OPEC and allies agree to record oil production cuts — but will it be enough?

Oil prices have risen higher on the news that members of the Organization of Petroleum Exporting Countries (OPEC) and 10 other producers have agreed to reduce overall output by 9.7 million barrels per day (MMbpd) starting 1 May.

The previous highest cut was a 4.2MMbpd cut made during the 2008 global financial crisis.

United States President Donald Trump, who had been pressing Saudi Arabia and Russia to end their price war and agree to cuts to put a floor under the oil price, praised the deal that was hammered out over Easter by video conference.

However, analysts have pointed out two problems.

Deal is not without problems

Citigroup believes that by the time the cuts have any effect, “super-large” inventories would have built up and will weigh on spot prices.

The second highlighted problem is the economic damage caused by COVID-19’s impact, in which world consumption has fallen by almost three times the amount of the cutbacks.

The online conference was tellingly chaired by representatives of the two protagonist nations, Saudi energy minister Abdul Aziz Bin Salman and his Russian counterpart, Alexander Novak.

After news of the deal broke, West Texas Intermediate crude rose 3.8% while Brent crude was trading 3.2% higher.

Mexico holds out for smaller cut

All but one country — Mexico — agreed to reduce output by 23%.

Mexico had delayed resolution of the agreement by refusing to make a larger reduction, agreeing to only cut by 6% or 100,000bpd.

The agreement involved the 10 OPEC members (Algeria, Angola, the Republic of Congo, Equatorial Guinea, Gabon, Iraq, Kuwait, Nigeria, Saudi Arabia and the United Arab Emirates) along with the OPEC+ nations Azerbaijan, Bahrain, Benin, Kazakhstan, Malaysia, Mexico, Oman, Russia, Sudan and South Sudan.

Canada, Norway and the US have signalled they will also cut output.

Both Russia and Saudi Arabia will reduce oil production by 2.5MMbpd, while Iraq’s 23% cut equals 1.06MMbpd less output.

However, Oslo-based energy consultant firm Rystad Energy has estimated the oil production oversupply for April is on track to reach 28MMbpd, almost three times the agreed first stage of the cuts that begin in just over two weeks from now.

First cutback lasts only two months

After two months of the 9.7MMbpd adjustment, from 1 July the reduction will be scaled back to 7.7MMbpd through to 31 December.

From 1 January 2021, until 30 April 30 2022, the overall output adjustment will reduce further, to 5.8MMbpd.

Goldman Sachs commodities analyst Damien Couravalin said the OPEC+ deal was “historic yet insufficient”.

He calculated that, based on updated oil storage balances, there needed an additional 4.1MMbpd added to the reduction in oil pumped out of the ground from 1 May.

“Crude prices will decline further in coming weeks as storage capacity becomes saturated,” he said.

The weakness in crude pricing will be a downside risk to Goldman Sachs’ short-term US$20 per barrel forecast.

While Citigroup global head of commodity research Edward Morse termed the deal “unprecedent measures for unprecedented times” that could lift prices to the mid-US$40/bbl by the end of 2020, he also saw a short-term problem.

“It’s simply too late to prevent a super-large inventory build of over 1 million barrels between mid-March and late May to stop spot prices from falling into single digits,” he said in a client note after the agreement was announced.

The deal is being seen as rescuing the OPEC+ alliance, which was regarded as being in jeopardy due to the Saudi-Russian price war.