Machinations behind an OPEC++ meeting

Oil prices rose sharply last Thursday when US President Donald Trump tweeted that he had spoken to both Saudi Crown Prince Mohammed bin Salman and Russian President Vladimir Putin to end their war for market share and predicted a production cut of OPEC+, an alliance between OPEC and 10 allied nations lead by Russia. Trump flagged the preferred size of the cuts at between 10 and 15 million barrels per day. The oil price jumped by 22 percent with Brent ending the day at $29.29 per barrel. Brent then traded above 30 over the weekend.

Hopes were high that OPEC+ would hold a virtual meeting on Monday, April 6, which was not to happen as Saudi Arabia and Russia disagreed on a technicality about how the OPEC+ agreement had come to an end. They also disagree on the production period to be used as the going-in point for any cut. Russia insists on the first quarter, when Saudi Arabia produced about 9.7 million b/d. Saudi Arabia would like to use current production, which stands above 12 million b/d for the Kingdom. The real issue is that both Russia and Saudi Arabia feel that OPEC+ cannot take the burden alone. Particularly Russia has strong feelings about American sanctions and vociferous US opposition to its Nordstream 2 pipeline bringing Russian gas to Germany under the Baltic Sea. The project faced particular problems at the last leg of construction, with contractors withdrawing as a result of direct sanctions.

Agreeing on cuts among OPEC+ is no mean feat. It will be all the harder if more countries join in the negotiations. Norway is said to be willing to join. Canada, Brazil and Mexico are other potential participants. The big question is the US. Some two weeks ago OPEC Secretary-General Mohammed Barkindo had reached out to Ryan Sitton, head of the Texas Railroad Commission, the regulator of the Texas shale space. The shale producers are worst hit by the ultra-low oil price because they are high-cost producers and many of them risk bankruptcy if the current price environment persists.

Trump met US oil companies on Friday, but there were no specific outcomes — particularly not an offer to join in the OPEC+ virtual meeting. To be fair, it would not be easy to negotiate a US cut, because unlike in Saudi Arabia or Russia there is not a national oil company or very few dominant producers with close ties to the government. The US has a plethora of producers, many small, other medium-sized independents and three oil majors. However, given the current state of the industry, a US cut would be more nominal than real in nature.

Saudi Arabia, which holds the presidency of the G20, is under pressure to produce a result by the end of the week and before G20 finance ministers hold a virtual meeting. Trump has been a staunch ally of Saudi Arabia and he will expect the Saudi government to play ball.

The phone wires are running hot while oil diplomats hold direct talks and also test the waters via back channels. Russia will insist on US participation in the deal and expect a relaxation of sanctions in return for any cuts in production. One source close to OPEC said that while he understood Trump’s predicament regarding his domestic oil industry in an election year, he felt that it was nonetheless important for the US to show some goodwill. Trump’s threat to impose tariffs on imports of Saudi and Russian crude are not as severe as they sound, as both countries direct the majority of their exports to Asia and some to Europe.

The real question behind production cuts is storage. Pricing for storage has gone up, but at some stage the world may run out of capacity. Sitton puts that time at early June for the Permian basin.

The other question is how significant the cuts need to be to have a permanent impact. The International Energy Agency said that it will be difficult to put a floor under the market given the demand destruction and uncertainty over the end of coronavirus disease (COVID-19) measures.

Right now, the proposed number for a cut bantered about is 10 million b/d. Nobody has clear visibility of how much demand decreased during the COVID-19 crisis. Most analysts put that between 20 and 25 million b/d. The author’s models indicate that they are well above that. This means that the proposed cut will give temporary relief to the oil price. However, that may not be sufficient in view of the demand destruction, which is only going to get worse before it gets better.

The OPEC secretariat is running the numbers of how big a cut should and would be, and how it should be divided up between “deal participants,” whoever they may be in the end.

This may yet be one of the most testing meetings for OPEC+. There are many demands and some countries have set a stake in the ground, delineating positions from which it will be hard to retreat from. One thing is clear though: Neither Russia nor Saudi Arabia are willing to take the pain on any deal alone. While they are said to be close to a compromise, a lot will depend on what countries outside of the OPEC+ alliance are willing to offer. By midday in Europe, Brent stood at $33.25 per barrel, having given up 2.5 percent on the day.