The Fuse

OPEC+ Reaches Historic Agreement, Still Falls Short

by Nick Cunningham | April 13, 2020

OPEC+ managed to agree to the largest oil cuts in history, ending a ruinous month-long price war.

Saudi Arabia and Russia agreed to large production cuts, with other producers chipping in smaller contributions. The cuts are historic in size, and the group managed to convince other non-OPEC countries to agree to reductions as well, at least nominally. However, in a sign of how disastrously oversupplied the market remains, oil prices barely moved in response to the agreement.

Global Deal Reached
After weeks of stubbornly refusing to negotiate, the two core producers of OPEC+, Saudi Arabia and Russia, came to the table. Each country agreed to lower output to 8.5 million barrels per day (Mb/d), a combined cut of about 5 mb/d.

Taken together with the rest of the non-OPEC coalition, the headline total is a cut of 9.7 Mb/d for May and June, eliminating about 10 percent of global supply. The production ceilings will be loosened to a cut of 7.7 Mb/d from July through the end of the year, and then again lowered to a cut of 5.8 Mb/d from January 2021 to April 2022.

In addition, G20 nations met virtually for an extraordinary meeting on April 10 in an effort to bolster the OPEC+ efforts. The summit produced a vaguely-worded communique, in which the 20 countries committed “to take all the necessary and immediate measures to ensure market stability.”

Notionally, at least, the U.S. projected oil production to decline by as much as 2 Mb/d this year. The U.S. government marketed its crippled shale sector and the expected declines in output as a “cut.” The key detail, however, is that the declines are market driven, not mandated. In other words, the cuts are either illusory or they would have happened anyway.

Analysts painted a skeptical picture. “[T]he lack of clarity on cuts outside OPEC+ and Russia’s track record on compliance with past cuts has us only assuming half the announced cuts actually happen,” Raymond James said in a note on Monday.

The deal ostensibly lasts for two years, a longer duration than many analysts had expected. Producers likely want to signal their commitment to ensuring stability in the market after having waged an unexpected price war.

But the refusal of Mexico to fully agree to cuts offers evidence of cracks in the OPEC+ coalition. The amount in dispute was trivial in the grand scheme of things – Mexico agreed to cut by 100,000 barrels per day, not 400,000 b/d – but the episode illustrates how some producers may eventually balk at production restraint. Russia’s insistence that condensates won’t count towards the production ceiling also suggests weakened cohesion.

Market still oversupplied as inventories fill up
Despite pulling off the largest production cuts on record, the reductions pale in comparison to the drop in demand. Depending on the forecast, oil demand could fall by 24 to 30 Mb/d in April, and by slightly less in May. Rosy outlooks on demand in the second half of the year hinge on a V-shaped recovery in consumption, something that is far from assured.

“[E]ven if one assumed 100% compliance with the largest cut in OPEC’s modern history, it still amounts to spitting in the wind in 2Q and does little to change the near-term outlook,” Raymond James warned. “Widespread production shut-ins are still inevitable, as global crude storage is on track to max out in June.”

The agreement could prevent a fall in oil prices to single digits, but will do little to rally oil prices in the near-term. On Monday, WTI and Brent rose by less than 2 percent, with WTI at $23 per barrel and Brent at $32. A collective shrug by the oil market to the largest production cut in history illustrates the magnitude of the global crisis.

The one certainty is that U.S. oil production will indeed decline. Output already fell 600,000 b/d in the latest EIA data. Last week, Concho Resources, a large Midland-based fracking company, said that it was beginning to shut in production at some of its wells in the Permian basin.

Prior to the OPEC+ agreement, U.S. commercial storage was on track to fill up by the middle of May, according to Plains All American Pipeline. “We estimate that US refinery demand for crude oil would be reduced by 30% or more, an approximate 5 million b/d decline. We also estimated that crude oil exports will likely be reduced by a similar percentage, which represents an additional demand reduction of approximately 1 million b/d,” Plains President Harry Pefanis wrote in a letter to Texas regulators last week. The pipeline company advised oil producers to cut proactively rather than waiting for storage to fill up.

A recent survey of U.S oil industry executives from the Federal Reserve Bank of Kansas City found that 40 percent of oil and gas producers in the district – which includes Oklahoma, New Mexico and Colorado – would become insolvent within a year if WTI averaged $30 per barrel. On April 1, Denver-based Whiting Petroleum filed for Chapter 11 bankruptcy protection, likely the first in many bankruptcies this year.

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