March 23, 2020 [Petroleum Economist] – The cartel may need to take significant action to help balance the oil market, particularly as the potential for a worldwide pandemic remains.

 
The current and possible future impact on oil demand and price, due to the spread of Covid-19, means that Opec and its main Opec+ partner Russia have tougher decisions in Vienna than they might have been expecting. And their decision to cut or not has blurred the global market picture. And there are supply-side variables as well.
 
One of these is Libya, a currently supportive factor against further oil price weakness. Over 2019 as a whole, data from cargo tracking specialist Kpler showed Libyan exports consistently averaging 1mn bl/d. January’s figures fell to 700,000bl/d, and for the first three weeks of February plummeted to 65,000bl/d.
 
“Basically, a million barrels a day of lost export, which does not fill the demand gap, but it goes a decent way to taking the pressure off the Saudis and others,” says Alex Booth, head of market analysis at Kpler.

The return of Libyan barrels, therefore, before signs of a Chinese demand recovery or greater certainty on Covid-19’s global impact could add a further bearish factor.

Opec+ Response

The behaviour of the Opec+ group is therefore another crucial variable. Output is being pushed down by a combination of Libya, potentially even lower Venezuelan production after the US took further action against Russian producer Rosneft there, and KRG crude quality issues in Iraq that have knocked “a couple of hundred barrels out of the market”. This is “doing some of Opec’s work for it”, says Joel Hancock, lead energy analyst at bank Natixis.

“I think in the near term, for the second quarter, they [Opec+] will have to announce a cut just to support the market and try to put a floor under prices at maybe $50/bl, because, at that point, we are looking at relatively severe budgetary pain for the Middle Eastern and north African oil exporters,” Hancock told Petroleum Economist, prior to the Vienna discussion. “For sentiment, if nothing else.”

Consultancy Wood Mackenzie says to help balance the loss of barrels from China, in the wake of the coronavirus, the cartel is considering a 0.6-1mn bl/d cut for the second quarter of 2020, before returning to the previous first quarter.

Will Russia, though, which can tolerate lower prices on national budget terms than some of its current Opec partners, still be prepared to play ball? “If we look at Russian production levels pre and post the Opec+ agreement, even all the way back to 2016, Russia has actually grown production by 60,000-70,000bl/d over the period,” says Hancock.

“It is not a huge amount, but, compared to Saudi cutting substantial amounts from their own exports, it shows that Russia is almost more there from a moral support standpoint than in any genuine heavy lifting. You could say that this is their psychology—that they do have pent-up supply they are not bringing to the market is their version of a cut; we are not flooding the market, we are holding back,” says Hancock.

What is clear is that Russia has a genuine option to decide to break with its Opec allies and maximise its output. “In the short-term, Russia could increase production except for Opec+,” says Ekaterina Derbilova, editorial director, Russia and FSU, at Argus, “and some firms have argued against the cuts.” The country’s producers have the “willingness and ability to bring more production online”, should they be freed of Opec+ strictures, agrees Booth.

Over $70/bl

One of the post-Covid-19 oil market ironies is that we may have been higher in its absence, not just above current levels, but previous ranges. Hancock notes that in September-October 2018—just after the US rejected the Obama-era Iranian nuclear agreement but before it announced sanctions waivers—the front of the oil curve reached as high as $85/bl.

But, beyond that, the back end of the Brent curve has been “stuck in a $55-60/bl world for about five years now, no matter what the front months have been doing”, says Hancock, on the view that US shale production is always going to be able to supply to the market at that sort of marginal cost.

The pre-Covid-19 Natixis view had been that—if cracks had appeared in the shale growth model and a potential requirement for a conventional resources investment price signal had emerged—the bank was “relatively confident”, says Hancock, that the longer-dated forward curve would shift higher and pull the front months with it. Opec+ continuing with cuts and keeping the market physically tight would also have contributed to support the prompt market.

Its assumption was that this would have played out more in the second half of 2020 than the first, given that Opec+ had in December already put in place a production cut for the first quarter, based on the impact on new volumes from the Norwegian Johan Sverdrup and Brazilian pre-salt developments.

But while these projects help to ensure that 2020 non-Opec production growth is relatively strong in volume terms, Hancock is more struck by their 50pc non-US, 50pc US breakdown. “Over the past two to three years, it has been more like 70-80pc US,” he says.

This year’s non-US, non-Opec supply increments are ‘generational’, not repeatable, so “there is no more oil from those producers waiting in the wings”. “In 2021, we will return to more normal, based on the five-year trend, non-US, non-Opec growth, so, if we do have a slowdown in the increase of US tight oil production, non-Opec supply growth looks quite weak in aggregate,” says Hancock.

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