The oil industry, facing its deepest crisis in history, still has the audacity to see hope: prices jumped 21 percent after a tweet by Donald Trump promised Saudi Arabia and Russia would cut back production by 10 million barrels per day, or “Could be as high as 15 Million Barrels”
In the face of an epic collapse in demand, and Trump’s claims, Riyadh has called for all producers to meet on Monday – online – and discuss stabilizing the market. This pointedly included not just OPEC, Russia and the other recent “OPEC+” allies such as Oman, but “other countries”.
Just spoke to my friend MBS (Crown Prince) of Saudi Arabia, who spoke with President Putin of Russia, & I expect & hope that they will be cutting back approximately 10 Million Barrels, and maybe substantially more which, if it happens, will be GREAT for the oil & gas industry!— Donald J. Trump (@realDonaldTrump) April 2, 2020
This raises three questions. Firstly, what is the interest for the various countries to participate? American politicians have been making menacing noises, threatening tariffs, embargoes on imports of OPEC oil, or withdrawals of security for Middle East states.
For the US itself, shale oil output requires constant drilling, at costs well above current prices, to sustain output which otherwise declines fast.
Oil states, mostly Republican-voting, face economic oblivion. The country’s foreign policy has become oriented around “energy dominance” and using oil sanctions or exports of liquefied natural gas to force others to submit. Hawkish foreign policy pressure groups are already panicking at the thought of losing this vital weapon.
Read more: Russia does not plan to raise oil output: Novak
But the politics of cooperating with Russia and OPEC to push up oil prices are doubtful. The vast majority of Americans benefit from low fuel prices at the pump, especially now.
By seeming to act, but with a deal dependent on others, Trump can get the best of both worlds. On Friday, he seemed to backtrack, calling for the free market to fix the problem of oversupply.
Russia has talked up its ability to survive, with sovereign reserves, a floating currency, low production costs and a budget break-even oil price around $42 per barrel. But the budget is now being revised to an oil price of $20 per barrel, the country plans to borrow $13-19 billion this year, and foreign investors are skittish.
Prices for Russian oil delivered in Europe have fallen below the cost of production plus transport and taxes – meaning it’s loss-making. Before Trump’s tweets, the Urals price grade used as the standard for taxation fell to $11 per barrel, under the $15 benchmark below which oil companies are exempt from paying royalties and export duties – some relief for them, but bad for the state budget.
Read more: Russia, US hold talks as price war hammers oil markets
So Moscow may have realised it’s not as well-equipped for a price war as it thought. Still, it is not inclined to show weakness or seem desperate. Vladimir Putin has said the country is ready for 10 million bpd production cuts in coordination with Saudi Arabia and the US. The Kremlin might hold out for relief from US sanctions – helping its ability to borrow abroad – as the price of a deal.
It is right for Saudi Arabia at least to consider the US president’s suggestion politely. The current very low prices are painful for the budget, though sovereign wealth holdings can cover the deficit for now. Discussions are likely to take months to produce any result, allowing the Kingdom to change tack if necessary. But conceding fast in the price war risks letting Russia and Texas off the hook. A fast decline in competing suppliers opens a more rosy prospect for its market position next year.
Secondly, are the cuts enough? Every day brings a more shocking forecast from a trader or investment bank: from 100 million bpd pre-crisis world demand, we have lost 10, 17.8, 20, 26, 30 million bpd, depending whom you ask, as planes and drivers stop. Without coordinated deliberate action, storage will quickly fill and prices will drop to single digits, forcing producers to close wells. A 10 million bpd cut would ease the glut to an extent, but not entirely – just postponing the inevitable reckoning.
Thirdly, where would the 10 (or 15) million bpd come from? The last OPEC+ agreement fell apart over cutting 1.5 million bpd. At most, Saudi Arabia might scale back from its planned levels by 4 million bpd, other GCC countries by 2 million bpd and Russia 2 million bpd. That leaves the US, Canada and other non-OPEC states to chip in 2 million bpd.
Ryan Sitton, one of the three commissioners of the Texas Railroad Commission, has said the state would cut some of its 5 million bpd production if Trump reached a deal with other producing countries. Oklahoma produces 570 000 bpd; its producers have asked the Oklahoma Corporation Commission to curtail output.
Read more: What if Texas joined Russia and OPEC to avert the oil market collapse?
The Trump administration has reportedly considered shutting down offshore production in the Gulf of Mexico, about 2 million bpd, over the convenient excuse of the coronavirus spreading on offshore platforms. But this would likely be bitterly resisted by the big companies – Shell, ExxonMobil, BP and Chevron – that operate there. Coordinated action by companies and states would likely require a national security exemption from anti-trust legislation.
Alberta, Canada’s premier oil province with 3.8 million bpd of output, already cut back output in 2018 to avoid overloading pipeline capacity; its premier, Jason Kenney, has said he is open to coordinated cuts.
But American and Canadian production is set to collapse anyway, as storage fills up, and prices fall well below operating costs. Some other countries, such as Brazil, have already shut down uneconomic fields. To mean anything, they will have to volunteer cuts to a level well below where their output would decline to anyway.
It seems unlikely that such an unwieldy coalition could be formed and put cuts into action before storage in many places effectively fills up. By that point, holding a deal together would be a formidable challenge, as participants respond to upticks in price by boosting production. Yet if production cuts work neither in the short nor the long term, Saudi Arabia still benefits from listening.
Robin M. Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis
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