The Fuse

OPEC+ Tries For Global Deal, But Glut is Still Too Large

by Nick Cunningham | April 06, 2020

OPEC will meet on April 9 for an emergency meeting to potentially hash out a massive cut to global oil production.

The global supply surplus could top 20 to 25 million barrels per day (Mbd) for a period of time, a hole so large that even coordinated production cuts may struggle to move the needle. But with storage facilities filling up with oil at an astounding rate, cuts will come in one form or another.

OPEC+ to become OPEC++?
With a tweet on April 2, U.S. President Donald Trump kicked off a diplomatic frenzy, with Saudi Arabia and Russia eyeing global production cuts that could include oil-producing countries beyond the OPEC+ coalition.

The global supply surplus could top 20 to 25 Mbd for a period of time, a hole so large that even coordinated production cuts may struggle to move the needle.

The main number under consideration is a cut of 10 Mbd, a figure so large that Saudi Arabia and Russia would be unable to do it alone. Neither would, or could, agree to cut their output by as much as a third to half of their current levels, which would be necessary to add up to something close to 10 Mbd.

As a result, their participation is contingent upon other producers chipping in. That could include a coalition of other non-OPEC countries, including Norway, Brazil, Canada and perhaps even the United States. The G20 has called for an emergency meeting of oil ministers for April 10.

A deal is not impossible, but there are several formidable obstacles standing in the way. First, the resurgence of diplomatic momentum hit an immediate snag. Russian President Vladimir Putin said it was really Saudi Arabia that was trying to kill U.S. shale, something that Saudi energy minister said was “completely false.”

Russian President Vladimir Putin said it was really Saudi Arabia that was trying to kill U.S. shale, something that Saudi energy minister said was “completely false.”

“I don’t see how an agreement can be reached if we are in a war of words at the moment,” a Saudi oil official said, according to the Wall Street Journal. The proposed meeting for April 6 was pushed off until later in the week. The same dynamic that plagued the failed March OPEC+ meeting exists today – Russia and Saudi Arabia do not see eye-to-eye on what to do in the face of a surplus. But there is hope, as the threat of sub-$20 oil can be incredibly motivating to oil producers.

Another significant roadblock is the questionable ability or willingness of the U.S. to participate. The authority of the federal government to impose production cuts is unclear, and in any event, President Trump suggested that the free market would “figure it out.” Putting the onus back on Saudi Arabia and Russia may not be well received by the OPEC+ group and the lack of American participation would make the task of cutting supply much more difficult.

The Texas Railroad Commission (RRC) offers one avenue to impose cuts. One of the three commissioners on the RRC is adamantly supportive of rationing production, but Ryan Sitton will need to convince at least one of his two peers to go along.

Oil is now filling up every usable storage site around the world, flowing into strategic petroleum reserves, commercial storage, floating at sea on tankers and even filling up at old shutdown refinery sites, according to the Wall Street Journal. Time for a deal is running out.

Cuts won’t be enough
A major production cut of 10 Mbd would be both difficult to achieve and historic in size. It will also likely be insufficient given the collapse in demand. The IEA’s executive director Fatih Birol estimates that the global surplus could reach as much as 25 Mbd.

A major production cut of 10 Mbd would be both difficult to achieve and historic in size.

U.S. gasoline demand could be down by as much as 50 to 60 percent year-on-year, according to a new study from Bank of America Merrill Lynch. As more than 230 million people in the U.S. now live under some sort of a lockdown, demand has vanished. Refineries have cut 2.5 Mbd of gasoline processing output in the past two weeks, but inventories are still rising. “In short, the implosion of demand has quickly turned gasoline from refiners’ golden child to their Achilles heel,” Bank of America said.

As refineries curtail output or otherwise shut down, the backup is already felt by pipeline companies who, in turn, are now telling drillers to reduce production.

In other words, cuts may be inevitable, whether they are coordinated at an international level or not. Available storage is expected to rapidly fill up, potentially forcing steeper price declines and production shut ins. According to a report from Raymond James, at least 4 Mbd of current supply cannot even cover operating costs if oil prices stay at $25 per barrel. At $15 per barrel, about 26 Mbd cannot cover opex. That doesn’t necessarily mean shut ins of that size are immediate, but the odds of forced closures rise the longer the downturn persists.

That figure does not include the array of other costs an oil driller faces, such as finding and discovery, interest expenses and other corporate administration costs. A much broader slice of global supply is unprofitable at prevailing market prices.

U.S. shale drillers, in particular, face some difficult decisions. Having struggle to turn a profit for years, the pace of drilling was expected to slow even before the global pandemic. A staggering 102 oil rigs have been removed from the field in just the past two weeks, according to Baker Hughes. That includes 54 rigs from the Permian. Frac spreads – the crews actually doing the hydraulic fracturing – are also falling off of a cliff.

But the shut ins will stretch around the world as physical storage space fills up and prices crash. That may soon occur whether OPEC+ (or OPEC++) acts or not.

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