With the most recent round of coronavirus-inspired lockdowns in various parts of the world, OPEC may face its biggest challenge yet: cutting even more production. Would the cartel and its members survive such a decision?
OPEC originally planned to relax the current round of production cuts starting in January. And for now, that plan still stands. But there has been talk among OPEC members and analysts that it could waylay that plan, extending the cuts beyond January 2021 to some indefinite future date.
The reason for the possible extension of the current round of cuts is OPEC's view on oil demand, upon which all plans—budgets, production plans, austerity measures—hinge.
And if the new round of lockdowns in various parts of the world are any indication of future oil demand—and oh, are they ever—OPEC must seriously be considering the possibility that its plans to relax the production cuts should be scrapped.
Current lockdowns are threatening the very fabric of the oil industry, and some oil and gas companies haven't survived the last round of lockdowns and depressed demand. It's very likely that more oil and gas companies won't make it this go around.
Austria is starting on November 3 its latest lockdown. Under the new orders, residents must stay at home during the hours of 8pm to 6 am—until the end of November in a desperate attempt to arrest the spread of the virus. Hotels must close, and restaurants and cafes will close—all of this will profoundly affect oil demand. For Austria, it gets most of its oil from Kazakhstan—an OPEC+ member— while its gas comes from Russia.
Last week, France implemented its second lockdown too, and this time it's expected to last until December 1. Under these measures, people are allowed to go to work only, in addition to buying essential goods and attend medical appointments. One of the most noteworthy restrictions here is that traveling between regions is banned, and must stay within 1 kilometer of their homes—a rule that will surely eat away at oil demand for the nation that gets most of its oil from Saudi Arabia and Norway. Related: Venezuela’s Oil Industry Is On Its Last Legs
Next on the list is Germany, which went into another lockdown on Monday. Germany has tight travel restrictions, and all nonessential travel is prohibited. According to energy market research group AGEB, Germany's energy consumption is set to fall this year by 10%--for crude oil specifically, Germany is looking at a 3% drop, according to AGEB. Germany's largest oil supplier is Russia—the defacto leader of the plus part of OPEC+. The UK and Portugal are locking down again as well, with the UK's lockdown beginning on November 5.
With these lockdowns and likely more to come, will it push down oil demand to levels that will create even more of a glut—and a headache for OPEC? And if so, will OPEC member budgets be able to take another hit from the ugly combination of lower oil prices caused by the glut, and fewer barrels produced from which it can generate revenue?
The answer is complex. Most OPEC members are heavily dependent on oil revenues—some nearly completely. And there have already been rumors of unhappy members who have indicated—off the record, of course—that they will not be on board come January should OPEC come knocking and asking for an extension of the already painful quotas that it is enduring today.
Those disgruntled countries which have begrudgingly cut production as a duty they must perform include Nigeria and Iraq.
OPEC and Russia—or more likely Saudi Arabia and Russia—seem to be favoring an extension of the cut. They are said this week to be weighing the possibility of delaying their January plan to relax the cuts. Oil prices rose on Tuesday on the mere rumor of such an event, but OPEC members are likely less enthusiastic.
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The reasons for this are clear. Economy diversification efforts in OPEC member countries are slow in coming. Their budgets are inextricably linked with oil revenues, and on Tuesday, the Energy Information Administration (EIA) predicted that OPEC members' oil revenues will fall this year to the lowest level in 18 years—the result of both low oil prices and lowered production. Collectively, OPEC members are set to earn $323 billion in net oil export revenues this year, compared to $595 billion last year, the EIA added.
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Aramco reported a profit for Q3 on Tuesday, but it was 45% lower. That's painful, yet Aramco announced that it was keeping its dividend. That dividend is mostly going to the government—98% of it in fact—and the fact that the dividend is being kept while profits plunge 45% is a definitive indication that Saudi Arabia's budget needs those revenues to come hell or high water.
In the end, even if some countries feel more pain than they can bear, Saudi Arabia and Russia will likely pull the strings as usual. If the two think it prudent to extend the current production cuts beyond January, the rest of OPEC+ will likely fall in line—no matter how painful it turns out to be.
By Julianne Geiger for Oilprice.com
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