[Editor's note: This story appears in the May 2020 edition of Oil and Gas Investor. Subscribe to the magazine here. It was originally published April 29, 2020.]

Rarely has there been as many moving parts in the global crude market. How much demand for oil has been really destroyed by the coronavirus pandemic? How much oil has Saudi Arabia really loaded onto crude carriers in hopes of buyers? If there were a resolution of the price war between Saudi Arabia and Russia, would it simply help sentiment—and offer little real solution?

There’s no way crude and product inventories held in storage won’t continue to rise, barring an overnight cure for the coronavirus. The fear is that storage—whether floating, coastal or landlocked—will be filled to tank tops in the near term. The hope is that by reaching a deal on global production, the date for maxing out storage will be pushed out to allow the world economy more time to get back on its feet.

There’s no shortage of estimates of oil demand destruction or the timing of inventory builds to fill storage.

Analysts’ estimates of peak demand losses for a time ran around 20 million barrels per day (MMbbl/d) but jumped as high as 26 MMbbl/d in a late March interview by Jeff Currie, global head of commodity research at Goldman Sachs. Ryan Sitton, the Texas Railroad Commissioner, carried an estimate of 18 MMbbl/d, but he raised it to 22 MMbbl/d to 24 MMbbl/d after U.S. jobless claims surged to 6.65 million, setting a new weekly record, in early April.

Although details are few, a proposal for a 10 MMbbl/d cut in oil production has been aired by President Donald Trump with Saudi Arabia Crown Prince Mohammed bin Salman, who in turn contacted Moscow. In addition, commissioner Sitton spoke earlier with Russian oil minister Alexander Novak, calling for “an unprecedented level of international cooperation” in the wake of the coronavirus impact on oil.

Pioneer Natural Resources Co. and Parsley Energy Inc. sent a letter to the Texas Railroad Commission in which they asked for “fairness” in production cuts as part of a plan to help stabilize oil prices worldwide.

Without such action, the independent sector, currently comprising 74 firms, might see 64 of their number fall by the wayside, leaving just 10 producers with strong balance sheets, according to Pioneer CEO Scott Sheffield. The remaining 64 would be weighed down with debt-to-EBITDA ratios of about 5x, levels that would make them financially unattractive as takeout targets, he said.

Sheffield argued that it was not in the strategic interests of the U.S. to return to the days when the U.S. depended on imports from the Middle East for 60% of its crude oil needs.

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While commissioner Sitton said production cuts as high as 20 MMbbl/d to 25 MMbbl/d would be needed to balance the global market, lower cuts could also play a role. If 10 MMbbl/d of production cuts were able to “extend the life of intermittent storage” to, say, four months versus a previously expected two months, that would buy additional time for a recovery in demand by the global economy.

But according to an early April report by Citi, moves to cut production may be coming “too little, too late.”

“What’s required is a good 10 MMbbl/d immediate reduction in oil supply that is needed to prevent inventories globally from reaching tank tops,” according to the report. The Citi analysis assumed a drop in global demand of nearly 16 MMbbl/d on average for the second quarter, peaking at 18.5 MMbbl/d in the eight weeks through the end of May, it said.

A critical question is how much of the cuts materialize on a voluntary basis, and how much they occur due to forced shut-ins as producers are simply unable to sell their production.

Among key producers, “Russia will be forced to cut output by at least 1 MMbbl/d due to a combination of lost condensate production from lost natural gas sales and export bottleneck,” said Citi. “Saudi Arabia, in the midst of a period of allocating sales to clients, looks likely to be confronting a market that might want—at any price—no more than 6.2 MMbbl/d, 1 MMbbl/d lower than March levels.”

In addition, “while the U.S. looks likely to be seeing a production drop of 1 MMbbl/d, it is unlikely to occur before the end of the third quarter,” added Citi.

As lost demand deepens, much will depend on these market forces in determining an approximate time for reaching tank tops. Forecasts vary, but some say storage could be brimming as soon as the end of May

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