OPEC+ Agrees to Historic Oil Production Cut to Subdue Pandemic-Induced Demand Shocks

  • Apr 11, 2020 BST
  • Team Kalkine
OPEC+ Agrees to Historic Oil Production Cut to Subdue Pandemic-Induced Demand Shocks

After intense parleys between Russia, Saudi Arabia and the United States of America over the past one month, crude production cut by at least 10 million barrels a day has been agreed by all the OPEC and non-OPEC oil producing countries except Mexico on Thursday, 9 April 2020. The agreement, however, remains conditional and has yet not been materialised due to Mexico’s consent pending on not accepting its share of production cuts.

It is to be noted here that due to this non unanimity among the concerned countries crude oil has lost nearly a third of its value in the last one month. Last month OPEC had called on a meeting between its members and non-member countries to finalise a crude oil production cut agreement in view of the sudden fall in global demand of the commodity driven by the outbreak of coronavirus pandemic. The production cut agreements arrived at the meeting were not agreeable to Russia and it decided not to abide by it, which had led  Saudi Arabia to increase its oil supply and substantially reduce its official selling price.  What followed was a massive fall in the world crude oil prices which threatened the survival of thousands of small and medium oil and gas companies around the world. The United States which is home to a number of small, medium and large oil and gas companies jumped into the rescue and managed to bring back both the warring parties to the negotiating table. The world crude oil markets are currently witnessing a demand shock due to a global shortfall in business activity levels induced by the coronavirus pandemic. 

Russia’s position – Russia entered into an agreement with the OPEC countries in 2014 so as to coordinate efforts to protect each-others interests by supporting global crude oil prices but since then significant changes have happened in the crude oil landscape. OPEC is no longer the largest producer of crude oil in the world. Several other large countries have over the year have increased their exploration and production activities of crude oil with the emergence of Russia, United States of America and Venezuela emerging as three of the world’s major producers. Agreement with OPEC thus has been losing its material value over the period, since any production cut on its part could be lapped up by any of the other non OPEC large producers leading to massive losses, and not much impact will come upon the global crude prices. Russia is particularly worried about United States which has ramped up its production of crude over the years while only benefitting from the production cut measures initiated by OPEC. This is what the country has been arguing over the past one month, that a production cut agreement with the active participation of United States is meaningless and would backfire at OPEC and Russia.

Position of United States of America – The United States of America has over the years emerged as the world’s largest producer of crude oil. Its vast oil sands resources are responsible for helping it to get to that position. There are numerous companies in the country which are engaged in extracting oil, which in turn are employing thousands of workmen. The country has a deep interest in getting a remunerative prices for the oil it produces as it keeps these oil sand companies in the green and its workmen employed. United States, however, is not a member of OPEC or any other such organisation which seek to regulate the international selling prices of crude. It is in support of OPEC’s decision to undertake production cut measures to curb fall in international crude oil prices and be able to sell an incremental amount of crude every year at these prices. In the United States cratering as a practice is prohibited under the countries anti-trust laws so all companies have to accept whatever the market price is. When the price war situation was initiated by Saudi Arabia, a massive portion of the United States oil sands industry came under threat, prompting President Trump to take immediate steps to arrest the global slide in prices. The negotiations that has been held with both Russia and Saudi Arabia were thus largely aimed at protecting the domestic industry than any thing else. This is what is being pointed out by Russia that United States cannot hide behind its domestic commercial laws and must come out and be party to an international effort to support crude oil prices if it has to be practical.

Where does OPEC stand – OPEC which once boasted of its ability to influence global oil prices has lost that shine over the years. It still however is one of the largest producers of crude oil in the world and is responsible for protecting the interest of several of its member countries whose economies are solely dependent on production and export of oil and gas. As new production capacity was added to the global resource pool, the global oil prices got threatened. To deal with the problem, the organisation started to invite other large producers of crude oil to be its members. The 2014 agreement with Russia was an effort in this regard. The situation however has started to become more complex with other countries ramping up their production capacities. The organisation now has to face the prospect of either signing more such agreements with different countries or lose control of crude prices.

In the official statement on Thursday, OPEC announced that the historical deal between the organisation and its allies would initiate a 10 million barrels per day production cut for May and June, and would then be tapered to 8 million barrels per day for the rest of the year 2020. The organisation has also asked other major producer to bring down oil production in a bid to boost oil prices. The negotiations between Russia, Saudi Arabia and United States could end up with the United States officially joining in, in the efforts to cut production to support prices as has been indicated by Russia.

The Pandemic demand shock – The outbreak of the pandemic is having a telling impact on the global demand of crude oil. The transportation sector of the world, call it airlines, railways or road transport have almost come to a standstill. The industrial demand for fuel oil has also come down significantly owning to the production stoppage in factories. It has been estimated that in the past one and half months the consumption of crude oil around the world has come down by more than fifty per cent. The storage capacities of most countries are also full and there was no other choice than to cut production. Moreover, the pandemic situation could linger on for a few more months now. In such a scenario, keeping the production volumes at current levels could have led to another massive fall in its prices which may very well not be in the best interest of any of the parties concerned. It is highly likely that the negotiations held this time around between OPEC, Russia and The United States of America could lead to a further expansion of the OPEC and it may even change its name to reflect its new expanded status.


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