The Big Deal to Cut Oil Production May Not Be Big Enough
The agreement by major oil producers on Sunday to reduce their daily production by 9.7 million barrels was the largest cutback in history and a feat of remarkable coordination by more than 20 nations led by Saudi Arabia and Russia with unusual mediation from the United States.
But it probably still won’t be enough.
Demand for oil has tumbled in recent weeks as the coronavirus pandemic has crippled global commerce and eliminated untold numbers of commutes, plane trips and cargo shipments. Experts estimate that demand has fallen by somewhere between 25 million barrels and 35 million barrels a day — or up to three and a half times as much as what the oil nations are promising to cut.
News of the deal briefly lifted oil prices on Monday, but those gains faded over the course of the day. The U.S. oil price benchmark ended the day at $22.41, or less than half of where it was at the start of the year. Had the group of oil-producing nations, known as OPEC Plus, not reached a deal, oil prices would have collapsed, industry experts said.
Leaders of the American oil industry, which is responsible directly and indirectly for roughly 10 million jobs, welcomed the deal and President Trump’s role in mediating a halt to a Saudi-Russian price war. But even they acknowledged that it would not end their financial difficulties.
“The problem is the demand is still not there,” said Kirk Edwards, chief executive of Latigo Petroleum, a Texas producer. “Even with these cuts there will be a tremendous amount of oversupply on the market, and that’s why you haven’t seen the oil prices dramatically increase.”
Mr. Edwards predicted that 40,000 workers would be laid off in the West Texas Permian Basin alone. “There is no reason to drill or complete any more wells this year because there is nowhere to take the production,” he added.
Dozens of small independent oil producers are on the brink of bankruptcy, and the deal between the Organization of the Petroleum Exporting Countries and its allies probably will not save them. A few oil company stocks, which have been sliding for months, rose on Monday, but most, including the largest American oil company, Exxon Mobil, were down.
Few American oil companies can eke out profits at current prices. Shale oil wells in Texas and North Dakota typically make money only when oil prices are above $40 a barrel, which is why the industry is rapidly decommissioning rigs and fracking equipment and laying off thousands of workers.
“Low prices will still need to do the work of forcing production cuts in many parts of the world, including the U.S. shale patch,” said Jason Bordoff, director of the Center for Global Energy Policy at Columbia University.
Eventually low prices could also spur demand, but probably not until the coronavirus epidemic has been brought under control.
Even as the United States, Canada, Brazil and Norway — countries that were not party to the OPEC Plus deal — independently cut their production, storage facilities and tankers are filling up fast. And experts point out that even the 9.7 million barrels OPEC Plus countries agreed to cut daily won’t take effect until May 1, almost three weeks from now. By then, most European refineries will have run out of storage space.
“The demand implosion is immediate and deep, while the supply decline will likely happen in stages,” said Francisco Blanch, head of commodities and derivatives research at Bank of America. “Plenty of downside risks remain.”
One big risk is that the countries that made the deal, cutting 23 percent of their production, won’t abide by it because OPEC countries have been known to cheat. Several members of the oil cartel surpassed their production quotas as recently as last month, according to S&P Global Platts, a division of the credit ratings firm.
“History indicates large, credible cuts can be expected from Saudi, Russia, the U.A.E. and Kuwait,” said Paul Sheldon, a political analyst at S&P Global Platts, referring to the United Arab Emirates. “But compliance with 23 percent reductions elsewhere will be challenging.”
After the production cut agreement was reached on Sunday, Saudi Aramco slashed its petroleum selling prices for the second month in a row. That move did not violate the agreement, but made clear that Saudi Arabia’s national oil company would defend its market share.
Still while the agreement makes the sharpest cuts in May and June, it pledges to keep production lower through April 2022 in an acknowledgment that demand will not snap back.
The oil industry’s prospects will most likely be linked to how the pandemic evolves — something few experts can predict with certainty.
“How cyclical is Covid?” asked Paul Sankey, managing director of Mizuho Securities in New York. “Is demand for oil structurally impaired by a future world of face masks? Keep in mind that demand collapse has only really been a monthlong effect so far.”
Oil-producing countries across the Middle East, Africa and Latin America are bound to face not only economic difficulties, but possibly political turbulence as governments are forced to cut social programs and energy subsidies. Saudi Arabia’s efforts to diversify its economy, for example, could be in jeopardy because the country is earning a lot less from oil exports.
In the United States, the slump in oil demand and production could depress the economies of states like Texas, Oklahoma, North Dakota and Alaska, especially in rural areas that depend on oil. Restaurants and hotels have already emptied in some areas that have not seen many coronavirus infections, but where drilling activity has effectively stopped.
Still, the OPEC Plus pact has helped established a floor under oil prices, at least for now, which might have saved some American oil business, said Roger Diwan, a vice president at IHS Markit, an energy research and consulting firm.
“This is critically needed relief,” he said. “The direct involvement of President Trump to forge this historical deal is the most unusual aspect of it and reflects his visible concern for U.S. shale producers.”