OPEC+ Deal Hangs In Balance

In anticipation of the OPEC + and G20 video conferences, analysts and market participants actively discussed what the future agreement would be to reduce oil production and whether oil-producing states would be able to coordinate their positions. Oil companies had reason to worry, as the statistics were extremely negative, and the price of oil (WTI) was ± $25. In contrast, small and medium-sized American shale companies needed a price above $30 so as not to fly into the pipe.

The construction of a future agreement was not entirely clear. Moreover, Saudi Arabia and Russia stated that a reduction is possible only if the United States joins the deal. Given the position of the United States, such a request looked, to put it mildly unrealistic.

After the end of the extraordinary session of OPEC members and non-OPEC states on the evening of April 9 (including representatives of Norway who had previously expressed their intention to reduce production), at the level of energy ministers, it can be said that there is still no certainty to the end of the determined situation increased. Its participants reaffirmed their commitment to the Declaration of Cooperation, signed on December 10, 2016, and worked out the details of the deal to reduce oil production.

The agreement, which expires on April 30, 2022, provides for a reduction in production:

✔ 10 million barrels per day, from May 1 to June 30, 2020;

✔ at 8 million barrels per day in the second half of 2020;

✔ 6 million barrels per day from January 1, 2021, to April 30, 2022.

As a starting point for the parties to the agreement (except for Saudi Arabia and Russia, for which the initial level of reduction is determined from 11 million barrels per day), the level of oil production in October 2018 was chosen.

Preliminary information released during the video conference indicated that Saudi Arabia would cut production by 4 million barrels and Russia by 2 million, although other estimates appeared. It should be noted that Mexico did not agree with the plan, as a result of which the deal hung in mid-air. As indicated in the OPEC press release, the condition for concluding the agreement is the consent of Mexico.

Thus, today in the course of the G20 teleconference, in all likelihood, it will be determined whether the transaction will take place or not (and what will be its final parameters), and a lot will depend on Donald Trump and his ability to convince intractable people using semi-economic coercion. The published quantitative parameters of the deal and the nuances of its approval clearly disappointed before this growing oil market. 

In our opinion, the market is somewhat exaggerating the need for a sharp reduction in production. Of course, some studies show that a shock reduction in demand can be extremely large. For example, a presentation by the independent Norwegian analytical company Rystad Energy indicates that by the end of April the combined reduction in oil demand could reach even 27 million barrels (OPEC expects a decrease in demand in the second quarter by 11.9 million barrels), but even its analysts suggest that after that, demand recovery will begin, and by the end of the year this figure will be no more than 5 million barrels. So a reduction in production by OPEC + by 6 million barrels per day in 2021 may well be sufficient. Wait and see.

At the same time, along with a shock reduction in demand, it is necessary to pay attention that, firstly, demand will gradually begin to recover, including because China is the first to come out of the crisis caused by the pandemic and resumes oil purchases. Secondly, gradual correction of the proposal itself is expected. According to estimates of leading US investment banks, the reduction in oil supply due to lower prices and logistical problems will range from 5 (Goldman Sachs) to 10 million barrels per day (Citi). It is also worth noting that a sharp reduction in the number of oil-producing wells in the USA has already begun - last week it reduced by 62 wells to 562. In general, the EIA expects that oil production in the US in 2020 will be reduced by 2 million barrels (by other estimates, if Saudi Arabia and Russia suddenly continue the price war, then the volume of production in the United States could almost halve due to a sharp drop in prices).

Thus, the expected imbalance between supply and demand, caused by a shock reduction in demand and a sharp increase in oil production during the price war, may ultimately be much lower than previously published estimates in the range from 10 to 20%.