Only a truly global compact to limit oil supply ‘can fix market collapse’

Equipment used to process carbon dioxide, crude oil and water is seen at an Occidental Petroleum Corp enhanced oil recovery project in Hobbs, New Mexico, US. (Reuters)

Only a truly global compact to regulate oil supply to international markets can stop a total collapse in oil prices caused by the coronavirus pandemic, according to a Gulf source.

Oil exporting nations are facing the worst market crisis in modern history. US crude oil prices fell $6.58 to settle at $20.37 a barrel on Wednesday as a 56 percent slide over the past 10 days marked the worst stretch over a similar period since the futures contract was launched in 1983. Experts are now predicting prices to fall to single digits.

“The market is in free fall,” said a Gulf source, asking not to be named. “Right now, this is bigger than any one country or group of countries… There has to be a global consensus,” he added.

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The coronavirus pandemic has caused an implosion of global economic activity that, coupled with the collapse in OPEC’s deal to regulate supply, has removed any floor to prices. The slowdown caused by draconian lockdowns in Asia, Middle East, Europe and America is expected to wipe out approximately 10 million barrels per day of oil demand in April, roughly 10 percent of the world’s total.

Making matters worse, the collapse in the agreement to regulate supply by the Organization of the Petroleum Exporting Countries (OPEC) and their allies including Russia is expected to add 3.5 million barrels per day of extra output when it is least needed.

Russia walked away from a proposed deal with OPEC to make further cuts in production on March 5, prompting Saudi Arabia to announce plans to hike output by 2.5 million barrels per day to the maximum level of 12.3 million barrels per day.

But even OPEC+, as the wider exporters’ club is called, is unable to accommodate the latest forecasts for demand collapse, the Gulf source said.

“Even if these countries come back together, they cannot move the needle. Demand has dropped and there is oversupply by many countries, so you have a big surplus,” the Gulf source said. “It is no longer about Saudi, OPEC and Russia.”

The United States, which has become the world’s largest oil producer thanks to evolutions in drilling technology, has traditionally refused to join any international agreements on oil supply. Its production gains over the past decade have taken market share away from OPEC.

Saudi Arabia announced earlier on Wednesday its intention to convene a virtual extraordinary summit next week bringing together the leaders from the Group of 20 major economies (G20) to address the coronavirus pandemic.

Analysts were extremely pessimistic on the outlook for oil markets.

“What we are seeing here is essentially the atomic bomb equivalent in the oil markets,” said Rystad Energy Analyst Louise Dickson.

Gary Ross, CEO of Black Gold Investors, said prices would quickly fall below the marginal cost of production.

“This is scary. It’s a once-in-a-century event,” he said. “They cannot cut enough to deal with this situation. Increasing production is adding fuel to the fire and helping to create the conditions for a financial crisis. They will fill every storage tank in the world then be forced to cut production. We will likely see prices fall below the variable cost of production. Certainly in the teens and possibly in the single digits.”

Paul Sankey, managing director at Mizuho Securities, wrote that because oil was a tangible asset, unlike equities, crude prices could even go negative if tankers full of oil cannot find buyers.

"It pumps out of the ground and has to be consumed or stored. This is not the equity market… or the gauge of consumer confidence. These cannot go negative," Sankey wrote in a note on Wednesday. "Negative prices are simply a higher cost of storage than market."

Roger Diwan, Vice President of IHS Markit, said exporters would be forced to make a deal once storage tanks across the world are filled up – and this is expected to happen very fast.

“You cannot have the oil flowing if the global economy stops. It is that simple. Storage will fill very quickly, and a deal will have to be made,” he wrote on Twitter.

Rystad Energy’s Dickson said the numbers simply didn’t add up: “We find that the theoretical oversupply of more than 10 million bpd in 2Q oil balances will in practice not be possible as it would equate to a stock build of nearly 1 billion barrels over just one quarter, which would exceed the likely available storage capacity in fill rates of storage globally in such a short time frame.”

“The consequence would be that oil production will need to be curtailed through lower oil prices in places where physically storage capacity runs out.”

Saudi Arabia can pump oil at an operational cost of about $3 per barrel, the lowest in the world. The costs for some US producers in shale oil fields are as high as $55 per barrel.

Nobody knows when demand will recover, with many major centers of demand in Europe and North America yet to witness the peak infection rates of coronavirus.

“Unlike structural economic collapses, we don’t know when the corona effect will ease up – markets could be wrestling with the virus well into 2021 in a worst case scenario,” said Rystad Energy’s Dickson.

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Last Update: Wednesday, 20 May 2020 KSA 10:05 - GMT 07:05
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