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Crude Oil: A historic Easter deal ends the price war, not the supply glut 

2020 average Brent prices forecast: 45 USD

14 APRIL 2020 – RUBEN NIZARD – Coface Brief

What

On Sunday 12 April, the Organization of Petroleum Exporting Countries (OPEC) and its allies (including Russia) approved a deal to cut oil output by 9.7 million barrels per day (b/d) or around 10% of global output – the largest cut in history – to try mitigate demand destruction amid the  COVID-19 pandemic. A month after the OPEC+ alliance collapsed[1], this signals the end of an oil price war between Russia and Saudi Arabia (the world’s second and third largest crude producers), which contributed to a more than 60% fall of oil prices since the beginning of the year. Despite this announcement, doubts have rapidly emerged on the ability of this deal to offset the unprecedented demand shock generated by the pandemic. As details of the deal suggest that the actual cuts are likely to be lower than the headline figure, optimism is growing even more cautiously. Even though this agreement is unlikely to erase a massive supply glut in 2020, it is likely to create a temporary floor for crude oil prices. In this context, Coface confirms it forecast for Brent prices (the international benchmark) to average 45 USD in 2020.  Why

  • A short but devastating oil-price war

On March 6, while the World Health Organisation had not yet announced the COVID-19 outbreak as a pandemic, the OPEC+ deal collapsed after Russia refused to deepen existing output cuts beyond Q1 2020. Saudi Arabia retaliated by starting an oil price war, which sent oil prices into a tailspin. Brent crude futures fell as low as 21.7 USD on March 30, the lowest level in 18 years. Even though it lasted only one month, the impact of the oil price war and of the COVID-19 pandemic is already devastating. The collapse threatens debt sustainability in oil-producing countries, while US shale producers have started aggressive cuts in spending. The weekly rig count in the US, the world’s leading oil producer, is already recording its steepest drop since 2015, suggesting future output losses. With the oil industry at risk, the US administration and president Donald Trump have stepped up their diplomatic push to bring Saudi Arabia and Russia back to the negotiating table. After a tentative 10 million b/d agreement was reached on Thursday 9 April in a virtual OPEC+ meeting, and endorsed by the G20 on the next day, the deal was eventually sealed on Sunday, as Mexico’s resistance to the allocated cuts was jeopardizing the broader pact.

  • 2020 oil pact: the devil is in the details

The headline cut has been reduced to 9.7 million b/d. Still, this level is over twice the 4.2 million b/d cut enacted in 2008 in response to the Great Recession. The cut will start on May 1 and will extend through to the end of June. Reductions will then be decreased to 7.7 million b/d from July to the end of 2020 and to 5.8 million b/d from January 2021 to April 2022. The group is expected to meet on June 10 to determine if further actions are needed. The baseline for calculation of the adjustments is the oil production of October 2018, except for Russia and Saudi Arabia both with a baseline level of 11 million b/d. This suggests higher baselines than current production level, meaning that the delivered cuts will probably amount to less than 7 million b/d. The US, Canada and Brazil will contribute an additional 3.7 million b/d in cuts and other G20 members by

1.3 million b/d. However, these additional cuts are not formal and could be market-driven rather than mandated. A 250,000 cut from the US to support Mexico’s OPEC+ commitment is the firmest pledge yet from the G20.

However, it remains unclear how these cuts would be enacted, since the White House does not dictate production levels of private oil companies and because US antitrust laws would be violated. For all these reasons, the announced cuts should be welcomed by a healthy dose of skepticism.

  • Too little, too late?

Despite their ‘historic’ nature, these cuts instill legitimate doubts on the oil producers’ ability to rebalance the market and support prices lastingly at a more comfortable level for them. With global demand expected to fall as much as by a third in April, the agreed cuts seem unlikely to prevent a buildup in inventories (see chart). With industrial activity coming to a standstill and a dramatic fall in travels, oil consumption is already expected to shrink for the first time since 2009 and the global financial crisis. For 2020 as a whole, the International Energy Agency was already forecasting last month a 90,000 b/d drop in oil demand. The forecast is likely to be adjusted downward this month. Hence, oil market analysts continue to fear that the world could run out of crude storage capacity.

Risks

While the prospect of a deal has helped to propel Brent futures above 30 USD, the bleak demand outlook does not prompt us to review our 45 USD average forecast for 2020 at this stage. After averaging 51 USD in Q1 2020, Coface still expects oil prices to bottom out in Q2 2020, before gradually rising in the second half of the year as activity and, with it, the thirst for black gold, pick up again. Risks to this forecast continue to be tilted to the downside for two main reasons: (1) the recovery in oil demand remains uncertain; and (2) with these unprecedented cuts, risks of noncompliance by OPEC+ producers are probably higher than ever. This latest development does not change our view that the vast majority of oilexporting countries will suffer from these lower price levels: Angola, Algeria and Nigeria in Africa; Iraq, Kuwait, Oman or Bahrain in the Middle East; Azerbaijan and Kazakhstan in Central Asia. We also continue to believe that the oil downturn will translate into more frequent and bigger bankruptcies in the US energy industry in 2020, as demonstrated by the Chapter 11 bankruptcy filing of Whiting Petroleum two weeks ago. The sector is expected to be one of the main drivers of the 39% increase in business insolvencies that Coface forecasts for the US in 2020.

[1] See Coface Brief: “Oil: COVID-19 prompts OPEC+ pact to fall apart”, March 9, 2020

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