Understanding oil price rotation – analysis
The first month of May the West Texas Intermediate (WTI) – the benchmark oil price index for the United States (US) – The futures contract crashed into negative territory for the first time on April 20. Although this was a temporary and specific phenomenon for the way WTI contracts work in the context of the US oil industry. The US, is a clear indication that the defeat of the demand induced by the coronavirus disease (Covid-19) has triggered an excess of consequences that are rebounding in the oil markets, including the affectation of Brent, the leader of the International Standard for crude oil prices.
This despite the mediation efforts of the President of the United States, Donald Trump, to stabilize the world oil industry through a pact of the Organization of Petroleum Exporting Countries (OPEC) ++, even though he is an “enemy “OPEC confessed. On April 12, the OPEC + cartel, a group of 23 oil-producing nations, after a dramatic stance, struck a landmark deal to cut oil production by 9.7 million barrels per day (mb / d) until May and June, after which the cuts will decrease until 2022. Despite its enviable credentials, the deal will not fetch enough prices to prevent closings. It will only work to stop Brent tapping a single digit and provide some relief before the storage tank spills.
This is made evident by unpacking the numbers. The 10 members of OPEC and another 10 of the expanded OPEC + group will reduce oil production by 6,085 mb / d and 3,615 mb / d respectively to balance supply with falling demand. Iran and Venezuela, sanctioned by the United States, and Libya, devastated by the war, are exempt from the cuts. Saudi Arabia and Russia, the world’s second and third largest oil producers, have agreed to each cut 2.5 mb / d of their output from an 11 mb / d baseline.
Meanwhile, some other numbers are thrown. Saudi energy minister Abdulaziz bin Salman said the Opec ++ group (Opec + and other oil producers) will cut 19.5 mb / d supply from the pipelines, voluntarily or not, from May . Russian energy minister Alexander Novak sets the effective cuts at 15-20 mb / d, while Trump, through his diplomatic tool of choice, Twitter, has written that the cuts will total 20mb / d. This, apparently, is taking into account the “expected” reduced production of 3.7 mb / d from G20 countries, such as the United States, Brazil and Canada; supply cuts through national purchases for strategic oil reserves; and possible cuts in Norway.
There are many moving parts here. It is difficult to predict how much US production will fall given the divergence within the industry to accept quota cuts. The Texas Railroad Commission, the Texas regulatory agency, had the last state cut in 1973. Although, Mexico agreed to a 100,000 barrel cut, the United States said it will help Mexico by picking up “some slack” – the details of this still it is not clear.
Regardless, even if one considers the 20mb / d supply reduction scenario to be realistic, the destruction of demand is staggering enough to overwhelm the proposed cuts. According to the International Energy Agency, the drop in world demand for crude oil will be 29 mb / d in April and 26 mb / d in May. Some other oil traders estimate it to be 35mb / d. A 3% decline in growth in 2020, as predicted by the International Monetary Fund, erases nearly a year of oil demand growth. Assuming members comply, Opec ++ reductions will therefore only partially offset excess supply until the next quarter.
But compliance with quota cuts for OPEC + members has been flawed on previous occasions: some, like Saudi Arabia, make deeper cuts while others cheat on their promises. The question remains: Who will monitor compliance? The G20 energy ministers meeting on April 10 signed an agreement to establish a voluntary focus group that will oversee the oil markets. But locus standi of a G20 platform to monitor an OPEC country is questionable. The only real physical barrier to shutting off oil taps is when storage spaces are depleted.
Furthermore, an agreement does not indicate that Riyadh and Moscow have buried the ax after their recent dispute over market share. The kingdom has lowered its official selling price, apparently observing the Mediterranean and Asian markets, and increasing global crude oil inventories until the new deal begins. It is also reportedly selling around 600,000 barrels of crude oil a day to the United States this month, the highest volume in a year. Moscow and others will react to boost their own volumes. Meanwhile, Washington has yet to rule out the possibility of oil import tariffs to protect its national oil industry. The dynamics between the three “alpha males” of the oil industry, the United States, Russia and Saudi Arabia, which unfolds in this vulnerable landscape will further determine how low Brent settles.
Markets have discovered this, despite the cushioned reduction numbers. Unsurprisingly, Brent moaned a few dollars after the Opec + deal before dropping below $ 30 again. Market reports suggest Brent needs to skip over $ 40 and remain pinned there to keep oil producers’ incomes from falling further.
With pipelines and warehouses clogged and the virus continues to gobble up oil demand to unprecedented levels, de facto leaders of the Opec + group, Saudi Arabia and Russia are being pressured to form 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.
Shreerupa Mitra is an international policy expert with HPCL and executive director of The Energy Forum.
The opinions expressed are personal.