A quandary for OPEC+
OPEC+ announced it would ease its production cuts as of August 2020. The committee made its decision assuming that the economy would gradually recover during the second half of 2020, but the global economic outlook remains uneven and mostly challenging.
In a nutshell
- Oil prices stagnated in June and July
- OPEC+ will relax production cuts
- Full recovery remains out of sight
This report is the second installment of a new monthly series on the latest developments in oil markets by GIS Expert Dr. Carole Nakhle.
Oil markets seem almost frozen, with prices hovering around $40 per barrel (bbl) in June and July after initially recovering rapidly in May. Still, at their monthly meeting in July, OPEC+ leaders announced they would relax their production cuts in August as planned because they see the oil market rebalancing. Broader economic developments as well as oil market data, however, indicate otherwise.
The OPEC+ timetable was set in April, evidently based on the assumption of a V-shaped recovery in 2020. In the absence of this development, the group will find it difficult to raise the price of oil.
OPEC often reiterates its commitment to market stability.
The coming months will test the rationale of the OPEC+ decision. Although data on the health of the global economy as well as the financial performance of oil companies are likely to look better in the third quarter relative to the second quarter (which incorporates data for April, the worst month), market fundamentals remain challenging.
In July, average oil prices increased by around $2/bbl, a 6 percent rise compared to June. Such growth, however, is marginal – especially in light of the massive production cuts carried out by OPEC+ since May. On balance, the market continues to be driven by the speed of demand recovery (or lack thereof) and the outlook for economic growth. Both remain uneven across regions.
Facts & figures
- The U.S. real gross domestic product (GDP) decreased at an annual rate of 32.9 percent in the second quarter of 2020, compared to 5 percent in the first quarter
- OPEC+ discipline slipped in July (94 percent compliance compared to 106 percent in June). Iraq (83 percent) and Nigeria (63 percent) remain the least compliant OPEC members
- Saudi Arabia’s fiscal breakeven oil price is around $80/bbl, or nearly double that of Russia
- Oil majors recorded their worst quarterly results in the last 20 years or more
- The EU agency in charge of infectious diseases recently demanded that member states with Covid-19 spikes must reinstate restrictions
OPEC often reiterates its commitment to market stability. As recently as July, OPEC+ insisted on “the critical role” that it “continues to play in supporting oil market stability and economic recovery.” One could argue that the group has indeed stabilized the oil market. However, the current stabilization has not caused much celebration within the OPEC+ circle, clearly indicating that the group’s aim is in fact to achieve stability at higher prices, given the budgetary situation of many of its members. Here, too, controversy arises, as the fragile economic recovery requires lower, not higher, oil prices.
On July 15, the OPEC+ Joint Ministerial Monitoring Committee (JMMC) held its regular monthly meeting and agreed to ease its production cuts from 9.7 million barrels per day (mb/d) to 7.7 mb/d as of August. This brings the group back to the original production schedule agreed in its April emergency meeting. The decision to gradually relax production cuts, the committee noted, follows “encouraging signs of improvement as economies around the world open up.”
Meanwhile, Saudi Energy Minister Prince Abdulaziz Al Saud announced that “we have momentum in our favor.” One day later, Russian Energy Minister Alexander Novak said he expected global oil demand to recover significantly in August – up to 10 percent below pre-Covid numbers. The OPEC+ decision conveys the view that the oil market is rebalancing, but “balance” with a precise meaning as defined by the group in 2016: demand equaling supply, and commercial inventories at their five-year average. And this is exactly where the trouble lies.
Facts & figures
Data says otherwise
A closer look at key data raises doubts about the OPEC+ optimism. First, the outlook for oil demand has not changed in recent publications of the main forecasting agencies (Energy Information Administration, International Energy Agency and OPEC), with projections for 2020 continuing to vary between 8 and 9 mb/d below last year’s levels. Second, the outlook for the global economy remains largely unchanged as well. China’s economic growth figures of 3.2 percent for the second quarter spurred optimism, but this momentum is mainly the result of state-driven industries. Consumer spending remains subdued.
On the supply side, private oil production also seems to be stabilizing.
Globally, the spread of Covid-19 is far from being under control. The race toward developing a vaccine is accelerating but has brought with it new geopolitical concerns. The impact of the current crisis is likely to last longer than originally expected.
On the supply side, private oil production also seems to be stabilizing, particularly in the United States., along with prices. There is no shortage of commentaries on the fate of shale oil, with many predicting its imminent demise. These predictions are mostly based on the sheer scale of bankruptcy filings among oil producers in the U.S. These discussions are reminiscent of past warnings about peak oil supply. Such warnings dominated energy debates in the first decade of the century but were disproven shortly thereafter, largely thanks to the U.S. shale revolution.
The decline in American shale production in reaction to this year’s price collapse was expected, since shale is more responsive to prices than conventional oil. However, with prices rising and stabilizing in May, shale oil production has also shown signs of recovery and stability over the same period.
Meanwhile, OECD commercial inventories (the only reliable measure of global inventories) remain at record highs. Not only are they well above the last five-year average, they are also outside the range over the same period, exceeding the buildup of 2015 and 2016.
For markets to rebalance, demand has to increase and supply to decrease – fast enough to generate a significant inventory draw. If the last time OPEC+ tried to drain excess inventories from the system (in January 2017) is any indication, it will take a long while to “rebalance,” especially under current circumstances when neither supply nor demand conditions are met.
From today’s perspective, the decision of OPEC+ to relax its production cuts seems detached from market realities. The decision, however, does not come as a surprise since it is based on the terms of the emergency deal agreed in April this year. The extension of the original level of cuts by one month (in July) was the exception, bridging Saudi and Russian interests. In fact, during a recent interview given to the Al Arabiya TV channel, the Saudi oil minister reiterated that the April deal was dictated by politics, not economics, and that “the agreement went well above any oil minister: it was at a sovereign level.”
The April deal was evidently negotiated under the expectation of a V-shaped recovery in 2020.
The problem with the April deal is that it was evidently negotiated under the expectation of a V-shaped recovery in 2020. However, the past few months have shown that the recovery is more likely to extend into next year.
The silver lining is that the global economic outlook and the financial performance of oil companies will look better in the third quarter, compared to the second quarter – the worst quarter of this year and arguably the worst ever. However, this improvement will not solve the challenges discussed above.