As the death toll and economic carnage of the coronavirus mounts, the world’s big oil producers met in Vienna in a desperate bid to prevent oil prices from collapsing, tentatively agreeing to cut their total output by an additional 1.5 million barrels a day.
But the big question is still whether countries outside the OPEC exporters’ cartel, namely Russia, will ultimately agree to the ambitious proposal, which would take the group’s production to the lowest level since the Iraq War.
Oil prices shrugged off the preliminary agreement, which goes much further than the actions that the Organization of the Petroleum Exporting Countries was talking about late last month. But OPEC saw a decisive move as necessary as the economic and human toll of the COVID-19 outbreak continues to rise, with nearly 3,300 deaths globally and now 11 in the United States, including the first in California, which declared a state of emergency. Factories in Asia and Europe are sputtering, schools are closing, sporting events are being canceled, and airlines expect to lose more than $100 billion this year as business travel and tourism screech to a halt.
That sudden slowdown in economic activity—in a year that was meant to mark a return to stronger growth—shows up clearly in the demand for oil.
China, where the outbreak began and where the economic hit has been hardest, has already seen a huge drop in demand for oil, with refiners using millions fewer barrels per day than usual. Some forecasters such as IHS Markit now expect global thirst for crude in the first quarter to collapse by almost 4 million barrels a day. “Never before has such a quarterly drop been recorded,” IHS noted in a press release.
The London-based analytics firm also expects annual oil demand to be less than it was last year, one of the few such contractions in the last four decades, and the first since the great financial crisis of 2008-09. Others see oil demand shrinking, or at best staying flat—very rare for a world that usually gobbles up an additional million or so barrels every year.
Antoine Halff, a former chief oil analyst at the International Energy Agency, has analyzed the Chinese oil sector in the wake of the virus and found refiners cutting their operations by as many as 4 million barrels a day, a sign of vanishing domestic appetite for the stuff, while they sock away the excess into storage.
“These are massive numbers,” said Halff, now at Columbia University’s Center on Global Energy Policy. “It’s important to offset that” with production cuts, he said.
That was the backdrop for a more-contentious-than-usual meeting this week in Vienna of the big oil exporters that make up OPEC, as well as Russia, which, though not a member, has been working with the oil cartel to manage global production in recent years. Late last month, OPEC initially suggested making an additional cut of about 600,000 barrels a day to shore up crude prices—on top of the nearly 2 million barrels a day the group has already cut, and which will remain effective at least through the end of this month.
Now, seeing the scope of the demand collapse, OPEC has tentatively agreed to cut an additional 1.5 million barrels a day—even while maintaining those earlier cuts—conditional on Russia’s ultimate agreement. Thursday’s agreement calls for OPEC members, led by Saudi Arabia, to cut 1 million barrels a day, while non-OPEC members—essentially Russia—would cut 500,000 barrels a day.
But it’s not clear if those targets include the 400,000 barrels a day that Saudi Arabia was already unilaterally holding off the market; that could make Thursday’s announcement a little less ambitious than it seemed.
“No one knows what oil demand will do (or is doing) and so the priority now is to reassure markets” rattled by catastrophic projects of falling global appetite for oil, said Bob McNally, the president of Rapidan Energy Group, a consultancy. While he said he couldn’t rule out the tentative accord breaking down by Friday—Russia, more comfortable with lower prices, has been less eager than Saudi Arabia to cut production—“the odds favor following through,” he said.
Before Thursday’s announcement, prices for crude oil in both London and New York had fallen about 25 percent this year.
Getting Russia on board for the bigger cut is important for a couple of reasons. First, given the potential scale of the collapse in oil demand, OPEC and its partners need to produce an ambitious cut to shore up crude prices. Second, Saudi Arabia has already shouldered the burden of most of the previous cuts, and even if it’s able to trim more output, it may not be willing to keep stomaching all the pain on its own.
“I don’t think they have the appetite,” Halff said.
OPEC isn’t just battling the fallout from the coronavirus. It’s also still fighting a rearguard action against surging U.S. oil production, which keeps adding barrels to an already flooded market, keeping prices lower than they would be. Last year as a whole, the United States set a fresh record with average production of 12.2 million barrels a day; by late February this year, the country was pumping 13.1 million barrels a day, essentially wiping out much of OPEC’s prior cuts.
The U.S. boom has both frustrated OPEC’s efforts to stabilize prices and complicated that very calculus.
The more that OPEC sacrifices its own output (and revenues) to hold prices steady or even push them higher, the bigger a favor it does for the U.S. oil patch, which is financially struggling with prices around $45 a barrel; any lower than that, and nearly all U.S. shale firms would be hard-pressed to break even. Adding to the pressure are mounting debt and shrinking credit lines from Wall Street, which after years of throwing hundreds of billions of dollars at shale producers with little to show for it is starting to close the financial tap.
Back in 2014, faced with a similar flood of U.S. oil, OPEC tried to play chicken and kept pumping, sending prices into free-fall but gambling that lower prices would bankrupt many less cost-competitive shale producers. That gambit failed, as shale producers got much more efficient and learned the survive even with lower oil prices. But those productivity gains of recent years have all but run their course, so U.S. shale producers have few tools left to squeeze out profitability if oil prices go much lower.
This week in Vienna, OPEC could have taken advantage of the coronavirus and its economic havoc to replay its 2014 strategy and try to force U.S. rivals to the wall once and for all, even if that meant swallowing lower crude prices for the near term, which would cause some pain for all.
“At the end of the day, [OPEC] are the low-cost producers, they should be able to withstand the impact better than the competitors,” Halff said.
But OPEC’s decision to make a deep cut to put a floor under prices, even if it means throwing a lifeline to its U.S. rivals, is a reflection of the group’s belief that the U.S. shale boom is running out of speed and won’t be as big a threat in a few years.
“The demand effect from the virus is massive, but temporary—it’s unlucky, but OPEC is thinking, ‘let’s not burn down prices for a year on something like this,’” McNally said. Meanwhile, U.S. shale producers expect production growth in 2020 to be less than in 2019, as efforts to squeeze ever more barrels out of lucrative fields in Texas and North Dakota are running out of steam; that means U.S. oil production will plateau sooner than most analysts had thought.
“Shale is winding down. OPEC is on fourth and goal—this is just about not fumbling the ball on the final play,” McNally said.
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