OPEC+ will hold a committee meeting this week to assess the status of the oil market and decide on its next steps. For now, the group appears ready to begin unwinding the extraordinary production cuts, which could test the recent price rally. The historic cuts of 9.7 million barrels per day (mb/d) that OPEC+ implemented after the pandemic-related crash was always intended to be temporary. Initially, the cuts were set to expire at the end of June and begin tapering at the start of July; the group agreed to extend that first phase by a month.
As of now, the cuts are slated to expire at the end of July, reducing the cuts from 9.7 mb/d to 7.7 mb/d. Various press reports have suggested that the group is ready to let those cuts taper as scheduled, rather than push for another extension.
Russia intends to rachet up production in August, and OPEC+ delegates are “leaning towards” relaxing the cuts, according to a report from Bloomberg. The Wall Street Journal reported a similar angle, adding that OPEC+ producers are reluctant to continue to shoulder the burden of propping up prices while non-OPEC producers around the world bring their own production back online. “If OPEC clings to restraining production to keep up prices, I think it’s suicidal,” a source familiar with Saudi strategy told the WSJ. “There’s going to be a scramble for market share, and the trick is how the low-cost producers assert themselves without crashing the oil price.”
Keeping 9.7 mb/d off of the market helped engineer a price rally to $40 per barrel and create an atmosphere of stability. The big question now is how the market will react to an easing of those cuts. “It has been all but a bumpy ride for oil during the last months and the OPEC+ deal on supply has been a pillar for the market,” Louise Dickson, oil market analyst at Rystad Energy, said in a statement. “The upcoming OPEC+ meeting this week is now expected, as planned, to make this pillar a bit weaker.”
Dickson added that it is “not necessarily a bad thing” for OPEC+ to increase production since “supply would have to grow as demand recovers.” Demand has sharply rebounded, although remains below pre-pandemic levels.
The problem is that it remains incredibly difficult to calibrate supply additions to match the trajectory of demand recovery. The delicate balancing act is even trickier because demand may slow again due to the spread of the coronavirus. “[W]hat OPEC+ may have not accurately forecasted is the speed of the recovery, thus a premature partial lift of oil production restrictions can have a depressing effect for prices,” Dickson concluded.
Other analysts are less concerned about OPEC+ bringing supply back. “Our balances show hefty deficits in the third and fourth quarters, even with a tapering,” Bob McNally, founder of consultant Rapidan Energy Group, told Bloomberg. “I think the market will handle it pretty well.”
If demand continues to increase, the “call on OPEC” will “surge massively” in the second half of the year, Commerzbank said in a note on Monday. “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,” the investment bank said.
Meanwhile, the news from Libya is murky. The National Oil Corp. recently lifted force majeure on oil exports and said that it would begin to add supply back onto the market. However, over the weekend, the Libyan National Army said that the blockade would continue. In response, the NOC once again declared force majeure on Sunday, accusing the UAE of backing the blockade. The return of Libyan oil, should it occur, will likely be gradual. As such, it may not add too much to global supply.
Another source of additional supply – U.S. shale – may not be as large as feared. In the past, any tightening up of the oil market simply created more room for aggressive shale drilling. But the rig count remains at historic lows, despite the increase in crude prices back to $40, and financial stress could keep drilling subdued. As steep decline rates take hold, it appears unlikely that U.S. production will come back in any significant way this year or next.
This creates more room for OPEC+ to unwind their cuts, although the coronavirus remains an enormous uncertainty.
By Nick Cunningham of Oilprice.com
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