average of $64 per barrel in 2019. At the time when governments of advanced countries are turning to debt capital markets for massive fiscal financing, emerging market countries could be crowded out.