By Liam Denning
Covid-19 has made a mockery of just about any plan made a month ago. Global oil demand has dropped by perhaps a third. If people aren’t buying fuel, then refiners aren’t buying crude oil, which means producers are selling into a void — and therefore must cut. Thursday’s fractious OPEC+ meeting — with Mexico taking a starring, stubborn role — was all about apportioning unappetizing slices of a cake called inevitability.
By Friday afternoon, as a meeting of the energy ministers for the Group of 20 countries wound down, an agreement of sorts was in place. But Mexico’s role remained unclear and the G-20’s draft statement offered only vague support for efforts to stabilize the oil market. If this is the cavalry riding to the rescue, it is just as well the market isn’t open.
There is one salient point to focus on: Even the headline OPEC+ cuts can’t prevent a big buildup in inventories. The best producers can hope for is to flatten the curve on that and avoid storage space running out altogether, which would likely push prices into single digits. OPEC estimates demand is down roughly 12 million barrels a day for the quarter. Under that scenario, the agreed cut of almost 10 million barrels a day for May and June would still mean half the remaining onshore storage capacity filling up by July 1.
As it is, that 10-ish million figure likely overstates the true immediate cut, given Mexico’s ambivalence and the fact that the figure is set against production levels from last fall. Russia’s commitment to cut 2.5 million barrels a day — beyond what the market forces upon it — looks especially ambitious. Meanwhile, OPEC’s estimate for demand destruction may well be optimistic and, in any case, there’s no telling how quickly demand will recover.
This may well explain the planned set of tapered cuts adding up to five billion barrels over two years. But who’s really buying a two-year target set by a group that broke up in acrimony mere weeks ago and was held hostage by Mexico over a few hundred thousands of barrels a day? This is a coalition formed under duress and now reformed under yet greater duress; picture a giant feuding family suddenly forced to quarantine together for at least two months. OPEC+ shouldn’t be willing to tolerate Mexico’s intransigence and Mexico shouldn’t want to belong to a group that would. Yet here they are.
This should temper the bullishness that got going a week ago after President Donald Trump’s 10 million barrel tweet. It has been astonishing to watch the rally of almost 30% in exploration and production stocks since then. Production in the shale fields is starting to roll over already, with the sharp drop in fracking crews a leading indicator (see this). The resulting natural decline was all the U.S. “offered” at Friday’s damp squib of a G-20 meeting. Trump also indicated market forces had already taken care of the other oil “cuts” he offered, seemingly without success, to smooth over the Mexican spat (translation: don’t bank on any actual incremental barrels leaving the market).
Trump will no doubt spin all this as art-of-the-deal anyway. Like the OPEC+ cuts, though, it is just a demand shock doing its thing. Trump’s threatened tariffs on barrels if no OPEC+ deal was forthcoming were bluster, given they would raise consumer costs in a recession and ahead of an election; hurt oil majors and refiners; and might not even do much for frackers, whose light crude is simply less valuable with gasoline and jet-fuel demand tanking.
Regardless of long-term targets, adherence to cuts beyond June, particularly on the part of Russia, will be determined by the pace of recovery in demand and the pace of decline in supply from other countries — especially the U.S. Meanwhile, Saudi Arabia may be suffering in absolute terms (see this) but it also has worked assiduously not merely to bring Moscow to heel but to tighten screws on the more ebullient members of the fracking crowd. This is a temporary truce in a multilateral fight between the big three oil powers.
So anyone piling back into E&P stocks on hopes for this OPEC+ agreement should know their sector’s continued suffering is critical to its maintenance. Frackers now face an oil market where the old supposed certainties of demand growth, easy financing and the OPEC+ put can no longer be taken for granted. Restructuring and rationalization are unavoidable. After a week of high drama, expect this reality to reassert itself.