DA NANG – The oil market verdict is finally in and it points to likely danger ahead. The odd collection of major oil-producing nations, including the Saudi-led Organization of Petroleum Exporting Countries (OPEC) and it’s non-OPEC partners jointly decided on July 15 to increase production starting in August.
In April, the group had agreed to trim production by a record 9.7 million barrels per day (bpd) to offset the worst oil demand destruction in history that month of around 27 million barrels per day (bpd) due to the Covid-19 pandemic.
Now, OPEC+ will modify that production deal by 1.6 million bpd. However, technically around 2 million bpd of production was earmarked to come back.
But because certain member states didn’t meet their output obligations under the earlier deal, especially cash-strapped OPEC producers Iraq and Nigeria, the deal will require those countries actually to cut output for a combined 400,000 bpd.
Consequently, subtracting 400,000 bpd from 2 million bpd gives the market a 1.6 million bpd output hike. Even though several members have been cheating on their output obligations, some countries have actually cut production more than required, helping the group reach a cumulative and record-breaking 108% compliance rate.
False dawn?
The OPEC+ decision is based, at least in part, on the hope that oil demand will continue to gain momentum in the months ahead. As most countries ended economically crippling lockdowns in May and June, oil demand edged up and in lockstep projections that demand will continue its slow recovery.
Last week, the International Energy Agency (IEA) increased its oil demand forecast for the rest of the year to an optimistic 92.1 million bpd, an adjustment up of 400,000 bpd from its June forecast. In 2019, global oil demand averaged 99.5 million bpd.
However, the IEA tried to keep itself grounded in reality by warning of the impact on markets of fresh Covid-19 outbreaks in numerous countries.
“While the oil market has undoubtedly made progress … the large, and in some countries, accelerating number of Covid-19 cases is a disturbing reminder that the pandemic is not under control and the risk to our market outlook is almost certainly to the downside,” the IEA said in its monthly report.
The Paris-based agency added that the easing of lockdown measures in many countries caused a strong rebound to fuel deliveries in May, June and likely also July.
Some analysts expected OPEC+ to extend its 9.7 million bpd oil production deal for another month, as they did in June, to keep US oil production shut-ins motivated by low prices in place.
Oil prices for both global benchmark Brent crude and US benchmark NYMEX-traded West Texas Intermediate (WTI) crude have plunged from over US$60 per barrel in January to the high $30s and now low $40s per barrel. That’s still well beneath most US shale producers’ breakeven points.
Last month, at least more 18 US shale producers filed for bankruptcy, adding to a growing list from previous months. Yet OPEC+ producers are hedging with their output increase that, with prices still off by more than US$20 per barrel since the start of the year, they are still repressed enough to keep US production idled.
It’s a risky bet and similar to the one OPEC made (and subsequently lost) in late 2014 and 2015 when it flooded global oil markets by turning on the oil production spigots. That move did drive large numbers of high-cost US shale producers into bankruptcy due to low prices. Yet, almost as many came roaring back due to improved fracking technology and creative cost-cutting.
It remains to be seen, however, if saddled US producers can come back again this time. According to the last Dallas Fed energy survey, of those producers that shut-in production, some 56% said they would bring back most wells by the end of July.
Current prices also fall within the range that those interviewed would expect to see shut-in production returning to the market, with 57% believing that this output would come back at a price between $36-45 per barrel.
Yet, given the number of active oil wells in the US that have recently been idled, it appears that a resurgence in US shale production could be limited.
On July 10, Baker Hughes reported that the number of active oil rigs in the US edged down by 4 to 181 this week, levels not seen since the company started keeping rig count data in 1940. Last week’s drop followed a decline of three oil rigs the previous week. The number of oil rigs has not increased since the week ended March 13.
Vaccine swing factor
The OPEC+ deal notwithstanding, the swing factor for oil markets remains the Covid-19 pandemic. More specifically, traders are grappling with how long it will persist, how severe will fresh outbreaks be and how will the US and other countries be impacted as cooler temperatures ensue in the Northern Hemisphere in September and October.
Fresh and sustained Covid-19 outbreaks could shred the OPEC+ deal and wipe out enough demand – given that lockdowns would follow fresh outbreaks – to cause a possible repeat of the extreme oil demand destruction seen earlier this year.
According to the John Hopkins Coronavirus Research Center, as of July 16 there were more than 13.5 million confirmed Covid-19 cases globally, with nearly 600,000 deaths. The US, the most infected country by far, has nearly 3.5 million confirmed cases and just under 140,000 deaths.
The way out of the ongoing Covid-19 nightmare and associated doldrums for global oil markets is a Covid-19 vaccine. Certain hopes are rising coincident with the disease’s unrelenting spread.
On Tuesday, US biotech company Moderna posted phase 1 data showing its vaccine candidate elicited a “robust” immune response across all dose levels in all patients tested. The company is gearing up for a randomized phase three study in 30,000 participants set to launch later this month.
Nearly two dozen possible Covid-19 vaccines are in various stages of testing around the world, with candidates from China and the University of Oxford in the UK also entering final testing stages.
The fate of oil markets – as with the global economy – hinges on their failure or success.