OPEC+ is set to bring 2 million barrels per day (Mbd) back online this month, easing the collective production cuts the group agreed to back in April.
The decision to bring some curtailed supply back online comes after the OPEC+ coalition rescued crude prices from negative territory, stabilizing the market at around $40 per barrel. However, the group is ramping up production just as the demand outlook has begun to deteriorate, threatening another downturn.
A new surplus?
The extraordinary cuts of 9.7 Mbd that OPEC+ producers kept offline for three months helped “rebalance” the market, although at about 90 percent of previous levels. Instead of a 100-Mbd market seen prior to the pandemic, total global supply averaged 86.9 Mbd in June, with demand slightly higher, according to the International Energy Agency.
While the rebound in demand towards the end of the second quarter technically moved the oil market into a deficit, in practical terms the historic buildup in inventories means that the world will be awash in oil for the foreseeable future. Still, with a one-month extension of the OPEC+ cuts through the end of July, Brent has traded in a very narrow range just above $40 per barrel for weeks. With the market somewhat firming up, OPEC+ gained confidence that the immediate crisis had passed.
The apparent successful efforts on the part of OPEC+ bolstered confidence in the group’s ability to unwind some of those cuts. In July, OPEC+ members agreed to ease the 9.7-Mbd cuts to 7.7 Mbd beginning in August. At the time that decision was made in July, a range of analysts thought that it was a prudent decision, and that the downside risks of adding supply back onto the market was limited.
“The oil market is thus heading for a clear supply deficit, which is why OPEC+ is likely on Wednesday to decide to gradually withdraw the record-high production cuts by 2 million barrels per day – as planned – from August,” Commerzbank wrote in a note on July 13. “[T]he call on OPEC is likely to surge massively in the second half of the year.”
Second and third waves
However, the return of OPEC+ supply is coming just as the coronavirus has begun to spread at a faster rate. Having hit the east and west coasts first and the south second, infections are now clearly rising in the Midwest and other parts of the country.
But the problem is no longer overwhelmingly confined to the United States. “More than 300 million people – mostly, though not exclusively, in emerging markets – have gone back into ‘lockdown 2.0’ over the past month,” Raymond James wrote in a report published on August 3. The investment bank said that the percentage of the world’s population living in an economy that has “reopened” peaked at 89 percent in early July. That percentage has declined to 82 percent by the end of July as restrictions have returned.
For example, in recent days, some version of a lockdown or rolling back of earlier “reopenings” have hit Melbourne and Manila. Raymond James pointed out that a multi-week lockdown was announced in the Pakistani province of Punjab, with a population of 110 million, and the Indian state of Bihar, home to 125 million people. Uzbekistan, Kazakhstan and Lebanon are in their second lockdown. Cases are even on the rise in Europe, ending hopes that the virus had been definitively contained.
Oil demand was already starting to flatten, after a substantial rebound in May and June. Renewed travel restrictions threaten to stall out the recovery for a longer period of time than previously expected.
That raises questions about the return of OPEC+ supply. “The upcoming partial return of curtailed OPEC+ oil production from August is set to create a new four-month supply glut of around 170 million barrels,” Rystad Energy said in a recent analysis. Underlying this analysis is a more pessimistic outlook on oil demand.
The firm sees oil demand remaining flat between August and October, with total liquids demand stuck at around 90.5 Mbd. However, unlike demand, “global oil supply is set for a mini growth rally,” Rystad says. Supply could rise to 91.2 Mbd in August, 92.5 Mbd in September and 92.9 Mbd in October. If close to the mark, supply would exceed demand in each month, building up inventories all over again, albeit at a much slower pace than seen earlier this year.
“OPEC’s experiment to increase production from August could backfire as we are still nowhere near out of the woods yet in terms of oil demand. The overall liquids market will flip back into a mini-supply glut and a swing into deficit will not happen again until December 2020,” Bjornar Tonhaugen, Rystad Energy’s Head of Oil Market Research, said in a statement. “We doubt that the market can take the additional production volumes from OPEC+ from August without negative consequences for oil prices.” The firm says that OPEC+’ tapering plans “may need to be put on hold if the goal is to sustain the oil price recovery.”
For OPEC+, there is little appetite to cut deeper again. Some countries, such as Iraq, have promised to overcompensate their cuts this month in order to make up for lagging in previous months. But beyond August, cutting deeper would be a heavy political lift. With a potential surplus for the next several months – coming on the back of a large inventory overhang and the return of OPEC+ oil – the oil price rally has stalled out.