DA NANG – Global oil markets are not only breathing a collective sigh of relief over a new OPEC+ production cut deal, but in early trading in Asia on Monday oil prices were trending higher on the news.
Global oil benchmark Brent crude rose to US$42.45 per barrel, with the possibility of $50 per barrel oil on the horizon if there is no resurgence, or second wave, of Covid-19 in major population centers. US oil benchmark West Texas Intermediate (WTI) crude also rose to around $40 per barrel in early trading.
On June 6, the so-called OPEC+ club of producers, including de facto leader Saudi Arabia, the world’s largest crude oil exporter, and oil production heavyweight Russia, the second largest global producer, agreed to extend oil production cuts of some 9.7 million barrels per day (bpd) in June for another month.
OPEC members Iraq and Nigeria, whose early lack of willingness to join along had threatened to derail the deal, finally fell in line, though their compliance will still be an issue to reckon with even amid stricter monitoring.
The original deal reached in April, amid the worst oil demand destruction in history due to the Covid-19 pandemic, called for cuts of 9.7 million bpd for both May and June, then dropping to 8 million bpd for the rest of the year.
Starting in January 2021, production cuts are scheduled to drop to 6 million bpd and last until April 22, 2021.
At the time of that deal, OPEC+ producers were hoping the cuts would help to soak up record global oil inventory levels and put pressure under prices that had tanked well below producers’ breakeven points.
At the time, most analysts saw the move as too little, too late. However, the deal has helped crude prices double in the past two months as almost 10% of global supply has been removed from the market and demand has stared to recover from the reopening of numerous global economies.
Saudi Arabia could also consider carrying the 9.7 million bpd cuts forward to August or even December, OPEC sources said on Saturday.
Consultancy Rystad Energy said as the new deal was being brokered that “crude inventories will continue to draw down to the tune of 3-4 million bpd over July-August, as crude supply may be reduced by an additional 2.5-3 million bpd in July, compared to only a tapering down of the cuts as per the original agreement from April.”
At least part of the reason for the recent resurgence in global oil markets comes from the US, the world’s largest oil producer.
Low prices that plunged beneath breakeven points forced production shut-ins among US shale oil producers of all sizes, while several large US players intentionally trimmed production to help support the market – a rare combination of US-OPEC+ participation.
That cooperation was on an informal basis since US producers are prohibited by anti-trust laws from price-fixing or production agreements.
The loss of US production has seen the country narrow its global oil production lead from a record breaking 13.1 million bpd at the start of the year to 11.2 million bpd for the week ending May 29, according to data from the US Energy Information Administration (EIA).
Operating US oil rigs dropped by 16 to 206 last week, their lowest number since June 2009. Natural gas rigs dropped by one to 76, their lowest on record according to data going back to 1987, according to oil services company Baker Hughes.
In lockstep, oil inventories at Cushing, Oklahoma dropped by 1.7 million barrels to 51.7 million barrels in the week ended May 29. It was the fourth draw after nine weeks of builds where the oil hub’s stocks had increased by more than 28 million barrels, according to the EIA.
The EIA expects that US crude production will continue to decline in 2020 and into next year, hitting its lowest point at 10.7 million bpd around March 2021. As such, the drops could relegate the US to the world’s second largest oil producer after Russia, who often produces around 11 million bpd.
Monday’s oil price gains sustain last week’s momentum, when markets seemed to already price in a favorable OPEC+ deal even before it was announced.
Prices for both Brent crude futures and WTI increased around 11% last week, with Brent ending the week at $42 per barrel. WTI, for its part, ended the week around $39 per barrel – healthy strides considering Brent had dipped to the low $20s and WTI to the mid-teens range just two months ago.
Oil prices trending upward, however, can also spell trouble for markets trying to make a comeback, especially since the onset of the US shale oil revolution nearly ten years ago. While US production declines over the past month helped turn the tide for arguably the worst oil market crash in history, it can also be the spoiler for any sustained rally.
Indeed, some US producers are already considering bringing idled production back online. One company, Delaware-based EOG Resources, said last week that it planned to bring back 125,000 bpd worth of production that was cut in May.
The ramp up is part of the company’s strategy to step up production in the second half of the year, when it expects even better oil prices. Expect other US companies to soon follow that lead, as oil prices keep trending higher and head north of their production breakeven points.
The same dynamic took hold in 2017 after a previous OPEC+ production cut deal reduced a severely oversupplied market that saw prices tank below $30 per barrel the previous year.
The then-historic deal eventually restored Organization for Economic Cooperation and Development (OECD) global oil inventory levels to their five-year averages and saw prices climb to just under $70 per barrel for Brent and around $65 for WTI by January 2018, increasing 26.7% collectively over the previous twelve months.
From January 2017 to April 2018, OECD inventories decreased by 234 million barrels. The US accounted for more than half of that decline, as US crude oil and other liquids inventories dropped by 162 million barrels over that period, according to EIA data.
By the end of April 2018, both OECD and US inventory levels were lower than the averages for April 2013 to April 2017 – representing a grand slam for orchestrators of the first OPEC+ deal that restored confidence in both Riyadh and Moscow that they could still micromanage global oil markets. Yet the victory would be short lived.
As higher global oil prices kicked in during that particular market period, US oil producers that had been forced out (likely Riyadh’s game plan all along) also brought production back online, much to the dismay of the Saudis, Russians, and other OPEC+ producers.
This time around, however, it could take more time for US producers to play the role of spoiler since global oil inventories are still at record highs and need to be drained even as pandemic-deflated demand slowly but surely starts to reflate.