OPEC proposed making substantial production cuts in order to head off another price slide, although Russia has yet to sign on.
On Thursday, OPEC met in Vienna and announced a proposed 1.5 million barrels per day (mb/d) of additional cuts. The idea calls for OPEC itself cutting by 1 mb/d, and the non-OPEC coalition reducing output by 0.5 mb/d. However, as of Thursday, Moscow had not signed onto the agreement.
“T[]he COVID-19 outbreak has had a major adverse impact on global economic and oil demand forecasts in 2020, particularly for the first and second quarters,” OPEC said in a statement on Thursday. “Global oil demand growth in 2020 is now forecast to be 0.48 mb/d, down from 1.1 mb/d in December 2019. Moreover, the unprecedented situation, and the ever-shifting market dynamics, means risks are skewed to the downside.”
OPEC’s demand estimate is now half of what it was from just three months ago, and even the 0.48 mb/d growth figure looks a little optimistic. Goldman Sachs, among other analysts, actually sees oil demand falling into negative territory this year.
It is a bit unusual for OPEC to publicly make a proposal without having a deal in hand. To be sure, the rumor mill about the size of cuts and internal politicking is typical at every meeting in Vienna, but an official proposal prior to approval is rare.
The move is likely to put pressure on Russia to agree, but Moscow has been skeptical of additional cuts for quite some time. And just a few days ago, Russian President Vladimir Putin said that his country was more or less content with where oil prices are right now, noting that the Russian budget takes into account the possibility of low oil prices. Related: The 3 Hottest Inverse Energy ETFs
However, it is hard to imagine Russia walking away from this agreement. It would require only a modest reduction on Moscow’s part, and it may provide a little bit of a boost to oil prices. More importantly, a no-deal result would almost surely lead to a steep selloff in crude. Odds still seem likely that Russia agrees.
It is in that context that OPEC gambled by publicly proposing a cut of 1.5 mb/d – a larger cut than the OPEC Joint Technical Committee recommended only recently – an attempt, perhaps, to pressure Russia into getting on board. The upside of participating would seem to outweigh the downside.
Making the ultimatum explicit, Iranian oil minister Bijan Namdar Zanganeh told reporters that if Russia does not sign on, “there will be no deal.”
But that could be a hollow threat. OPEC has shown signs of a determination to cut even without Russia. The pressure on government budgets from low oil prices is too great.
Still, some see a small chance that the Saudis are not bluffing, and could walk away if Russia doesn’t play ball. “OPEC is making the cuts conditional on Russia joining. What Moscow perhaps is underestimating is that Saudi Arabia may be ready to walk away if it doesn’t get a positive answer,” said Amrita Sen, chief oil analyst at consultant Energy Aspects Ltd., told Bloomberg.
Russia, for its part, sees U.S. shale on the ropes, with financial stress deepening for small and medium-sized drillers. U.S. oil production growth has slowed dramatically in recent weeks and months, and if WTI lingers below $50 for a lengthy period of time, output will plateau and may even decline. Related: Has U.S. Electricity Lost Its Spark?
Even if OPEC+ manages to come together once again and agree to deeper cuts, the hit to the economy and to oil demand from the coronavirus is severe.
“As global stocks increase by the day, the ongoing OPEC+ meeting is unlikely to result in cuts sufficient enough to balance the market, under all of our scenarios,” Rystad Energy said in a report.
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Notably, that report was published February 11, which seems like a lifetime ago. That was before the coronavirus really spread beyond China’s borders, before it swept across the Middle East, Europe and entered the United States. It was before the Federal Reserve panicked and cut interest rates by 50 basis points. And it was before analysts began forecasting negative demand growth for 2020.
With or without another round of OPEC+ cuts, the oil market is in trouble.
By Nick Cunningham of Oilprice.com
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Therefore, for cuts to be meaningful and effective, OPEC will have to cut production by 5.0 mbd. This is impossible to do since it will bankrupt the economies of Saudi Arabia and other OPEC members.
While Russia has cooperated with OPEC in the past to ensure that previous cuts and existing ones have had some effect on oil prices, it believes that any new cuts or a deepening of existing ones will have no effect whatsoever on oil prices while the outbreak is still going on.
Moreover, Russian oil companies are against any cuts as they want a quick return on the huge investments they made in recent years to expand their production capacity. They also believe that any cuts will give a lifeline to US shale oil drillers. Above all, Russia’s economy can easily live with an oil price of $40 a barrel or even less compared with more than $85 for Saudi Arabia and most other OPEC members.
Still, President Putin may reluctantly, for geopolitical reasons, give the nod to new OPEC cuts with a symbolic cut of his own just for the sake of maintaining good relations and cooperation with Saudi-led OPEC.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London