OPEC And The Journey Back to Normal

With just over two weeks to go before the largest coordinated crude oil supply cut in the world is set to expire, the 23-nation club that is OPEC+ gathered to discuss that very issue. It had two choices: extend the 9.7 mmb/d cuts by another month (having already provided a single month extension from the original expiration in June) or adhere to the schedule of quota trenches agreed back in April. With rumbles of discontent within the club and signs that global oil demand had turned a corner as economies recovered, the club chose the latter.

This means that beginning 1 August 2020, the nations that comprised OPEC+ will taper their drastic supply cuts to the next level – overall cuts of 7.7 mmb/d that are scheduled to remain in place until 31 December 2020. That’s a return of 2 mmb/d of crude to the market; but the net effect will be even higher as recovering crude oil prices have also prompted market-driven producer nations, such as the US, Brazil and Norway to restore curtailed production as well.

This gradual return to a ‘normal’ level of crude production was deemed necessary. But some are questioning whether the haste is presumptive. It is certainly true that demand has recovered. Led by China, which is largely back to full capacity, and the re-opening of key economies in Europe and Asia, the EIA estimates that global fuels consumption had recovered by 10 mmb/d from April levels. OPEC itself predicts that world oil demand by rebound by 7 mmb/d in 2021 from an average of 90 mmb/d in 2020, with demand for OPEC crude surging by 25% in 2021 to an average of 29.8 mmb/d. That’s a bullish projection, but it is certainly backed up by consumer behaviour and business sentiment, eager to move back into the full swing of commerce to reclaim the few months that were lost entirely to Covid-19.

But that recovery is fragile. There are fears that countries have re-opened too fast and too soon. In Australia, a state-wide lockdown was re-imposed in Victoria as Covid-10 cases spiked. In Europe, where EU border controls were removed, there have been clusters of cases discovered in Spain, in Germany and elsewhere, prompting regional lockdowns. While nowhere near the full-scale lockdowns seen in April, this does showcase the ever-present threat of the virulent virus. In Asia, re-openings have been more gradual and cautious, but Covid-19 is still rampaging in India, where cases are spiking. And the situation in the Americas is still dire: spiralling out of control in the USA, and reaching critical levels in key parts of Latin America like Brazil, Mexico and Colombia. The asymmetrical regional situation of the pandemic means that restoring full global connectivity is at least 6 months from even being considered, and that the possibility of another wave of severe lockdowns is high.

For now, OPEC is sanguine, betting that most countries will be able to keep the situation under control. The move to taper the cuts was widely expected already, but crude prices still fell in response. However, OPEC+ has made a strong show of prioritising adherence, demanding firm commitments from errant members, countries like Iraq, Nigeria, Kazakhstan and Angola to compensate for their overproduction in May and June with cuts in August and September. All four have, in principle agreed to these, including laggard Angola, with Saudi Arabia even commending Iraq for implementing 90% of its cuts in June. The OPEC+ technical committee has directed the countries to make an additional 842,000 b/d of cuts, which would be able to blunt the net rise in OPEC+ production to just over 1 mmb/d instead of a full 2 mmb/d.

Will this be enough to keep the market buoyant and confident? For now, it seems so. Although crude prices fell in response to the announcement on July 15, the decline was still within the trading range, indicating that it was nowhere near a shock to the marketplace. OPEC+ did also offer an olive branch by stating that it would continue to closer monitor the demand recovery and will not hesitate to act if the situation turns, which are words that will mollify a jittery market.

The oil world is itching to return to some semblance of normality, as is the rest of the global economy. The signs so far are promising. China, for example, saw its economy return to growth, expanding more than expected in Q2 2020. These green shoots of hope have been taken by OPEC+ that its approach is working and it can relax a little. One would have to hope that those assumptions hold true, and the long road to recovering from the worst crisis the oil world has possibly ever seen can begin to accelerate into higher gear.

Market Outlook:

• Crude price trading range: Brent – US$42-44/b, WTI – US$40-42/b
• Recovering oil demand kept crude prices steady, but OPEC+’s move to taper its supply cuts to the next tranche caused prices to skirt the lower part of their range
• Crude oil prices were also supported by US data showing American crude and fuel inventories had continue to fall – indicating demand recovery amid constrained supply
• Libya’s NOC was forced to redeclare force majeure on all oil exports, just two days after it lifted the previous force majeure, after militant action blockaded key oil ports; this does prevent an unexpected return to crude supply to an already nervous market

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