Russia and Saudi – is a cut coming?
It’s unlikely that either party anticipated the demand destruction from the COVID-19 pandemic to be this big. Reports of around 5-10mmbpd month-on-month reduction for March and analysts are forecasting a 15mmbpd reduction for April (some estimating as high as 30mmbpd). Both KSA and Russia (particularly the latter) are equipped to but sub $25/bbl may be too much.
We now have another OPEC+(+) meeting to debate with rumours fuelled by President Trump’s tweet of a potential 10-15mmbpd cut. However, the exporter looks as divided as ever with news that the session has been pushed from Monday to Thursday as KSA and Russia’s “blame game” threatens productive talks. The news of such a large cut as well as the US’ potential participation sent Brent up to $35/bbl on Friday, but the subsequent delay and new discord is expected to make short work of this rally. The 10mmbpd number is also up for scrutiny, Russia has apparently stated it is prepared to only cut 1mmbpd.This 10% cut is significantly lower than its 18% share under the original cuts and with smaller producers unlikely to be able to scale-up cut commitments, KSA would need to shoulder a much larger share of this new cut.
Does the US have to give a little for a cut from Russia or Saudi to come?
The White House has been quite vocal and in fact was the instigator of the chatter on new cuts that drove a 25% spike in oil prices on Friday. US officials are expected to join OPEC+(+) talks this week and there is a sense that a cut anywhere near 10mmbpd would need the US to be involved in some way. This is problematic given the highly fragmented nature of the US shale sector with a myriad of differing levels of production, hedging positions and debt covenants not to mention potential antitrust issues regarding price setting. Furthermore, news that the US response to save oil jobs may now look at import tariffs on foreign oil as opposed to regulating output would likely further antagonise and threaten any meaningful cut.
Storage & outlook for oil
Regardless of the outcome of this week’s summit, the truth is there will be production cuts, it just depends on whether these are voluntary or not. Whiting Petroleum became the first casualty of the price war when they filed for chapter 11 last week. Whilst the Bakken focused E&P might emerge from the process with its production intact, it won’t be the only shale producer that will fall into administration should WTI stay under $30/bbl. Several analysts estimate . VLCC rates are through the roof and traders are now looking at creative alternatives such as railcars to store cheap oil cargoes.
Given the scale of the potential demand destruction expected in April, a 10mmbpd production cut seems like a placebo for those looking for a remedy for market imbalance. However, slowing down the influx of barrels into diminishing storage capacity will be critical in staving off a scenario where some oil producers may have to pay to get rid of their supply, effectively creating a negative oil price as was the case for an obscure Wyoming heavy crude that ended up trading at $-0.19/bbl last week. Although major benchmarks are unlikely to go negative and this is more a harbinger of imminent well shut-ins, it still points to a situation that would have bordered on fantasy just 3 months ago. Whatever the outcome of Thursday’s session, oil prices look set to trade under $35/bbl for April at least putting a huge strain on producing companies and governments alike. After that, If China’s economy posts another significant uptick and COVID-19 infection rates level off in the Europe and the USA then perhaps we will be talking about the early signs of a potentially long demand recovery in May.
Thom Payne, Head of Offshore
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