From the Economist's Chair: Opec+ isn’t over until it’s over...

Author David Fyfe, Argus Chief Economist

British Labour Prime Minister Harold Wilson said during the 1960s that “a week is a long time in politics”. If so, a month seems like an eternity for an oil market buffeted by coronavirus and the Opec+ fracturing that took place on 6 March in Vienna.

Imminent unchecked producer competition, including a threatened 12 mb/d+ of supply from Saudi Arabia, and seemingly relentless reductions in 2020 economic and oil demand forecasts left the industry staring down the barrel of a gun: While crude futures fell to $20/bbl at end-March, physical values tumbled by a further $10/bbl.

Few producers outside the Middle East can cover cash costs with prices below $10/bbl, so the question became whether these prices would be low enough to force production shut-ins both rapid and deep enough to avoid overwhelming storage and pipeline infrastructure.

Crude production tends to be sticky, even confronted by sub-breakeven prices, as technical constraints, producer hedging and a desire to sustain cashflow all combine to prevent instantaneous reductions in supply.

Nonetheless, Argus Consulting projections in the April issue of Crude and Refined Products Outlook (CRPO) show non-Opec production potentially falling by over 6 mb/d from end-2019 levels by 3Q20, partly on weak prices, but largely amid signs pipeline operators, refineries and terminals are already starting to turn away crude amid collapsing refiner crude demand.

Ominously, CRPO also estimates 2Q20 oil products demand could be 18-20 mb/d below both year-ago and 4Q19 levels, as economies worldwide lock-down to limit the spread of the virus. Jet kerosene and gasoline demand are hardest hit as both local and international passenger transportation has ground to a halt.

And this demand decline will be much steeper than expected non-Opec supply shut-ins by the US (-5 mb/d), Canada (-1 mb/d) and around 0.5 mb/d combined from the North Sea and Latin America.

With Opec producers having threatened to potentially raise production from around 28 mb/d in 1Q20 to nearer 30 mb/d in 2Q20, there was a clear and present danger that available global storage of 1.2-1.5 billion barrels could become overwhelmed as early as mid-May.

Indeed, early-April market reports suggest up to 100 mb of crude is destined for floating storage (the costliest form of oil storage), as bottlenecks onshore, and steep market contango, offset relatively expensive tanker rates.

Something had to give in this equation – either prices stay very low, pushing a swath of high-cost producers into bankruptcy, or a political accommodation is reached between the world’s largest oil producers - Saudi Arabia, Russia and the USA.

The Saudis won’t cut alone, demanding Russia also steps up to the plate (remember, it was Russia’s refusal to extend cuts beyond 31 March that sunk the 6 March Opec+ meeting in the first place). And Russia won’t agree unless the US and other high cost producers shoulder part of the burden too.

Now Opec+ Ministers will meet by videoconference on Thursday 9 April. Aramco will exceptionally defer releasing its May OSPs until Friday, after the discussions end. Potential supply cuts of 10 mb/d are rumoured, although how these would be apportioned across Opec+, or whether the US, Canada and others might be asked to contribute additional voluntary cuts (on top of shut-ins already set in train) is uncertain.

At first glance, US anti-trust legislation makes the concept of supply management by shale producers problematic.

The Texas Railroad Commission will nonetheless convene by video conference on 14 April to discuss curtailing output. For his part, President Trump at the weekend seemed to prefer crude import tariffs as a route to aiding beleaguered shale producers.

Argus supply/demand balances suggest that further cuts of 10 mb/d (on top of the non-Opec declines mentioned above) spread over 2Q20, then scaled back to 5 mb/d in 3Q20 could prevent storage from overflowing.

Indeed, if global oil demand, as expected, stages a recovery from 3Q20 onwards, then much of the supply overhang built up during first-half 2020 could be drained by the early months of 2021.

So, the mechanics of voluntary production restraint make sense, and the prospect of a renewed producer accord drove Brent futures up towards $35 by late on 3 April. However, it does beg the question whether Saudi Arabia and Russia will countenance throwing another lifeline to US shale producers, just as they did in late-2016. And whether the US Administration would or could mandate domestic production cuts to help overcome Saudi and Russian misgivings.

Nobody wants to be seen exacerbating the unprecedented current market turbulence. But reaching a timely, durable and enforceable deal that satisfies three such unlikely political bedfellows looks challenging indeed.

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