Saudi, Russia Truce Over Oil Cut Deal: A Glance Through Oil Price Dynamics

The falling oil price in 2020, in turn, further influence the already grappling economy amid COVID-19 and hampering sustainable development. The plummeting prices have challenged many oils driven economy with a weak balance sheet such as African oil producer, which is still recovering from the 2016 price flip. The major oil-producing countries will also feel the heat with job loss, reduce expenditure toward exploration and even in worst-case closure of refineries, if the price continued to fall. It is notable to mention that the US shale oil industry is more susceptible to low price due to its high production cost.

Oil Price Tumbling – An Introduction

The magnitude of dwindling of Brent Crude oil price (BZ: NMX) is immense, i.e. 67% between maximum US$ 68.91 per barrel (b) on 6 January 2020 to minimum US$ 22.76/b on 30 March 2020. The price then rebounded, reaching the lowest, due to changed people views from despair to hope of gaining traction post the Coronavirus spread. The oil anticipated to be safe out of doldrum post the US President Donald Trump claims over oil production cut deal between Russia and Saudi Arabia. However, Russia denial on the agreement has put brakes on an oil price surge.

Interesting Read: Confidence Over Trump’s Announcement Pushes Oil, Sited Hope for Oil.

Interestingly, the price increase of 50% from US$ 22.76/b on 30 March 2020 to US$ 34.11/b on 3 April 2020 is still short of 51% from the maximum at the start of the year. Having said that, the US President Donald Trump claim prevailed, and on 9 April 2020, OPEC led by Saudi Arabia including Riyadh, Moscow and Russia forming OPEC+ Group has pact up to decrease the production by 10%, i.e. 10MMb/d (million barrel per day). Also, sought others to cut a further output by 5% based on October 2018 production, the baseline for volume calculations.

Oil Supply Cut – Phase Wise Detail

The deal is about cutting the OPEC+ production by 23% with Saudi Arabia and Russia taking the cut of around 2.5MMb/d each and Iraq over 1MMb/d amid May to June 2020. Expanding the deals plan on phase-wise include 10MMb/d production cut for the period of next two month till June. Later in 2H2020, the total production cut agreed at 8MMb/d. Post which the production rate cut is planned to be around 6MMb/d between 1 January 2021 to 30 April 2022.

Did the Oil Price Recover Post the Production Cut Announcement?

Curiously, the Brent Crude oil price instead of increasing fell by 8% from US$ 34.11/b on 3 April 2020 to US$ 31.48/b on 9 April 2020.

Isn’t Mind Gobbling? But there is some reason behind such movement of price.

Firstly, even though the global supply cut of ~15% is the biggest in history, still there exist a gap of 15% when the demand tumbled by 30%. The lockdown, halting business operations as a precautionary measured amid COVID-19 has destabilised the oil and gas market with demand drying up due to the standstill of airplanes and public transport as well as personal vehicle movement restriction to mention few.

Secondly, the production cut agreement hit the opacity when Mexico President Andres Manuel Lopez Obrador offered only one-fourth cut in production than the 5% as required by the OPEC+ Group. The OPEC+ wanted the other Countries such as the US, Canada, or Mexico to mention few as a part of the production cut agreement. However, the Mexican government offered a production cut of 100,000 instead of 400,000 barrels per day (bpd).

In the milieu of which the Mexican President in G20 talk on 10 April 2020 said that the US is ready to take an extra cut on Mexico’s behalf to the extent of 250,000 bpd. Adding the US help, the total presented production cut from Mexico is 350,000 bpd, short of 50,000 bpd to close the OPEC+ deal.

Hence, the production cut of 10MMb/d still needs approval from Mexico.

G20 Talk: Supported Oil OPEC+ Oil Cut Agreement

On 10 April 2020, Saudi Arabia Prince Abdel Abdulaziz bin Salman hosted talks with the energy minister of G20, the Group of 20 major economies for the approval on OPEC+ group agreement on a production cut. Over hours of discussion, the Mexico production cut didn't resolve while Country like Canada has shown full co-operation in production cut if the deal is implemented.

G20 Communique without detailed information on production volume concurs to price stability need and supported the production cut to ensure energy market stability and energy security.

Let us Introspect Why Oil Producer Opting for Production Cut and Not for Storing and Benefitting when Market Improves? At-least The Countries Who Have Strong Balance Sheet!

Honestly, it's not a wise option. The demand is anticipated to dwindle by ~15 to 35MMb/d from the per day total consumption. If 35MMb/d of demand fall is considered due to COVID-19 impact, then the storage capacity of around 1 billion barrels is required in just a month. And it is worth mentioning that the world onshore and floating storage capacity is approximately 900 million barrels.

Suppose if it happens, then the producing company may start paying to the customer to offtake the produced oil, further negating the oil price, glooming the oil economy beyond recovery.

In the line of which the US Energy Secretary, Dan Brouillette in G20 talk said that "all nations should come together by every means at their disposal in order to help slash the oil surplus". He also indicated that the US production is likely to fall by 2MMb/d to 3MMb/d by the end of the 2020 year.

Even International Energy Agency head, Fatih Birol, urged importing country to make an extra purchase for their strategic reserves, helping in shrinking the supply and demand.

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