OPEC Confronts Covid-19
March 3, 2020Last December, just prior to the Organization of the Petroleum Exporting Countries (OPEC) ministerial, despite swirling controversy and market uncertainty, we (correctly) predicted that the alliance had no choice but to deepen and extend their supply cuts through the first quarter of 2020. As they convene again this week, a warmer winter, ample oil supply, growing stocks, and deteriorating demand projections precipitated by the spread of the coronavirus, also known as Covid-19, have conspired to force OPEC to begrudgingly undertake additional action. While the combination of economic stimulus (e.g., today’s decision by the Federal Reserve to cut interest rates by half a percentage point) and the market’s anticipation of further OPEC production cuts, ranging from 600,000 barrels per day (to over 1 million, have seemingly reversed recent sentiment and, at least temporarily, lifted prices, whatever action OPEC ultimately takes seems unlikely to produce the desired effect of rebalancing the market and substantially raising prices. Rather, the strategy today may be one of attempting to stem further bloodletting and hope demand recovery can be achieved later in the year.
In the past few weeks as the coronavirus has spread beyond China to greater Southeast Asia, parts of the Middle East and Europe, Latin America, and more recently to the United States, commodity prices have been in freefall. The threat of a global pandemic has panicked populations and caused governments to restrict travel, quarantine affected individuals, shut down schools and businesses, and prepare for worsening conditions. The epidemiology of the virus suggests further outbreaks are inevitable and changing protocols, diagnostics, and questionable case data are likely to extend the duration of the outbreak and the economic damage.
As a consequence of reduced air travel, lower economic activity, and refinery shutdowns (some for seasonal maintenance, others caused by the economics of reduced product demand and deteriorating margins), crude oil demand could be down several million barrels per day, while inventories are slated to grow—thereby delaying meaningful oil price improvement even after economies begin to recover.
In the past month alone, CiTi estimates that China’s refinery runs have declined by over 3.5 million barrels per day (mmb/d) since January. And while OPEC’s compliance with its January cuts have been exemplary, even with the additional losses from Libya, quarterly inventories are projected to grow. Recently, OPEC’s analytical committee recommended an additional reduction of some 600,000 barrels per day, a figure at which Russia reportedly balked. And while it is increasingly likely that Saudi Arabia will once again absorb the lion’s share of any additional cutbacks, given Saudi energy minister Abdulaziz’s previous warning that the country will not act alone, expect Russia to join in any collective decision even if their “contribution” will be modest and likely slow to materialize.
All that said, the prospect of more than an additional 1 million barrel per day cut will be distasteful for producers and still unlikely to do more than temporarily stem the bleeding. Those U.S. producers that hedged output at materially higher prices are likely to continue drilling activity (others will be challenged), undermining OPEC’s efforts in the months ahead. And while the current freeze agreement that has governed OPEC output for the past two-plus years is likely to be extended yet again (at least short term), additional challenges—both immediate and longer term—will continue to complicate the group’s analysis, planning, and strategy going forward. The stability and intended price levels sought by the group when the oil supply cuts were first proposed have largely failed to deliver on either of those objectives, though admittedly the cuts have kept prices above where they otherwise would have been. And then there is the ongoing challenge of when and how to reintroduce those previously cut volumes back into the market.
The persistence and spread of Covid-19 is only the most recent in a number of factors that have repeatedly conspired to undermine the OPEC strategy—although the significance and uncertainty surrounding the outbreak’s trajectory and ultimate impact remain unknown. And its impacts are felt far more personally than measurements of oil demand and global economic activity.
As OPEC convenes this week, member states will almost certainly attempt to retake control of the market, but in the face of unknowable uncertainties, they are equally likely to come up short no matter how ambitious an effort is forthcoming.
And as we continue to progress through the year, a number of critical questions remain, including the strength and timing of global economic growth and oil demand; the outcome of subsequent rounds of trade negotiations; the pace of growth of non-OPEC supplies; the evolving developments in Venezuela, Iran, Iraq, and Libya; the impact of changing demand on crude preferences and sourcing; fracking, flaring, and environmental regulations for U.S. wells; crude prices and finance availability for producers. Longer term, climate regulation and alternative fuels will undoubtedly impact oil markets.
But for this week, look for OPEC to amplify and extend its supply cut agreement, with the Saudis once again assuming additional obligations, if necessary, to preserve the pact. It simply has no other choice.
Frank Verrastro is a senior vice president and trustee fellow with the Energy and National Security Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Albert Helmig and Larry Goldstein are non-resident senior associates with the CSIS Energy and National Security Program.
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