After the better part of five days of marathon negotiations spearheaded by Saudi Arabia with the goal of eliminating coronavirus-induced overhang in oil supply, global oil producers hammered out April 12 an agreement to reduce oil output by a record 8.5 million barrels a day.
The short version is the deal is a joke. I could spam readers with a full newsletter on just how much a joke it is – it relies upon cuts from countries who have never cut before, not all OPEC states are participating, it expects the Russians to cut as much in exports as Kuwait exports in total, the plan is to not begin the cut until May and then start rolling it back only two months later – but really it comes down to something far more basic:
Oil traders, the folks who probably have the best feel for just how much demand has dropped, estimate the global oversupply is now between 30mbpd and 35mbpd. Simply the reduction in demand for jet fuel is probably about 5mbpd. The OPEC cut is only for 5.6mbpd with another 2.9mbpd coming from non-OPEC members. Even if everyone plays along, this just isn’t enough to make a difference.
Which pushes the discussion to other directions. The world is running out of storage capacity. We’re really not quite sure how much spare storage exists in the world since everyone measures it a bit differently, while countries like Saudi Arabia and China are notoriously squirrely about just how much they have stashed around the world. Industry guesses as of the end of March ranged from 1 billion to 2 barrels, so I’m just going to split the difference and call it 1.5 billion.
If everyone sticks to the OPEC plan and if that 1.5 billion figure is correct and if the oil traders know what they are talking about, then all global storage is filled to the brim by early June at the latest. Should the OPEC deal collapse and everyone just keep pumping, zero-hour moves forward to roughly mid-May.
Or maybe sooner.
The quick and dirty of the backstory is that in addition to the coronavirus-induced demand collapse, the Saudis are engaged in a price war with the Russians. In every agreement the Saudis have hammered out with the Russians since the Soviet collapse, the Russians have never actually cut and simply made the Saudis eat the difference. Similar attitudes have prevailed in Venezuela, Iran, Nigeria and Iraq – the first two of whom are not even included in the cuts agreement.
Ok, on with the show.
On April 13 the Saudis announced sales prices for their crude shipments. They added $5 a barrel to their asking prices for American deliveries, but cut their asking prices for Asian deliveries.
US President Donald Trump has been aggressively lobbying the Saudis for a significant production cut in order to help US shale producers. While the April 12 OPEC agreement will likely keep Trump off the Saudis’ back for the time being, the change in contract prices is far more significant. They suggest the Saudis are going to stop dumping crude oil on the US market, so that the shale producers don’t drown quite so quickly. Add in that roughly half of all remaining (known) oil storage is in the United States, and most American shale producers won’t be facing chock-full infrastructure until at least late-summer. Any sort of output reductions in the American shale patches, whether caused by rapid well-decline rates or deliberate shut-ins, will extend that deadline out further.
But simultaneously, any Saudi crude that is not being shipped to the Gulf of Mexico will instead be steaming towards Asia, intensifying Saudi Arabia’s price war in countries where Russian and Iranian and Nigerian and Iraqi crudes feature. So the price war lives on, just in a more constrained economic geography. We could see a complete overload of Eurasian storage capacity in a matter of a few weeks.
All in all it’s a pretty shrewd play by Riyadh. Lead an agreement you know the Russians will violate in order to provide political cover. Reduce flows to the United States to get Donald Trump off your back. But redirect those flows to places that will really hurt your Eastern Hemispheric competition.