The U.S.-Saudi-Russia Oil Cease-Fire Won’t Last
After two days of high drama, low farce and long periods of
tedium, the OPEC+ group of countries, led by Saudi Arabia and Russia, almost
agreed to cut their oil production by an initial 10 million barrels a day in
response to the coronavirus-triggered collapse in demand. That “almost” is
important.
The drama was provided by Mexico refusing to accept its
allotted cut. The farce followed when the country’s oil minister left the
virtual OPEC+ meeting to hold separate talks with her U.S. and Canadian
counterparts, while the other energy ministers agonized for hours over how to
respond. The tedium? Well, that was just the bits in between.
Mexico was asked to cut 400,000 barrels a day of production
in the first phase of an OPEC+ deal that would run for an unprecedented two
years. It offered one-quarter of that, and from a slightly higher baseline than
what was asked for.
An unlikely white knight appeared to ride to the group’s
rescue on Friday in the form of U.S. President Donald Trump. He proposed an
arrangement with Mexico’s President Andres Manuel Lopez Obrador (known as AMLO)
in which 250,000 barrels a day of the “market-driven” decline in U.S. output
would be rebranded as “Mexican.” But don’t be fooled: This won’t take a single
additional barrel of oil off the market beyond those that would disappear
anyway because of the Covid-19-prompted collapse in demand. That’s why this is
still an “almost” deal, rather than a certain one: The Saudis and the Russians
still have to decide whether they will swallow Mexico’s lack of genuine commitment.
In fairness, the OPEC+ deal is grand in its scope, given the
size of the cuts and their duration. The 20 producers taking part will
initially cut output by 10 million barrels a day, or 23%, for two months — May
and June. That will then be tapered to 8 million barrels a day until the end of
the year, and then reduced to 6 million barrels for another 16 months, until
April 2022.
The deal raises some even bigger questions than Mexico.
Russia, for example, is to cut its output by 2.5 million barrels a day over the
next three weeks. Really? Igor Sechin, head of state-controlled oil company
Rosneft, was a fierce critic of Russia’s modest contribution to previous
reductions. I can imagine how he’ll react when he’s told his company has to cut
output by almost 1 million barrels a day by May 1.
The contribution from Friday’s meeting of G-20 energy
ministers — which followed Thursday’s marathon OPEC+ call — was, to put it
mildly, underwhelming. India’s minister mentioned filling the country’s
strategic oil reserve, but there were no concrete new offers from the group.
With oil prices on the floor, building up reserves makes
sense anyway, and China and India have already started. But storage space is
limited.
The U.S. has room for another 77 million barrels in its
Strategic Petroleum Reserve, but Congress refused last month to approve the
budget for an initial 30-million-barrel purchase. Oil traders and analysts
estimate that China could buy an extra 80 million to 100 million barrels this
year. Meanwhile, the Indian government is asking state-run refiners to buy 15
million barrels of crude from Saudi Arabia, the United Arab Emirates and Iraq
to fill its tanks. Beyond those three countries, there’s little storage
capacity elsewhere.
U.S. Energy Secretary Dan Brouillette told the G-20 meeting
that the oil market collapse will impose some 2 million barrels a day of
American output cuts by the end of the year without any government
intervention. Some predictive models, he added, see the drop as big as 3
million barrels. Russia previously rejected such “free market” cuts, arguing
that production falling in response to a lack of demand is not an output
reduction. But in the end it capitulated, along with the other OPEC+ countries.
There was no mention in the OPEC+ communique of the deal being dependent on the
actions of anyone else outside the group.
Inside the group, there’s still the Mexican problem to
solve. Russia’s similar refusal to make deeper cuts in March led to the
collapse of the last OPEC+ production deal and prompted the start of Saudi
Arabia’s retaliatory output surge. Will Mexico’s refusal do the same? As I
wrote this, the OPEC+ countries were still struggling to find a solution.
It seems they have three choices:
Pretend to believe the Trump-AMLO arrangement will deliver
real cuts, and press on as if nothing’s happened.
Wave goodbye to Mexico, which has never delivered meaningful
cuts anyway, and announce a 9.6 million-barrel-a-day cut.
Continue the output surge.
If they ratify some form of the agreement, this will be the
second time in less than five years that Saudi Arabia’s attempt to pursue a
pump-at-will policy has collapsed. After just one month, this one has lasted an
even shorter time than the previous effort, brought to an end by the OPEC+ deal
with Russia and other countries toward the end of 2016.
But these are quite clearly extraordinary times, with an
unprecedented demand collapse. Don’t be surprised if the war over market share
between the Saudis, the Russians and the Americans resumes once the lockdowns
ease and people want oil again. This is probably a temporary truce rather than
genuine peace between the three biggest producers.
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