Grim Realities Force Historic Supply Deal

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Extraordinary times call for extraordinary measures. And as the global oil industry teeters on the brink of collapse, the Opec-plus producer group has responded, with a staggered output cut of 10 million barrels per day. These gargantuan levels will taper off successively over two years. The deal was awaiting finalization at press time late Thursday, after Mexico objected to the terms. The agreement is very much a creation of Saudi Arabia and Russia, which called off their price war that had exacerbated the recent coronavirus-induced collapse in oil prices since early March. An additional 5 million b/d of G20 producer cuts could be tacked on during a meeting Friday, but Opec-plus will follow through on its cuts regardless. To be sure, historic demand destruction wrought by the coronavirus -- estimated by some as high as 20 million-30 million b/d in the second quarter -- has made rebalancing the oil market an impossibility in the near term (related). For major producers, the best bet was to try to dress up inevitable production shut-ins from a broken market as formal supply cuts. But this also has been a tour de force of oil diplomacy, albeit at times of a forceful nature. Big challenges remain, not least the still-rocky, Saudi-Russian relationship, but supply management, in tatters just a few weeks ago, is back with a vengeance (PIW Mar.20'20). The 10 million b/d in cuts will last for two months, with members reducing supply by 23% from an October 2018 baseline (with exceptions for both Saudi Arabia and Russia who have baselines of 11 million b/d). From July to the end of the year, Opec-plus output will be reduced by 8 million b/d, and then from January 2021 to end April 2022 a 6 million b/d reduction will be in force. The arrangement will be reviewed at the end of next year. Such an unprecedented cut duration is clearly not realistic, but it does signal that Opec-plus is serious about doing whatever it takes to tame what Opec Secretary-General Mohammed Barkindo called the "unseen beast" of the coronavirus, which has "completely upended market supply and demand fundamentals." In the end, Russian demands that the US participate in formal supply cuts dissipated, perhaps because the US oil industry is now in such dire straits (related). Market forces and logistical constraints had severely limited the runway for the Saudi-Russian price war and Riyadh's market flooding strategy to continue. Rapidly filling global storage tanks and devastated refinery demand mean that even low-cost producers could soon need to start shutting in output (related). Global inventories have been built up to such levels that it could take up to two years to work them down to pre-coronavirus levels in January, when benchmark Brent was struggling to hold above $60 per barrel despite 2.1 million b/d in Opec-plus supply cuts. The hope is that the new deal can help address these ugly realities, set a floor under benchmark prices and reduce the duration of pain the industry must endure ahead. Benchmark Brent fell 4% to around $31/bbl on Thursday, reflecting trader doubts about the deal. The physical market is in unprecedented turmoil. Refiners spit back crude cargoes as refined products tanks are full, especially for gasoline and jet fuel. Crude producers are crash landing and moving cargoes to tanks and vessels, as even $5/bbl oil can find no home in North America. Storage is king, all others suffer. US market players circulated this week a new contract clause that said possible negative crude prices should be considered "zero" to prevent having to pay buyers to take their crude. As this misery plays out, oil futures seem on a different planet. Futures are pricing expectations, and signal the hope that "any phony deal," as one broker calls it, can help put a $30 floor under Brent. Some traders think the deal might help prevent inventories from building beyond control and might outlast the coronavirus so stockpiles can drain faster. However, any deal will not save US shale or Canadian oil sands from shrinkage or make any relatively high-cost oil viable in today's coronavirus-afflicted or tomorrow's energy transition-shaped world. The push for an agreement shows that Saudi-led Opec and Russia retain a strong economic incentive to support oil prices, and that price wars to seize short-term market share are self-defeating. The dramatic response by non-Opec to the price collapse also demonstrates that, over the longer term, market share gains are inevitable for high-volume, low-cost producers like Opec and Russia. The coronavirus has likely accelerated this process. But the entire industry has also been dealt an unmistakable warning about the impact of underappreciated demand risks -- chiefly the energy transition (PIW Mar.13'20). The best way to manage shale growth is to "let it run its course," argues investment bank Goldman Sachs, citing the resource's short-cycle, high-decline-rate nature. That is essentially what was happening before the coronavirus, with shale production set to fall in 2021 regardless (PIW Mar.6'20). Now, US output looks set to plunge sharply. The US Energy Information Administration said this week oil output will steadily fall through the first quarter of 2021 to just shy of 11 million b/d, or nearly 2 million b/d less than the peak reached before the coronavirus. Key World Oil Producers Cut

Oil Demand, Oil Inventories, Oil Supply, Security Risk
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