[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 28, 2020.]

Six weeks ago, Saudi Arabia and Russia were launching their market share salvos to glut the market with oil to spite the other. This as the global economy listed sharply due to coronavirus fears and taking some estimated 20-25 MMbbl/d out of demand. Now they’re trying to put that supply genie back in the bottle. But will it matter?

Unfortunately, scant little. At least in the near term.
 
Oil and Gas Investor’s May cover story will analyze the first wave of the COVID-19 induced demand destruction and OPEC+ instigated supply surge, but that is just the first chapter of this epic drama that will take months and likely years to unfold entirely. Realistically, the world needs to recover from the coronavirus before the oil markets are going to return to any kind of a semblance of yesteryear’s prices led by renewed demand. And if the bug takes hold again for a round two, timing is anyone’s bet.

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The historic agreement between OPEC, Russia and a supermajority of other G20 nations in early April to remove some 10 MMbbl/d from global supply will serve to “flatten the curve,” so to speak, to slow the flow before global storage options breach the brim. It was the breathtaking, unprecedented drop in demand as the world stayed home to stay safe that quickly turned the attitudes of spatting oil-producing nations from fight to flight, according to IHS Markit vice chairman Daniel Yergin in a statement.

“What facilitated the deal was the realization on the part of the major producers that they were not, in any event, going to be able to find markets for their oil at high production levels.

“What this deal does is enable the global oil industry and the national economies and other industries that depend upon it to avoid a very deep crisis,” he assured. “Without this deal, the global industry would have run out of storage for the flood of excess oil in a few weeks and prices would have crashed, which would have also really hit financial markets. This restrains the buildup of inventories, which will reduce the pressure on prices when normality returns—whenever that is.” 

That’s not to say there won’t be near-term pain. Yergin’s colleague Roger Diwan noted, “On a global basis, these cuts remove the specter of an aggressive price war and lower the likelihood that global tank tops will be breached but does not solve the distress physical markets are likely to face in May and June.”

Bernstein analyst Neil Beveridge projects a near-term oversupply of 13 MMbbl/d in second-quarter 2020, “which will test inventory limits and could push prices back to US$20/bbl or below,” he said in an April 13 report. “Even with SPR [Strategic Petroleum Reserve] filling and Chinese stockpiling (combined 500 MMbbl), we still expect that OECD inventories could build by a further 500 MMbbl, which would take storage utilization to record levels.”

In a report April 12, Citi’s Ed Morse said he also feels sallow regarding bloated inventories and near-term prices.

“However large and credible the combined OPEC+ and G20 cuts, the main problem is timing; it’s simply too late to prevent a super-large inventory build of over 1 billion barrels between mid-March and late May and to stop spot prices from falling into single digits,” he said. “With these combined cuts unfolding only in May (affecting delivery in June and July), front-end contangos should widen again and prompt prices should fall, triggering further involuntary production cuts.”

So it gets worse before it gets better. Citi’s forecast for Brent to average in the second quarter? $17.

However, there is a light at the end of the pipe. Morse said the too-little-too-late April OPEC+G20 agreement, while ineffective near term, should “rapidly” help markets to rebalance going into the third quarter, “and with our expected demand rebound, should facilitate a rapid change from a massive inventory build to a massive inventory draw, supporting prices for the rest of the year.”

Those prices: $35 Brent in the third quarter ($33 WTI) and $45 in the fourth quarter ($42 WTI).

But it doesn’t stop there. “If OPEC+ fully complied with proposed cuts, through to 1Q21, this would likely tighten markets significantly, driving oil prices into the $60s and even $70s in 2021,” Morse said. But that optimism is likely to be tempered if Russia and OPEC raise production as second-half 2020 inventories draw down and prices recover. With that caveat, Citi calls for an average of $56 Brent in 2021 and “seeing the $60s at times,” with WTI averaging $52.

So will the deal matter? Bernstein’s Beveridge said the OPEC+ commitment to cut production by 6 MMbbl/d for a full two years out shows “the era of supply side price management is not over. If demand returns to normal levels in 2021, this could lead to sharply higher prices if compliance holds.”

Eventually it will matter.

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