For a brief span of a few hours last month, U.S. oil sunk below $20 per barrel, a price tag last seen during the presidency of George W. Bush—in 2002. The price of West Texas Intermediate (WTI) has since rallied, but nobody would bet against the U.S. benchmark returning to those depths, or even plunging further.
That’s how much is riding on tomorrow’s extraordinary meeting involving ministers from the oil cartel OPEC and other producers including Russia. The so-called OPEC+ virtual summit will be followed on Friday by Saudi-chaired talks among energy ministers from the G20 economies, including the United States and other non-OPEC producers such as Brazil and Canada.
They all want the same thing: an end to a Saudi-Russia price war. That, and a collapse in demand triggered by the coronavirus pandemic, have driven the price of Brent crude, the global standard, down more than 50% year to date. WTI is down by 60% in that period.
Thursday’s video conference, starting at 4 p.m. Vienna time (10 a.m. Eastern Time), might be a final chance for Saudi Arabia and Russia to save face and back away from a production free-for-all that threatens to drive many U.S. shale drillers out of business and inflict severe damage on the economies of oil-producing nations. The ongoing riff between the oil giants, it has been suggested, could even imperil OPEC.
How did we get here?
A blow to U.S. shale
A three-year OPEC-led agreement to curb oil production collapsed on March 6 when Russia refused to sign up to a Saudi plan to cut production further because of weak demand owing to the coronavirus outbreak. Saudi Arabia quickly slashed official selling prices and said it would raise oil supplies to 12.3 million barrels per day from April. Other producers, such as the United Arab Emirates, also raised output, sending U.S. oil prices skidding.
The Saudis and Russians were banking on their low production costs to emerge as winners in an oil price war while dealing a blow to the U.S. shale industry, which has expanded rapidly in recent years, turning the United States into the world’s biggest producer.
The problem with this power play was the awful timing. Since the agreement broke down, the coronavirus pandemic went global, triggering lockdowns across the U.S., Europe, and Asia and sending demand plummeting, leaving the world drowning in oil. Consulting firm Rystad Energy estimates that COVID-19 restrictions will translate to global demand for oil falling by 23 million barrels per day (bpd) this month alone.
Oversupply of oil has grown so acute that storage tanks around the world are rapidly filling up, and supertankers are being used as floating oil containers. The ensuing chaos in the market may be even to convince Russia and Saudi Arabia, both heavily dependent on oil, to call off the price war.
Even though cheap oil is a good stimulus for a slumping economy, Washington isn’t happy. President Trump stepped into the fray last week tweeting that he expected Saudi Arabia and Russia to reach a détente, an intervention that put even more pressure on tomorrow’s talks.
“No deal” would be costly
Oil market expert Ellen Wald said she was “cautiously optimistic” that OPEC+ could agree to a production cut, particularly if other producers such as Brazil, Norway, and Canada buy in as well.
Failure to reach agreement, she added, could see WTI fall below $20 a barrel—a near certainty if Saudi Arabia were to continue to pump 12 million bpd, Wald told Fortune.
By contrast, an agreement would lift oil prices even though the market would still be oversupplied. “If oil settles in the $30 range, I think they will be in good shape. If it hits $40, I think that’s really the best anyone can hope for at this point,” Wald said.
Oil prices have seesawed this week, with WTI at $24.33 a barrel Wednesday, and Brent steady at around $32 a barrel.
Any production cut will have to be sizable enough to avoid disappointing oil market expectations raised by Trump’s tweet about a reduction of 10 million to 15 million barrels per day (bpd).
“I think anything less would not be seen well by the market. I think OPEC+ could pull off a 10 million bpd cut. Remember that’s a drop in the bucket compared to the global decline in demand which is like 20 million to 30 million bpd. I think it would be very difficult for the market to see a smaller cut as a positive sign,” said Wald, president of Transversal Consulting and author of Saudi, Inc., a book about Saudi Arabia and its oil industry.
The U.S. factor
But reaching agreement may not be easy because Russia insists that the United States must be part of any production-cutting agreement. The U.S., Saudi Arabia and Russia together produce around one-third of global oil production of around 100 million bpd. The U.S., as is customary, will not be part of tomorrow’s meeting.
“The United States really has no mechanism to regulate oil production in the same way that these other oil-producing countries do…I think that it could go one of two ways: Either the United States and President Trump will be used as a scapegoat for these countries not to cut…or they will look to Energy Secretary Dan Brouillette to provide them with a sense of how quickly U.S. production is going to fall based on market forces,” Wald said.
Adding to the tension, Trump has raised the pressure on OPEC and Russia to cut output by threatening to impose “very substantial tariffs” on oil imports if prices don’t recover.
Christopher Haines, global crude oil analyst at research consultancy Energy Aspects, said it would be “very, very challenging” for OPEC and its allies to reach a production-cutting agreement in Thursday’s talks. “The main issue is that Russia has essentially said they will participate as long as the U.S. is onboard, but I don’t see how you can make the U.S. participate in this deal,” he told Fortune.
“I’ll be quite surprised if they come to some kind of agreement on Thursday unless it is essentially to codify cuts that are already happening. What I mean by that is the U.S. might come in and [say]: Since the start of the year, these are the capex cuts that our companies have done, these are the production reductions that our companies have done, and this amounts to this many barrels,” he said.
Haines too believes that failure to reach an agreement on Thursday could lead to another sharp drop in the oil price.
“If you look at global storage and how quickly it is filling, if we get to a point where that is very near the top of capacity, then you are going to see a very rapid decrease in the oil price,” he said, estimating that global storage tanks could be full by the end of May.
Oil exporters were already announcing cutbacks because there were no buyers for crude right now. “It’s just whether it’s codified in a meeting like this, or whether it happens because of market forces,” Haines said.
Already, evidence abounds that regardless of what OPEC and Russia decide, producers around the world are cutting exploration budgets and production because of the slump in demand. Brazilian state oil firm Petrobras said last week it was cutting production by 200,000 bpd. U.S. oil giant Exxon Mobil said Tuesday it was cutting 2020 capital spending by 30% and lowering cash operating expenses by 15% in response to low prices.
The U.S. Energy Information Administration this week cut its forecast for U.S. oil production in 2020 by more than a million barrels a day to 11.8 million bpd.
Meanwhile, the U.S. oil and gas industry is stepping heavily on the brakes and is reducing drilling at record speed, Rystad Energy said, putting the horizontal oil rig count on track to fall by about 65% from mid-March levels. From a peak of about 620 rigs in mid-March 2020, the oil rig count is forecast to free-fall to a potential bottom of around 200, Rystad Energy estimates.
Rystad Energy’s head of oil markets, Bjornar Tonhaugen, said in a note this week that even if OPEC and its allies agreed on a 10 million to 15 million bpd cut and implemented it around mid-month, it would only be enough to scratch the surface of the more than 23 million bpd supply overhang predicted for April 2020.
“Be prepared for another drop in oil prices soon, when market participants realize that the real issue they have to deal with is the declining oil demand, for which the proposed cuts, even if realized, are set to fail to bridge the gap,” he said.
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