Oil: The Art of the Deal

Published on April 8, 2020

Saudi officials are scrambling to pull together the last pieces of a high stakes, immensely complex new framework agreement to begin draining the vast excess of crude swamping the international oil markets “to ensure energy market stability.”

We would be remiss not to warn a deal could still fall apart the closer we get to the 2pm GMT start time tomorrow, and much will still uncomfortably depend on the extent of the commitment and participation by US-based oil producers.

** But our best sense right now is that there will indeed be a multi-phased agreement that will begin with the 20-member OPEC+ statement tomorrow afternoon declaring their ambitions to cut collective crude exports by between 6 to 8 million bpd. It will be built around a commitment by Saudi Arabia to trim current output by 2.5 million bpd from around 12.3 million barrels per day with Russia committing to cut output by perhaps as much as 1.5 million bpd from end of April figures of around 11.3 million bpd.

** Critically, the OPEC+ agreement will likewise be conditional on an affirmation by G20 energy ministers, including Canada, Brazil, and the United States, in their tele-conference meeting on Friday to add both to the output cuts, by at least another 2 million to 3 million bpd, and a commitment by G20 member states including the US, China, and the European Union, to commit to crude purchases to fill national Strategic Petroleum Reserves. US producers have already seen their collective output plunge by more than 3 million bpd.

** If the other G20 oil producers and SPR managers join in the new OPEC+ framework, we understand that there is the prospect of deeper, and real, output cuts by both Russia, by perhaps another 500,000 bpd, and especially Saudi Arabia, which is said to be putting another 800,000 or one million bpd on the table, entirely conditional on the extent of US participation in the broader agreement. We think, on balance, Riyadh and Moscow will press ahead with the new framework even if the US producers shy away from a formal role in the near term.

** The OPEC+ framework would extend for three months, beginning May 1 and will be subject to revisions – up or down – over the three months and certainly at the end of the 90-day period when it is hoped there will be clarity on the full depth and duration of the demand destruction due to the Covid-19 pandemic. Extending the agreement beyond the summer will become increasingly contentious depending on the extent of the broader participation by the non-OPEC+ oil producers.

** We are not entirely sure there will be an individual member state breakdown of new quotas, and there is bound to be considerable market skepticism over any of the numbers that will eventually be provided, or in back of the envelope estimates. There almost certainly going to be some built in room to fudge:

** For example, Saudi Arabia, we understand, may emphasize its export figures rather than output figures in order to underscore an even bigger contribution to the agreement. That is because at some point soon, it will need to divert as much as 500,000 bpd in its output to meet a domestic surge in seasonal summer demand. In addition, it is our understanding that Saudi Aramco had already been drawing down domestic inventories in order to claim an output surge in April above 12 million bpd.

** Russia, meanwhile, has tended to meet its target quota by the end of the agreed to period rather than the start, and was allowed to do so since the Saudis, in needing Russia participation in some fashion, were so previously willing to look the other way. That is no longer the case, so the Russian numbers will need to be credible, and it will be a challenge for output to be cut as much as being suggested, and the execution will almost certainly still be dragged out.

** Relations and trust between Moscow and Riyadh are toxic at the higher political levels, but the leadership of both countries share at least one powerful incentive to work through their personal and political differences: the demand US shale producers are no longer allowed to free ride on the back of OPEC output sacrifices.

** Simply put, there will be no lasting OPEC framework agreement without some form of active US participation in the output cuts. What’s more, the “organic” or “market driven” supply side destruction in scores of weaker US shale producers going bust is not the same as a policy-driven limit to output.

** However awkward it is for the Trump Administration or however strong the resistance by the US International oil companies that have lobbied hard against any sort of national restrictions on output, the other big oil powers will need to see movement on the US side in the coming days.

** One way to square the circle, we understand, is through the state-level enforcement of existing regulations, like flaring requirements or licensing requirements, that would effectively cap if not reduce current US-based crude output. That may work at least at the start of the framework by providing political cover for the Saudi leadership to step back from its current flooding of the markets.

** We think it worth adding that the Saudi incentive to pull back from its flooding of the global crude markets that are bringing the US energy sector to the brink, with all the subsequent job losses in a US election year, are the growing volume and number of bipartisan threats by Congress to withdrawing US arms sales, troops, and the US defense umbrella protecting the Kingdom.

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