Oil price war ends, but coronavirus demand crisis remains

After marathon Easter weekend negotiations, the Organization of the Petroleum Exporting Countries Plus (OPEC+) reached a historical agreement to cut 9.7 million barrels per day (bpd) of oil production, responding to what was a mounting crisis spurred by crumbling oil demand due to the coronavirus pandemic and a monthlong price war between Saudi Arabia and Russia.

As the market digests the details of the deal, Atlantic Council experts react to the deal and what it means for the market.

Randolph Bell, director, Global Energy Center, Atlantic Council

“After years of maligning OPEC, including advocating for “NOPEC” legislation in his 2011 book Time to Get Tough, US President Donald J. Trump seems to have changed his tune and come to begrudgingly appreciate the group, or at least its collective action in oil markets. Trump might still like low gasoline prices, but he also likes a strong US oil and gas industry, and that sometimes requires a higher oil price than what would occur in a purely free market. Now is such a time.

“While it has been clear for a while that Trump would intervene in oil markets when prices got too high for his liking (roughly $65 Brent), he also has now made it clear he will get involved when prices get too low (roughly when oil company executives say he is at risk of losing elections in oil states). While the United States, with its strong commitment to free markets, will never admit it has a price target, Trump’s ad hoc oil policy seems to be aiming for the sweet spot where most US shale production is in the money but US gasoline consumers are not severely impacted.

“The benefits of such a stance are immense, both from a domestic and geopolitical perspective. But don’t look for the United States to join OPEC or OPEC+ any time soon. Beyond the longstanding animus to the group within some elements of the US policy establishment, at a more operational level, the federal government simply does not have the statutory ability to use the tool that is most associated with OPEC: directly increasing or decreasing production. Instead, if Trump is reelected, look for him to continue to look for leverage points to push the market in his preferred direction, whether that is through Twitter, the threat of sanctions and tariffs, or the promise of long term economic and geopolitical partnerships.”

Reed Blakemore, deputy director, Global Energy Center, Atlantic Council

“The result of the OPEC+ marathon negotiations should help restore some positive market sentiment and possibly firm up something of a price floor over the short term. However, the impact of a month-long price war, amidst deteriorating oil demand, risks eventually drawing the deal into sharp relief over the next few weeks.

“First, the agreement provides more of a moment for the market to breathe amidst an impending storage crisis than a long-term solution. There remains a significant amount of oil in the market, and even in the hugely optimistic scenario of a medium-term bounce in demand, inventories will need to clear before cuts tangibly reduce the supply overhang. Add in the prospect of organic cuts from the United States and other Group of Twenty (G20) participants diluting as production responds to marginal price increases, and there is likely a long road ahead to restore market balance.

“Second, if there is one lesson that can be learned from the past three months of COVID-19 weighing on the market, it is that it is unwise to short the extent of oil demand decline. There are not enough indicators to suggest that we have reached the bottom of demand destruction from COVID-19 just yet, and with the amount of oil ready to flood the market at any moment, prices will remain much more sensitive to the demand picture even with global producers back on the same page.

“The restoration of OPEC+ is one bright storyline to take from the past week, but the process of its re-commitment to support the market adds a number of geopolitical angles worth watching over the next few months. US President Donald J. Trump has proudly signaled his role in bridging the gap between Saudi Arabia, Russia, and even Mexico, but the horse-trading required to bridge that gap, including that between Saudi Arabia and Russia just to set the table prior to April 9 will slowly but surely emerge.

“In the end, the past month has shown that oil geopolitics still matter when producers are not on the same page, and while much attention will likely be paid to Mexico’s eleventh hour disruption in the agreement, over the long term we are more likely to remember this as the agreement that brought Saudi Arabia and Russia back to the table, with serious implications for the role of the United States in the oil market moving forward.”  

Ellen Wald, president, Transversal Consulting; senior fellow, Global Energy Center, Atlantic Council

“This is a deal in the sense that the producing countries managed to get a positive sounding headline out before markets opened. When it comes to actual production cuts, there are still some significant hurdles. First, the combined agreed cut of 9.7 million bpd from OPEC+ and potentially 3-4 million bpd from other producers is far from the estimated loss of demand that we are seeing due to the coronavirus pandemic. The true extent of the global demand destruction is unknown, but could be as much as 30 million bpd.

“Second, there is no understanding of how the United States will bring about a cut in oil production other than via natural, organic declines in production due to poor financing and low revenue for oil companies. There is no reason to believe that the United States can ensure delivery cuts. US oil production is not centralized. The expected production decline of 2 million bpd could be much less, or it could more. Either way, the US government cannot guarantee a result.

“Third, Russia again received a major exemption for its gas condensates, meaning the cut is not as impressive as it would be otherwise. Fourth, with a timeframe of only two months, it will be difficult to hold producing nations to account. In fact, the short period makes accountability effectively irrelevant.

“Fifth, although the deal is being hailed as historic, it is at best a stop-gap measure. There is no expectation that the economic slowdown caused by the response to the coronavirus will be resolved in June, when the most significant production cuts are scheduled to end. The decision only heightens the importance of the June OPEC+ meeting.”

Neil Brown, managing director, KKR Global Institute and KKR Infrastructure; senior fellow, Global Energy Center, Atlantic Council

“President Trump promised to stop America’s “endless wars.” Credit him a success. The Russo-Saudi oil price war lasted just over a month, but those thirty-seven days have felt endless for the US oil industry. The Trump administration’s intervention hastened the expected rapprochement between Russia and Saudi Arabia, the linchpin necessary for OPEC+’s new supply restraint agreement. Although US intervention was critical to speed agreement, durability of the new OPEC+ agreement is bolstered by the alignment of Russia’s and Saudi Arabia’s own respective economic and geopolitical interests to see it through.

“US oil producers scored three lifelines from the end of the Russo-Saudi price war and resurrection of OPEC+ supply cuts: restraint, sentiment, and time. Saudi Arabia, the UAE, and Kuwait flooded the market with low cost oil after Russia walked away from OPEC+ in early March, consistent with Saudi Arabia’s strategy to force Russia back to the negotiating table by crushing prices. Restraint from those lowest cost producers is essential to eventually finding a price floor in oil markets.

“Second, sentiment matters. Oil market forecasters and producers tend to make the tenuous assumption that Saudi Arabia and others in OPEC will perpetually balance the market. In recent years, Saudi Arabia has fastidiously sought to explain it is not willing to balance the market alone; the past thirty-seven days powerfully demonstrated its resolve. Baselines and compliance with the new agreement will be debated within OPEC+, but that is noise. The more important implication is that OPEC+ agreeing to cooperate through 2022 will rebuild market sentiment that supply management will be restored for the duration of the current economic crisis.

“Finally, the new OPEC+ supply restraints will also slow the breakneck pace of oil stockpiling and give more time for physical markets and US oil producers to adapt. US oil producers will still pull production sharply back this year, but they will have time do so in a way that protects their reservoirs and enables capital solutions. Prices will not spring back quickly, but more US oil production will eventually return as a result of OPEC+ supply restraint.

“Yet, ending the price war alone will not solve an oil market still crushed by coronavirus. Neither the depth and duration of demand destruction, nor the pace of eventual economic recovery, is known. As a result, low prices are likely to prevail in the near-term and an inventory overhand will weigh on prices even on the other side of coronavirus. Regrettably, that means communities across the United States that rely on the oil industry for jobs and tax revenue will continue to feel the pain.”

Brenda Shaffer, senior fellow, Global Energy Center, Atlantic Council

“The OPEC+ agreement may slow down the pace of the inevitable price crash, but it cannot avoid the inevitable. Until demand picks up, prices will remain low. However, current shutdowns are setting the stage for a price increase later in the year.

“As the world emerges from lockdown, stored oil will be consumed, and this will initially keep prices low, aiding the post-pandemic global economic recovery. And, with rising demand, and low supplies, due to oil production shutdowns and lack of new investments, post-lockdown prices could skyrocket. It is important to watch the shutdowns in oil production taking place, and to assess the post-lockdown supply picture.

“The United States would benefit from taking advantage of the low oil prices to fill the Strategic Petroleum Reserve (SPR). It would in the short-term help US producers and makes good commercial sense to fill when cheap. Other governments are doing this but, so far, Congress has not supported the Trump administration on this policy.”

David L. Goldwyn, chairman of the Atlantic Council’s Energy Advisory Group and a nonresident senior fellow with the Adrienne Arsht Latin America Center:

“There are lessons from the OPEC+ deal:

“No country or organization is “dominant” in a global oil market. The notion of energy dominance, that US production—or exports—would itself provide coercive power over other countries or markets was always a myth. It is clear now that Saudi Arabia, Russia, or even OPEC+ acting alone would have lacked sufficient market power to put a floor under oil prices or would be able to do so in the future. This deal is a down payment on the production cut the market will command this summer when storages fill, cost cuts take effect, and restructuring accelerates. In fact, US energy prowess has ironically provided new vulnerabilities, as the US oil and gas industry and the economic prosperity that it represents have been targeted for trade retaliation from China and, to some extent, by the export policies of Russia and Saudi Arabia. The fact that a US president was obliged to plead for OPEC unity, acquiesce to pressure from the president of Mexico to get a deal accomplished, and push for the cartel to expand its power to raise prices is not a sign of strength.

“US power comes from diplomacy, military capability, and tools of statecraft, not from commodity exports. The ability of the United States to push Saudi Arabia and Russia back to the bargaining table came from the perception that US military support to Saudi Arabia was at risk and because of the importance the United States plays in providing security in the Middle East. Diplomacy rather than force won the day, even as the United States forswore market management options that would have contributed to reducing excess supply.

“Global problems require collective solutions. Whether addressing COVID-19, containing Iran, or reviving the global economy, arrogant unilateralism has sharp limitations. Countries must act together—and they must find their collective interest—to be effective in combating transnational threats. The United States has squandered its own ability to lead these coalitions, as we have seen in Iran, in the lack of either a global response to coronavirus or to the decline in global trade. Perhaps seeing how working together and providing benefits for all, even if this deal is a modest down payment on a continuing problem, will lead to a fresh look at the benefits of international cooperation.

“Supply is stickier than demand. We have seen that there is a great deal of inertia in the supply of oil and gas. Countries and producers which have hedged their production, like Mexico and many US shale producers, those which have high sunk costs and steadily producing assets, create significant lags in the ability to oil and gas supply to decline to meet new levels of demand. Demand, in contrast, can fall off in a heartbeat due to pandemic, natural disaster, war, or technological innovation. This should be a note of caution to modelers who project that future supply and demand for hydrocarbons will be simple extrapolations of the present based on population and growth.

“All options are on the table. The idea of halting Gulf of Mexico production, restricting imports of foreign oil, using regulatory power to limit onshore shale production, and spending billions in federal money to guarantee energy purchases were only recently “unthinkable” radical ideas of the green movement. The fact that all of these, plus tariffs on foreign oil producers, have now been put forward by the oil and gas industry as potential tools to save it from market volatility have shown the new level of acceptability of these options. Combined with the idea that the federal government, when faced with a critical national need, can deploy hundreds of billions of dollars to provide social stability has made it quite thinkable that these tools could be deployed to provide guaranteed national income, education for all, healthcare for all, or mandate for a rapid clean energy transition.”

David Hobbssenior fellow, Global Energy Center, Atlantic Council

“Unique challenges require unique responses, and the outcome of OPEC+ discussions is indeed unprecedented. However, it is far from certain that this deal will achieve the aim of starving upstream investment enough to return markets to a balance around long run marginal costs of $60-$70 per barrel as desired by some. The global oil market will rebalance at a lower long run marginal cost than prior to the price collapse, since the discipline and cost cutting that has been forced on companies to survive will not be sacrificed immediately upon prices recovering. Furthermore, governments hungry for revenues as they try to restart their economies may absorb some of the fiscal headroom created by the price collapse.

“Estimates from OPEC and the International Energy Agency indicate that global capital expenditure had fallen short of the required level by $500 billion after the 2014/15 price drop. These proved very wide of the mark and the shortfall this time around will similarly build more slowly than many expect. As it begins to appear that the market will take longer to recover, the preparedness of OPEC+ to maintain production discipline will be tested as quarter three comes into view.”

Jean-François Seznec, senior fellow, Global Energy Center, Atlantic Council

“This was a great meeting, a master work of diplomacy. Every participant in the OPEC+ negotiations can claim victory. Saudi Arabia got Russia to agree to cut production very substantially. Russia can claim to have destroyed US shale. President Trump can argue that he saved the industry from annihilation, while keeping gasoline at around $2.00/gallon. Mexico will say that it did not really have to cut anything. However, all this self-congratulating does not come close to addressing the cratering of 25 million bpd of demand due to COVID-19 and will hardly make a dent in stocks.  Hence, oil prices will probably remain in the low to mid-thirties.

“Unfortunately, at $35/barrel, producers will still have major budget deficits to plug. They can no longer take for granted that they can raise cash from large borrowings from international banks, and they can hardly increase taxes on their people. Only the countries with substantial short-term liquid reserves will pass through the virus-induced slump for a short while. Saudi Arabia may have enough to last two or three years, while Qatar and the UAE with very illiquid reserves may have to sell some of their assets at great losses in declining markets to raise cash. Others like Iraq, Iran, or Oman will have to scramble to find solutions, none of which appear palatable to their people or governments. In other words, the OPEC+ meeting was like the famous metaphor about the surgery that was a success, but in which the patient died.”

John Robertssenior partner, Methinks Ltd.; senior fellow, Global Energy Center, Atlantic Council

“The reaction or rather, the lack of reaction, of market prices to the OPEC+ decision demonstrates that the apparently high production cut is, in fact, a classic case of too little, too late. When demand has already slumped so massively—Norway’s Rystad Energy anticipates that demand in April 2020 will be around 72.6 million bpd against 101.1 million bpd in April 2019—what is the impact of a supposed production cut of 10 million bpd, which is actually a more like a 7 million bpd reduction? Rystad Energy further anticipates that the overall fall in consumption for the whole of 2020 will be around 11 million bpd. That implies that even with a recovery in demand, as and when the global economy starts to revive once the worst of the coronavirus pandemic is past, the impact on demand for the year as a whole will be much greater than the actual (as opposed to the theoretical) OPEC+ cut. The producers must be hoping that Rystad is wrong and that the IEA’s more optimistic outlook, with production falling just 5.2 million bpd in 2020 to 95.5 million bpd, is right.

“What the cut shows is that producers both inside and outside of OPEC are prepared to act in a coordinated fashion. The question is whether they can build on this to affect a cut of sufficient magnitude to balance the market at a level that would ensure a recovery of prices. At present, the increase in oil prices since the OPEC+ agreement was announced—currently some 4.2% for Brent—means that in real (inflation adjusted) terms, oil prices are still pretty close to their levels around the time of the first OPEC price increases in 1973/4. It appears the OPEC era really is over.

As of April 13, the price of WTI was $22.93 per barrel. Adjusted for inflation, that’s only fractionally higher than the average WTI level in 1970, which was $3.39 a barrel, equivalent to $22.55 today.”

Phillip Cornell, senior fellow, Global Energy Center, Atlantic Council

“In the end, Saudi Arabia and Russia were quick to arrive at a deal on April 9. After a stand-off with Mexico over the weekend, OPEC+ finally agreed to cut 9.7 million bpd of production starting May 1, with 2.8 million bpd of additional voluntary cuts offered by the Gulf Cooperation Council monarchies. The deal set to last for an unusually long time, with curbs easing until April 2022. Russian compliance is always a question, and 12.5 million bpd is still far from covering the demand destruction of COVID-19 (upwards of 25-30 million bpd in April). Markets were not impressed perhaps because beyond OPEC+, the promises are even squishier.

“The question is what President Trump may have offered behind the scenes, because it wasn’t production cuts—he doesn’t have the authority. (Texas regulators do, and they’ll decide on April 15, but so far only one voting commissioner seems to support action). US Energy Secretary Dan Brouillette told the group that US production will fall by 2-3 million bpd due to market attrition. Trump simply rebranded 250 thousand bpd of that as “picking up the slack” for Mexico. Together with Canada, Norway, and Brazil, such attrition may reach 5 million bpd. The IEA is also expected to announce about 3 million bpd of strategic stock purchases from the United States, Japan, South Korea, and others over the next couple of months. If both India and China join an official communiqué it will be a coup for IEA diplomacy, but both have been filling already, and congressional approval for US purchases is not guaranteed.

“While the scope of international coordination this weekend is indeed historic, the story is familiar. Underneath a big headline figure (20 million bpd of “effective cuts”), in practice Arab producers carry most of the water, with a lot of smoke from partners to inflate numbers and try to appease markets.”

Matthew Bryza, senior fellow, Global Energy Center, Atlantic Council. He is a former US ambassador to Azerbaijan and deputy assistant secretary of European and Eurasian affairs.

“Though unprecedented in the scope of agreed cuts, the impact in price of the OPEC+ agreement will be outweighed by the loss of demand. The arithmetic is simple: a production cut of 10 million bpd even if fully implemented, cannot rebalance a market that has already lost 30 million bpd in demand due to the COVID-19 crisis. At best, the OPEC+ deal can buy time before global storage facilities are filled. Once storage reaches full capacity, however, oil prices could even turn negative, as producers face the painful choice of either shutting in production and possibly damaging oil reservoirs or paying someone to take unwanted production off their hands. The premier of Alberta warned of this very danger last week.”

Related Experts: Randolph Bell, Reed Blakemore, Ellen Wald, Neil Robert Brown, Brenda Shaffer, David L. Goldwyn, David Hobbs, Private: Jean-François Seznec, John M. Roberts, Phillip Cornell, and Matthew Bryza

Image: Unused oil tank cars are pictured on Western New York & Pennsylvania Railroad tracks outside Hinsdale, New York August 24, 2015. REUTERS/Lindsay DeDario/File Photo