- A coalition of oil-producing countries known as OPEC Plus reached a historic deal to cut production by nearly 10 million barrels per day earlier this month. Other countries have also agreed to curb supply.
- But as the market has shown, even steep cuts to supply won’t prevent the price from free-falling. On Monday, near-term contracts for US crude oil went negative for the first time in history.
- In recent reports, several Wall Street analysts explain that supply cuts won’t prevent storage tanks from filling up in as few as two months.
- Plus, historically, countries don’t fully comply with the production cuts to which they agree.
- Visit Markets Insider to view the latest on oil prices.
It seemed like just what the oil market needed: A record cut to supply, on the tune of 9.7 million barrels of oil per day, or about 10% of total production.
And that’s what a coalition of oil-producing nations known as OPEC Plus did on April 12, making history.
Yet as markets on Monday revealed, the OPEC Plus deal — shouldered in large part by top producers Saudi Arabia and Russia — won’t prevent oil prices from plummeting, and then falling some more.
On Monday, the price of near-term West Texas Intermediate (WTI) futures, a benchmark for US crude oil, plunged to about minus $37.63 a barrel. The international benchmark, Brent crude, slid, as well, settling at under $26.
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Production cuts on paper don’t always translate
The OPEC Plus alliance agreed to cut production by a record 9.7 million barrels a day (bpd), or about 10% of global supply, in May and June, after which the cuts gradually step down.
That amounts to most OPEC Plus countries slashing production by 23% in the near-term.
The US, Canada, and Brazil, which are not part of OPEC Plus, may also cut production by about 3.7 million bpd, Goldman Sachs analysts led by Damien Courvalin said in a note last week.
These cuts are unlikely to be through a voluntary agreement, but rather via “market forces” — namely, low oil prices — that make it economical to reduce supply, Courvalin said.
One unknown is whether all of these countries will actually make the cuts to which they’ve agreed.
Courvalin said he assumed full compliance from core OPEC members and 50% from all other participants in May, when the cuts are slated to begin.
That means the OPEC Plus deal would lead to an actual cut of only 4.3 million bpd, relative to production in the first three months of the year, he said.
Bank of America strategists were slightly more optimistic. In a note last week, they said the actual production cut would be more like 7.2 million bpd over the first few months, relative to February.
Whatever the number is, analysts are anticipating that it will fall short of the agreed-upon 9.7 million barrels.
That’s because some of the countries will have a hard time making the cuts, according to Greg Priddy, director of global energy and the Middle East at Stratfor. Iraq, for example, agreed to cut production by 1 million bpd, yet the country owes cost-recovery payments to foreign companies that are helping them raise production, he said.
“That presents them with a big dilemma,” he said. “Their finances are getting hit, but they also have contracts that obligate them to pay those companies.”
Even with production cuts, storage will fill up fast
Whether or not they’re realized, production cuts on the scale of 10 million bpd are simply dwarfed by the collapse in demand.
“This is clearly the largest production cut ever — and will be in real terms,” Priddy said. “But it’s also the largest demand destruction that we’ve seen in modern times.”
In April, global demand for oil is expected to be down by as much as 29 million barrels a day, or by about 30%, relative to last year, according to the International Energy Agency.
That stunning loss of demand means a lot of oil has nowhere to go. And the OPEC Plus cut won’t stop the threat of storage tanks filling up sometime before June, analysts at Credit Suisse wrote in a report last week.
Analysts at Morgan Stanley had a similar outlook.
“While this helps moderate storage builds,” they wrote of the OPEC Plus deal, “the market should remain oversupplied given the sheer magnitude of lost demand from the COVID-19 pandemic.”
They added that the US is on pace to fill storage in about two months.
Meanwhile, Courvalin’s team said that the agreement is “too little and too late to avoid breaching storage capacity” and that no voluntary cuts “could be large enough to offset” the demand collapse in April and May.
What it means for the oil and gas industry
The price of oil futures will continue to fall — at least, that’s one of the takeaways from a handful of reports last week.
“The global oil market will have the largest spare capacity in at least a decade, leading to a flatter Brent crude oil curve,” Bank of America analysts wrote. “As the dust settles, it could also potentially leave oil prices lower for longer.”
How much longer?
Goldman Sachs expects “a gradual recovery” in Brent prices, reaching $40 per barrel by no earlier than October, at which point it said inventories would start to wind down.
A consequence of low oil prices is that companies shut-in wells — in other words, they turn off the tap.
Really cheap oil can mean that some wells aren’t economical anymore, even if shutting them down can cause permanent damage to the supply.
Morgan Stanley analysts estimate that about 2 million barrels of oil will be shut in as a result of the pandemic.
“Producers have already begun to announce shut-ins, and we expect more will follow,” the bank’s analysts wrote.
Indeed, the oil giant Continental Resources has already announced that it’s curbing production by 30% for April and May, they said. Meanwhile, ConocoPhillips said it would curb production by 225,000 gross barrels of oil per day.
It’s these market-driven cuts to production in the US that will likely help rebalance the market — but not before companies slash their capital spending and lay off staff to adjust to those changes.
Read more:How 18 oil giants from Exxon to Halliburton are cutting staff and slashing spending in response to the historic oil price meltdown
“There are still going to be a lot of layoffs in the shale patch,” Priddy said. “This is still something that is going to hammer the industry.”
This story was originally published on April 13. It was updated with recent changes to the oil market.