OPEC and its OPEC+ partners plan to hold a virtual meeting on Thursday to discuss cutting oil production in the face of plummeting prices and a growing oversupply. About a month ago, the OPEC+ group seemed to have collapsed, but the sudden drop in global oil demand brought on by coronavirus closures, along with some well-timed pressure from President Donald Trump, appears to have incentivized Saudi Arabia and Russia to try to rekindle their OPEC+ partnership.
The market was initially optimistic about the prospect of a 10-15 million bpd cut in oil output that President Trump mentioned in his tweets last Friday. However, the process is not nearly as clear-cut as the President’s tweet described it.
Although OPEC+ has yet to meet, Saudi Arabia and the UAE have already indicated that any production cut from OPEC+ will also require the participation of other global producers. While 12 other such countries were invited to the OPEC+ meeting as observers, it is not clear which, if any, will attend. The U.S. has already declined to join.
Some analysts have been insisting that OPEC+ is taking a wise stance by pressuring non-OPEC+ producers to take part in cuts. Whether it is wise or not is irrelevant to traders. It is crucial to understand that this is an unprecedented maneuver. OPEC used to act on its own with rare requests for engagement from outsiders. In 2014, Saudi Arabia pushed over-production when it could not balance the market, but it did not make a serious attempt to pressure any producers except its OPEC partners. Then OPEC extended participation to OPEC+. Now, it seems that OPEC+ is insisting that all other producers participate with them—a major diversion from past behavior.
As has been the case at almost every OPEC+ meeting, Saudi Arabia and Russia are the key players. In a departure from OPEC’s traditional stance, the U.S. will apparently also play an important role. Here’s a look at each of these country’s positions:
Saudi Arabia
Saudi Arabia precipitated the one-day 30% drop in oil prices in March after it reacted to Russia’s anti-cut position by committing to more output and lower prices for some of its customers. That was a month ago.
Now, the Saudi monarchy is worried about its government revenue, especially given the current leadership’s ambitious spending plans and the government’s traditional role as provider for the people. The monarchy also must worry about how low oil prices over the long run will impact the price of Saudi Aramco (SE:2222) stock, which is currently publicly traded. 20% of Saudi citizens bought into the Aramco IPO, some with debt, based on the promise presented by the government. A low Aramco stock price could sour political sentiment.
Though the Saudi monarchy needs higher oil prices, Aramco is currently producing a record 12 million barrels per day. It is supposed to supply 12.3 million barrels per day, including 0.3 million from inventory. With demand as low as it is, the big question is whether Aramco has buyers for its oil in April and beyond. If not, prices will fall further and Saudi Arabia will look weak. Moreover, this high production rate leaves Saudi Arabia without its strategic spare capacity for the first time in decades. The kingdom announced plans to increase capacity to 13 million barrels per day, but that will take a while. For now the kingdom has left itself vulnerable without spare capacity. All of this would indicate that Saudi Arabia wants a production cut deal.
On the other hand, some speculate that Saudi policy is being driven in part by a desire to project strength against Russia. In that case, Saudi Arabia may continue its tough posture despite its own best interests.
Russia
Russia wants higher oil prices just like every other producer. Recently, Russia claimed that $40 per barrel prices are good enough for its budget, but the prices right now are significantly below that. This would indicate that the current prices are not good enough for the Russian budget, but can the producers agree on a cut big enough to get them above that $40 mark?
Russia does not want to be beholden to anyone else. Before the tiff between Russia and Saudi Arabia in early March, Russian President Vladimir Putin made it clear that he was ok with his energy minister, Alexander Novak, refusing any proposals for future cuts. Russia is not going to be part of any production pact that it cannot control.
We don’t know how desperate Russia is to raise prices just yet, but even if Russia does consent to a production cut agreement, the other partners have to be skeptical about whether Russia will meet its commitments based on past experiences.
United States
The United States has no mechanism for regulating oil production across the country. On Monday, Secretary Of Energy Dan Brouillette said, “In the United States we have a free market, and the industry will adjust on its own.”
Some states, such as Texas and Oklahoma, have regulatory authorities that can proration oil production within their respective states, but the process is complicated and state-based, not federal. There are a few other ways the federal government can try to curb oil output across the country, such as through environmental regulations governing, but any attempt to use regulations designed for environmental protection to regulate trade would be challenged in court.
Ultimately, the U.S. seems to be offering only one thing: a forecast for an organic, market-based decline in production. The EIA issued a new forecast on Tuesday in which it expects the U.S. will average 11.8 million bpd of oil output in 2020. This is a decline of 500,000 bpd from 2019 production. The EIA predicts that U.S. production will slowly decline from its March high of 12.72 million bpd over the next several months to 10.96 million bpd in October before starting to pick up again.
OPEC will likely have its own forecasts for U.S. oil output, but market watchers shouldn’t expect the U.S. to offer any so-called “production cuts” to OPEC+ beyond the EIA forecast for market-driven declines.
If the deal collapses, it very likely will be based on OPEC+ members’ frustration that they cannot compel other producers (like the U.S.) to act