Understanding the oil price churn
The pandemic-induced dip in demand has put the wobbly cartel of oil producers in a spotUpdated: Apr 21, 2020 18:20 IST
he front-month May West Texas Intermediate (WTI) — the United States (US) oil price benchmark — futures contract crashed into negative territory for the first time on April 20. Though this was a temporary phenomenon, and one that is specific to the way WTI contracts work in the context of the US oil industry, it is a clear indication that the coronavirus disease (Covid-19)-induced demand rout has triggered a glut with consequences that are ricocheting across oil markets, including affecting Brent — the leading international standard for crude prices.
This is despite US President Donald Trump’s mediating efforts to stabilise the global oil industry through an Organization of the Petroleum Exporting Countries (Opec)++ pact — even though he is a self-confessed Opec “hater”. On April 12, the Opec+ cartel — a group of 23 oil-producing nations — after much dramatic posturing cobbled together a historic agreement to slash oil production by 9.7 million barrels per day (mb/d) through May and June, after which the cuts taper off till 2022. Notwithstanding its enviable credentials, the agreement will fall short of propping up prices enough to ward off shut-ins. It will only function to arrest Brent touching single digits and provide some relief before the storage tanks spillover.
This becomes evident on unpacking the numbers. The 10 members of the Opec and another 10 of the extended Opec+ group will reduce oil production by 6.085 mb/d and 3.615 mb/d respectively to balance supply against plunging demand. US-sanctioned Iran and Venezuela and war-torn Libya are exempt from the cuts. Saudi Arabia and Russia, the second- and third-largest oil producers globally, have agreed to each cut 2.5 mb/d of their production from a baseline of 11 mb/d.
Meanwhile, some other numbers are being thrown around. Saudi energy minister Abdulaziz bin Salman said that the Opec++ (Opec+ and other oil producers) group will take 19.5 mb/d supply off the pipelines, voluntarily or otherwise, from May. Russian energy minister Alexander Novak pegs the effective cuts at 15-20 mb/d while Trump, through his diplomatic tool of choice, Twitter, has written that cuts will total 20mb/d. This, ostensibly, is by factoring in “expected” curtailed production of 3.7 mb/d of G20 countries, such as the US, Brazil and Canada; supply cuts through national purchases for strategic petroleum reserves; and possible cuts by Norway.
There are many moving parts here. It is difficult to predict how much American production will fall given the divergence within the industry to accept quota cuts. The Railroad Commission of Texas — the Texas regulatory agency — had the last statewide cut in 1973. Although, Mexico has agreed to a 100,000 barrel cut, the US has said it will help Mexico by picking up “some of the slack” — the specifics of this are still unclear.
Irrespective, even if one considers the 20 mb/d supply-reduction scenario as realistic, the demand destruction is staggering enough to overwhelm the proposed cuts. According to the International Energy Agency, the fall in global demand for crude will be 29 mb/d for April and 26 mb/d for May. Some other oil traders are estimating it to be 35mb/d. A 3% decline in growth in 2020, as predicted by the International Monetary Fund, erases almost a year of oil demand growth. Assuming there is compliance by the members, the Opec++ reductions, therefore, will only partially offset supply overhang till the next quarter.
But compliance to quota cuts for Opec+ members has been faulty on prior occasions--some, such as Saudi Arabia, make deeper cuts while others cheat on their pledges. The question remains: Who will monitor compliance? The G20 energy ministers’ meet on April 10 signed an agreement to set up a voluntary focus group which will monitor oil markets. But the locus standi of a G20 platform to monitor an Opec country is questionable. The only real physical barrier to shutting the oil spigots is when storage spaces run out.
Moreover, a deal does not signal that Riyadh and Moscow have buried the hatchet after their recent market-share scuffle. The kingdom has slashed its official selling price, ostensibly eyeing the Mediterranean and Asian markets, and swelling global crude inventories till the new deal kicks in. Reportedly, it is also selling about 600,000 barrels of crude per day to the US this month — the highest volume in a year. Moscow and others will react to push their own volumes. Meanwhile, Washington has not yet dismissed the possibility of oil import tariffs to protect its domestic oil industry. The dynamics between the three “alpha males” of the oil industry — the US, Russia and Saudi Arabia — played out in this vulnerable landscape will further determine how low Brent settles.
The markets have figured this out, notwithstanding the padded reduction figures. Predictably, Brent whimpered up a few dollars after the Opec+ pact before falling below $30 again. Market reports suggest that Brent needs to skip over $40 and remain pinned there to prevent oil producers’ revenues from shrinking further.
With pipelines and storages clogging up and the virus continuing to gobble oil demand at unprecedented levels, pressure is building on de facto leaders of the Opec+ group, Saudi Arabia and Russia, to seam a broader alliance or deepen cuts. However, countering the impacts of this pandemic on oil markets will be a daunting task for a wobbly cartel of oil producers with divergent interests.