The Fuse

OPEC+ Commits to Historic Production Cuts. But Will it Work?

by Gregory Brew | April 10, 2020

In his opening address at the 9th Extraordinary OPEC and non-OPEC ministerial meeting on April 9, 2020, OPEC Conference President and Algerian Minister of Energy Mohamed Arkab did not mince words.

“We are in the midst of a human tragedy,” said Arkab, addressing the other ministers via webinar, “on a scale perhaps not seen since more than a century. The pandemic,” he continued, referring to the COVID-19 pandemic which has currently infected 1.6 million people and killed nearly 100,000, “has reached almost every corner of the planet.”

“The impact on the oil market is also unprecedented,” said Arkab. “Large-scale demand destruction, and the resulting supply and demand imbalance, have the potential to fill global storage capacity quickly and force production shutdowns.”

The tone was set for one of the most important crises in OPEC history.

The tone was set for one of the most important crises in OPEC history. The April 9 conference, held over video chat over the course of five hours, concluded with a commitment to cut 10 million barrels per day (Mbd) for two months, starting on May 1. For the six months following this period, from July 1 to December 31, OPEC and other participating countries would commit to cutting 8 Mbd, followed by a 6 Mbd cut from January 1, 2021 to April 30, 2022. Baseline for cuts was October 2018, except for Russia and Saudi Arabia which will both cut from a baseline of 11 Mbd.

The meeting was not without drama. At a crucial moment, Mexico declined to participate and walked out (figuratively, of course) from the meeting. On April 10, the Mexican president announced that the U.S. would cut production equal to 250,000 barrels per day (bpd), while Mexico would cut 150,000 bpd. Mexico currently exports 1.3 Mbd.

Should cuts be implemented—and it’s a big “if” at this point—it would be the largest multi-national oil production program in history.

But given the shattering impact of COVID-19, it’s questionable whether the cuts will dent the progressive demand destruction surging through the global economy.

Ten Mbd is about 10 percent of global oil supply. Bank of America has estimated oil demand in Q1 will drop 12 Mbd, or 12 percent.

Other estimates are just as gloomy. Rystad Energy predicts demand will fall 9.4 percent in 2020, equal to 9.4 Mbd, falling from 99.9 Mbd to 90.5 Mbd year-on-year. Demand in April will fall by 27.5 Mbd, a 27.5 percent drop. Rystad predicts that demand will pick up in Q3 and Q4.

Oil Price Information Service’s Tom Kloza told CNN that demand would fall 18 or 20 Mbd. The cuts under discussion in the OPEC+ group appeared “woefully inadequate.”

According to U.S. Energy Secretary Dan Brouillette, the crisis “transcends the interest of any one nation and requires a swift and decisive response from us all.”

There has been considerable speculation in the U.S. regarding the likelihood of federal or state intervention in the domestic energy sector. Some have called on the Texas Railroad Commission to resume its historic role in regulating state oil production. The U.S. government floated the idea of suspending all production in the Gulf of Mexico, equal to about 2 Mbd. President Trump has threatened to put tariffs on imported oil from Russia and Saudi Arabia.

But it’s all talk. While smaller, debt-ridden shale firms have reached out for government assistance, the U.S. majors Chevron and ExxonMobil, as well as the American Petroleum Institute, have all rejected the idea of government-sponsored production cuts.

While acknowledging the need for a collective cut, Secretary Brouillette argued that U.S. production would fall by 2 Mbd by the end of the year, as shale firms suspended operations and rigs shut down across the country. Cuts could be as high as 3 Mbd, according to Brouillette.

Prices collapsed in early March when Saudi Arabia and Russia launched an oil price war, promising to maximize production. IHS Markit estimated U.S. production would fall 2-4 Mbd over the next 18 months. That estimate came in mid-March, in the context of the price war. Now that Saudi Arabia and Russia have promised to put their swords away and commit to cuts, it’s possible that prices may recover slightly.

It’s unlikely additional investment will be forthcoming.

That means that U.S. production may not fall as fast as Brouillette or IHS Markit estimate. Shale firms have higher break-evens than many OPEC states. Many have survived this long, through prolonged periods of unprofitability, thanks to Wall Street investment and easy access to debt. With the global economy shutting down to contain the spread of COVID-19, it’s unlikely additional investment will be forthcoming.

A cut in U.S. oil production is likely. But cuts come from government action. Instead, they’ll come from corporate decisions, as companies either shut-in production or file for bankruptcy. Russia has already said it doesn’t believe such action constitutes a real American commitment to cuts—Trump must either force through cuts or stand aloof from the OPEC+ program.

The world’s oil producers are joining together for the largest cooperative production initiative in history. But it’s success may hinge on the United States, where oil production has doubled in a single decade, and where—incidentally—COVID-19 has spread further and faster than any other nation. The convergence is a clear indicator of how the global pandemic and the global oil crisis remain deeply entangled.

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