Until the lockdown is removed in most of the countries, the aeroplanes start to operate, the economy starts humming (not necessarily to the full capacity) and the demand reaches 93 to 95 % of the pre-pandemic period, oil prices will be controlled by COVID-19 driven market, and not by OPEC+ or President Trump, writes Dr. Bhamy V Shenoy.
On April 12, curtains were finally drawn on one of the greatest dramas we witnessed in recent times in the oil market. The day brought an end to the fourth Oil Price War (OPW) -- one of the shortest and one without any winner. Main actors in this oil drama were US President Donald Trump, US President Vladimir Putin and Crown Prince of Saudi Arabia Mohammed bin Sultan.
To everyone’s surprise, Mexican President Andrés Manuel López Obrador, who did not even have a minor part in the crisis, managed to sneak an important role. But the ‘greatest negotiator’ the world has ever seen played a joke, ended the drama and claimed a victory. Let us see how.
Since the formation of OPEC, consisting of 14 members led by Saudi Arabia and controlling 30 million barrels per day in 1960, there have been four major Oil Price Wars. It began in 1986 when the price fell below a single digit, then in 1997 when Saudis were upset with Venezuela flooding the US market, leading to the fall from $20 per barrel to $10 and then again in 2014-2016 when it fell as low as $26. A month ago, on March 6, the oil price fell below $20/barrel.
Neither the oil market nor the OPEC members expected that Russia will start the fourth OPW and oil prices would collapse. No one could figure out the real motive behind Russia walking out of the OPEC+ (besides OPEC, it has ten more members led by Russia controlling 17 million barrels per day (mmbd) negotiation. Was it because Russia wanted to bring down the US shale revolution the way Saudis wanted to do it during the third OPW? Was it because Russia wanted to punish the US for its sanction against the Nordstream-2 gas pipeline which is almost ready to supply gas to Europe?
However, soon after the collapse of the OPEC+ negotiation and each oil-exporting country getting ready to increase its oil production, the little invisible Coronavirus pandemic started to get hold of the oil market. But OPEC+ did not realise how it had lost the power to control the market. Saudis and Russians thought they could sell at their maximum capacity.
Oil prices fell 30% in a single day when the negotiation failed. Several Texas shale companies were close to declaring bankruptcy. Oil sector jobs were soon to disappear. Trump thought he could drive a higher oil price and save the shale revolution by bringing Russia and Saudis to the negotiating table. He also did not realize that OPEC+ has completely lost the capacity to control the price which they had during the first three OPWs.
On April 9, OPEC+ agreed to a production cut of 10 mmbd. On April 10, G20 endorsed the agreement and promised to contribute some more through the market-driven reduction in Norway, Canada, and the US. However, as the market was rejoicing the historic and unprecedented production cuts, Mexico, a minor producer objected to its quota of 0.4 mmbd.
They were willing to reduce only by a mere 0.1 mmbd. It looked like the whole agreement will collapse. Then came the great negotiator Trump who was the real architect of OPEC+ meeting to end the fourth OPW. After talking with Mexican President Obrador he announced that the part of the US oil production cut will be credited to Mexico and US will “get it back later”. It was not clear what it implied. Since OPEC+ was desperate and needed some face-saving term, they readily agreed.
Soon after the agreement was signed by OPEC+ members, Trump started to trumpet that what was agreed was for 20 mmbd and not 15 mmbd as reported in the media. It required creative math to arrive at such a large number. Even more surprising was Saudi Energy Minister reiterating that the agreed production cut amounts to 19.5 mmbd. Besides 9.7 mmbd cut by OPEC+, G20 nations outside OPEC+ will add 3.7 mmbd and 200 million barrels (roughly 3.3 mmbd) to be added to SPR by the US, China and India.
Under the Grand Agreement, OPEC+ will cut 9.7 mmbd in May and June, 8 mmbd in July to Dec, and relax them further to 6 mmbd from Jan, 2021 to April, 2022. Since Russia and Saudi cuts are based on their theoretical production of 11 mmbd, real reduction by OPEC+ will be at best 6.8 mmbd and there could be 7 mmbd from other countries including oil for SPR. However, when the demand drop from 25 to 35 mmbd is compared against the realistic supply cut of less than 11 mmbd, there will be a huge mind-boggling surplus of 14 to 24 mmbd.
The oil market has never faced such an unmanageable supply surplus. Under this black swan event, when the demand for oil collapsed by 25 to 35%, the old strategy of reducing oil supply by allocating quota won't work. Finally, it is the market that will decide who produces oil depending on who can produce above the break-even cost of as low as $15/b.
In short, it is COVID-19 which will decide when the demand will get normalised. Then only will OPEC+ be in the driver’s seat. For this to happen, members should learn to cooperate and maintain production discipline. Until lockdown is removed in most of the countries, aeroplanes start to operate, the economy starts humming (not necessarily to the full capacity) and the demand reaches 93 to 95 % of the pre-pandemic period, oil prices will be controlled by COVID-19 driven market, and not by OPEC+ or President Trump.
(Dr. Bhamy V Shenoy is an energy expert and a consumer and environmental protection activist based in Mysuru. Former board member of Georgian National Oil Compan, Shenoy is currently a member of the governing council of Nitte Engineering College, Board member of national consumer NGO, VOICE in Delhi, and trustee of a rural-based NGO, Sehgal Foundation in Gurugram and advisor to Pratham Mysuru.)