What do you get when two sides have a spectacular public falling out in full view of the international press, and are subsequently forced by extreme circumstances to kiss and make up less than five weeks later? An OPEC+ oil production cut agreement!
The oil market story that unfolded earlier this year as simple as that. On March 6, talks between the oil producers’ group OPEC and its 10 non-OPEC counterparts, largely underpinned by Saudi-Russian diplomacy, collapsed dramatically in Vienna, Austria.
The bonhomie had lasted, at least on paper, since 2016 and was largely instrumental in bringing the oil market out of the 2015-16 downturn. However, when the Saudis saw the coronavirus or Covid-19 outbreak batter China, the world’s largest importer of crude oil with an average appetite of 14 million barrels per day (bpd), the Russians resisted.
Undaunted by Moscow’s stance and faced by unprecedented oil demand destruction that had yet to unfold, Riyadh-led OPEC producers proposed a deepening of their existing cuts by a further 1.5 million bpd until the end of the year in a move spearheaded by Saudi Oil Minister Abdulaziz bin Salman.
Instead, his Russian counterpart Alexander Novak declared that participating countries were free to ramp up “idle capacity from April 1”; a day after the expiry of the original deal. The indignant Saudis responded by slashing the Kingdom’s official selling price (OSP) for April for “all its crude grades to all destinations” the very next day, with communiqués issued by its oil behemoth Saudi Aramco reaching traders from Houston to Singapore.
As oil futures plunged and the Covid-19 outbreak in China morphed into a global pandemic, the oil market found itself in the unusual position of a simultaneous supply glut and demand crisis with whole countries going into lockdown, as airplanes were grounded, vehicles parked and people ordered to stay indoors.
Yet, the belligerence continued for a while. In the two weeks that followed, Russian commentators claimed their country could survive prices even as low as $8 per barrel, and the Saudis hired their own mammoth convoy of supertankers to flood the crude market. However, by then it had become manifestly apparent that the price floor might not even hold at $8.
In the interest of self-preservation by April 9 all OPEC+ participants, especially Moscow and Riyadh, were back at the negotiating table having found new friends in the shape of producers who weren’t part of earlier deals.
Converting the Easter Holiday weekend into a working one, a deal was cobbled together to take 9.7 million bpd of production off the market from the May 1 to July 1. The bulk of the output cuts were predicated on Russia and Saudi Arabia cutting 2.5 million bpd from agreed – and somewhat inflated – levels of over 11 million bpd.
And this was the same Russia, which under terms of the OPEC+ production cap prior to the collapse of talks in March consistently produced on average 11.25 million bpd, according to Reuters data, despite promising to keep its quota at or below 11.191 million bpd. Only in May, June and July 2019, was its output anywhere below its pre-December 2019 OPEC+ target, and that too was largely down to the Druzhba oil pipeline contamination crisis.
Nonetheless the cut was approved, albeit a tad too late for April which saw negative oil prices for the first time in trading history, and proved to be too little for May. But in June, with the demand picture improving, supply glut easing and oil prices tantalizingly close to $40, comes another round of OPEC+ wrangling.
It seems compliance with the stated cuts was poor, coming in between 74% and 78%, depending on which data aggregator you rely on. So Saudi Arabia and Russia are unhappy at the cheaters in OPEC, especially the likes of Iraq, and Nigeria and Kazakhstan to a lesser extent.
What was supposed to a simple rolling over of the existing agreement for another month, with global demand tipped to average at least 10% lower in 2020 from last year’s 99.97 million bpd, has now been made contingent upon full participation by errant production cut signatories.
If those assurances don’t arrive by June 9-10 – date of OPEC+’s next meeting – all bets are off and OPEC sources suggest compliance level could be lowered from its current 9.7 million bpd level to around 7-8 million. As things stand, it is doubtful Iraq will be able to comply since it has made “less than half of its promised cuts”, according to an OPEC source, and has “negligible” influence on lowering the 500,000 bpd produced in its near-autonomous Kurdistan region.
Underscoring it all is a two-fold problem as old as the emergence of OPEC+ itself back in 2016. Firstly, while extracting promises of an oil production cut are pretty transparent and straightforward, monitoring and enforcing them over a stated time period is not. And secondly, entering a production cut agreement is not all that difficult but getting out of it is a whole different matter.
For years, OPEC+ has lacked an exit strategy – and the latest round of talks won’t be any different with the cast of characters ranging from cheaters to enforcers largely the same. More so, what makes things even shakier is a hastily conjured up deal under duress that some, including the Russians, might feel has outlived its purpose.
What will perhaps keep things check is that all participants know inventories in 2020 could be pretty bloated hampering their efforts to balance the market. However, not for very long, as a repeat of the March 6 collapse of OPEC+ is not a case of ‘if’ but ‘when’.