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Energy 13 May, 2020 10:00 am   

The oil agreement is turning into a zombie (ANALYSIS)

Three OPEC+ countries have announced additional production cuts to the tune of over 1 m b/d until oil prices drop. The coronavirus did kill the oil deal, but it’s not done yet. Further cuts will be determined by the market, not political declarations – writes Wojciech Jakóbik, editor in chief at BiznesAlert.pl.

Saudi Arabia, Kuwait and the United Arab Emirates decided to voluntary cut their oil output by an extra 1.2 m b/d in total. The Saudis said they had decided to do this to convince other OPEC+ members to comply with the cuts decided upon in the April agreement.

The Saudis decided to lower production in June by an additional 1 m b/d. Kuwait and the United Arab Emirates will reduce output by 80 and 100 thousand b/d respectively. This additional 1.2 m b/d cut is on top of the 9.7 m b/d drop in oil output, OPEC+ members agreed to implement in May and June this year. The alliance plans to meet in June to assess the effectiveness of the solutions decided upon in April. The Saudi ministry of energy informed that the goal of Riyadh’s decision is to “encourage the OPEC+ countries and other producers to comply with the production cuts they had agreed upon and to introduce additional, voluntary cuts in order to facilitate stability on the global oil markets.”

In response to this decision, oil prices went up for a moment and then stabilized because probably the market read this move as an attempt at overcoming OPEC+ problems. Currently the organization needs to face at least three:

1. The fundamental challenge is that the coronavirus pandemic limited demand for oil to a level that makes further production cuts irrelevant. The International Energy Agency warned that demand in May would go down by 29 m b/d, a drop that would not be overcome by oil production cuts of 9.7 m b/d. The same goes for the voluntary cuts at 1.2 m b/d announced by the Saudis and their peers. New declarations to lower production in OPEC+ countries may be announced. However, their effectiveness will be limited by the next factor.

2. The next issue that plagues the alliance is the inefficient introduction of cuts. Saudi Arabia admitted that it wanted to encourage other OPEC+ states to comply with the cuts that had been already agreed on. The data shows that Iraq and Kazakhstan have not introduced their cuts yet. The situation in other OPEC+ states may be similar. In May Reuters reported that Kazakhstan decided to introduce the previously agreed on cuts on 5 May. It pledged to reduce output by 23%, which is about 390 thousand b/d. On 5 May a decree was issued to lower output in the Tengiz and Kashagan oil fields, but the cuts may be delayed as the flexibility of production in those fields is limited because of the contracts that need to be fulfilled by the Caspian Pipeline Consortium, which so far has been producing oil for export without any changes. Iraq may also delay its production cuts planned at 600 thousand b/d. According to the Iraq Oil Report, so far the cuts reached only 220 thousand barrels. Russia may experience similar delays. In April 11.35 m b/d were extracted in Russia and the production needs to be cut by 2.85 m b/d. According to TASS in the first week of May the drop amounted to 1.9 m b/d. The previous oil agreement said Russia had three months to reach a reduction by 300 thousand b/d, which it achieved only at the end of the deadline.

3. Moreover, the cuts are becoming less dependent on the will of the OPEC+ members. The dropping oil production across the world is caused by the fact that storage capacity is shrinking fast. Rystad Energy claims that without additional cuts, storage capacity will run out already in June 2020. This is why more reductions are expected and they may happen not because of political reasons, but simply because storage capacity is running out. On the other hand, a quicker output reduction is already visible in the less-regulated Northern America, where producers cut production quicker than OPEC+ expected them to. The alliance hoped the US, Canada and Brazil would make cuts by 3.7 m b/d before year’s end, but according to a survey by Reuters the reduction will reach 1.7 m b/d by the end of June. Probably this results from the surpluses in the world’s storage tanks and the impact the oil crisis has on those markets. According to Rystad Energy, thanks to the return of economic activity, the peak of oil output reduction in the US might have been crossed. Until recently the number of oil wells went down every week by 50-55. In the first week of May this number was at 32.

However, the International Energy Agency claims that even the deepest supply cuts may not be enough to remove the oil surplus from the market, which may reach even a fourth of global consumption. The Agency’s CEO Fatih Birol suggested that cutting the production by 10 m b/d (more than the OPEC+ agreement and the voluntary cuts by Saudi Arabia, Kuwait and UAE in total) will result in a ca. 15 m b/d surplus in the second quarter of 2020 anyway. Whereas the market is acknowledging that the surplus may increase in case a second wave of the coronavirus pandemic occurs in the fall. Analysts generally agree that the average price per barrel in 2020 should be about USD 30, which means there will be further cuts due to market reasons regardless of the future of the OPEC+ agreement, which is still formally binding. It’s a zombie that is trying to be scary (but puts producers at ease), even though in reality it’s dead.



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