US President Donald Trump’s call for a 10 million barrel per day – or even 15mn bpd – cut drove up oil prices last week but weak demand continues to run the show, with little respite expected from talks due to take place this week.
The dramatic way in which the OPEC+ meeting on March 6 fell apart, with Russia refusing to offer assistance and Saudi Arabia setting out plans to turn on the taps has seen the world become awash with crude. Neither side seemed to expect that things would fall apart quite as they did or that the escalation of coronavirus could reduce oil demand by as much as 20mn bpd.
Talks were due to be held on April 6, via video conference, with market hopes that an agreement might be reached on cutting output. Over the weekend, as the Russians and Saudis trading barbs in a blame game over the price collapse. The meeting has now been pushed back, perhaps to April 9.
“It would be logical that the major producers reach an agreement to cut production. We don’t have a completely clear picture on how great the real state of oversupply is or how full storage, is but it’s clear there’s much more oil being produced than we need,” said Investec’s head of commodities Callum Macpherson.
“That said, it’s incredibly complicated and there’s no precedent for such an agreement to be reached between OPEC, the OPEC+ countries, the US, Canada.”
Reaching such an agreement will be difficult given uncertainty over quite how far demand has fallen.
Riyadh’s thinking
Saudi is warming to the idea of action, but would require multilateral support for such a move. The country will probably need to engineer a way in which to cut production within the next six months, Falanx Assynt’s managing director Charles Hollis said.
“Given the amount of oil that has gone into storage and reduced demand, resetting the market may be challenging. Kuwait and the United Arab Emirates will want to see co-ordinated action, while Oman and Bahrain need higher prices. A gesture of solidarity for its Arab brethren might be how Saudi spins a reversion of policy,” Hollis said.
Saudi needs a higher oil price in order to balance its books. While the country has extremely low production costs, its budget only breaks even at a price around $80. It has a big reserve of cash, but this has been being depleted for some time.
Given the price crash, Riyadh has reduced its budget spending by 5%, although Hollis said further cuts were likely needed.
Social spending has been seen as one of the ways that the Saudi government secures support from its citizens. In addition to the budget reduction, those citizens who chose to invest in the Saudi Aramco IPO will be sitting on paper losses, which puts further pressure on the government.
Saudi’s decision to walk out of the OPEC talks in Vienna was a “hell of a risk”, he said. “There has been volatile decision making in a number of areas over the last three years and the recent decision on oil output may fall into that.”
The Falanx Assynt official attributed Saudi’s decision to flood the market as a gambit aimed at Russia.
Moscow’s move
“There is a genuine reluctance in Russia to cut production. The feeling is that, at this point, such a move would be meaningless given uncertainty over demand,” the Oxford Institute for Energy Studies’ James Henderson said.
Russian reluctance to participate in the cuts dates back to at least October 2019, he continued. The cuts they had brought in were more “the avoidance of growth”. Russia was hesitant to take part in reducing supply when this was growing so strongly in the US.
Russian Energy Minister Alexander Novak was sent to the talks at the beginning of March with “no mandate for a cut”, Henderson said. “He had no room for manoeuvre – it was a coincidence of unfortunate events.” When faced with such an uncertain demand outlook, the proposed cuts would have had no impact and producers would have been forced to come back for more reductions.
“This is not an OPEC problem, it’s a global problem,” Henderson said. Moscow would need to see major participation around the world in reducing output – or alternative incentives. “If Trump is asking for big cuts from Russia there would need to be a significant quid pro quo. It would have to be a major removal of sanctions, I believe.”
The idea that Russia and Saudi alone might meet the 10-15mn bpd cuts suggested by the US president were dismissed by Henderson. “The only beneficiary of such a cut would be the US. This is inconceivable and practically impossible.”
Even if that cut were agreed, global production would still be above demand. Storage would continue to fill up, albeit at a slower rate.
Russia feels confident in its positon and economically is well prepared to survive. The cost of producing oil is low and the budget is much less reliant on higher prices than Saudi, in addition to a flexible exchange rate – another advantage Riyadh lacks.
While there has been speculation that Russia intended to destroy US shale, Henderson described this as more a “convenient and not unwelcome consequence”.
Texas’ trial
US production was surprisingly resilient during the 2014-15 price crash but much of the efficiency gains have already been made. While much of the focus on the shale revolution has focused on the innovative combination of horizontal drilling and hydraulic fracturing, perhaps just as important were new ways of securing finance.
“While the US producers are not drilling new wells, there is a backlog of drilled but uncompleted wells (DUCs) that can quickly be brought into production. Where companies might be vulnerable is when they need to refinance. It’s hard to see banks providing much support at the moment and there’s a chance that bankruptcies could stem from a failure to refinance,” Macpherson said.
If the glut continues US production may start to come down within a “few months”, based on lag in the impact of the prices and DUCs.
The question of a government response is also an unknown. Texan regulators have teased the prospect of bringing in production limits, or they could even crackdown on flaring, which would have a knock on impact given its association with oil.
At a higher level, Trump is under pressure to provide support. The government could lend money, guarantee debts or even sanction imports of foreign crude into the US.
As if the crude supply and demand imbalance was not bad enough, Macpherson also raised concerns on the products market.
“There is also a dislocation in refined products. Diesel demand has fallen but is continuing, while jet fuel demand has all but disappeared,” he said. “As a result, new places need to be found for the storage of jet, as seen with the recent news that a cargo is being stored on a new VLCC.”
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