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Abstract
There is no denying global oil demand is on the rebound, and unfortunately it may be slowed by a new round of lockdowns gripping the United States and Europe from a second wave of the global pandemic. Even though many countries in the OPEC+ group rely on oil revenues to support their national economies, RARE PETRO anticipates they will most likely continue overall production cuts instead of boosting output in January. Regardless of whether or not the current production cuts of 7.7 MMBPD are extended, any move by OPEC+ to keep cuts above 5.8 MMBPD beyond January should be received favorably by the market and may give oil prices additional upward momentum.
Key Points
- It seems likely OPEC+ is concerned with current supply returning too quickly, sending crude markets into another tailspin. U.S. supply is expected to fall by 600 MBPD in 2020 and 655 MBPD in 2021, while supply globally is projected to fall 1.3 MMBPD in 2020 and rise 0.2 MMBPD in 2021.
- Demand estimates for most groups have been revised down from previous 2020 figures. Estimated demand for 2020 ranges between 90 to 93 MMBPD, and demand growth for 2021 is only expected to be about 6 MMBPD over 2020 estimates. Prior to new lockdown measures in recent weeks, October’s demand was outpacing global supply by 4.1 MMBPD.
- OPEC+ has identified four possible scenarios for future production cuts into 2021. Two will reduce cuts by 1.9 MMBPD resulting in crude inventories rising by 125 to 470 million barrels above the 5-year average. The other two scenarios extend current production cuts by either 3 or 6 months resulting in crude supply remaining 21 to 73 million barrels above the 5-year average.
- Compliance by OPEC+ members has been relatively high in the last 5 months with the lowest compliance rate in a month at 94%. Iran, Libya, and Venezuela are all exempt from the current production cuts. Venezuela will likely not be bringing additional oil to the market, but Libya and Iran both have the potential to increase global production by an additional 1.25 MMBPD if they resume rates seen prior to 2020.
- Saudi Aramco had to raise $8 billion by selling U.S. backed bonds to meet their Q3 2020 dividend payment. If prices remain low in Q4 2020 and into 2021, they will need to find other ways to generate cash flow for the payments. RARE PETRO estimates that an average Brent oil price of $49.86 for the remainder of the year will be required to meet their Q4 2020 dividend obligation.
- Russia has commented as recently as October 2020 that they are interested in moving forward with the originally planned production cuts of 5.8 MMBPD in January 2021. Their attitude seems to have changed following the November 17th OPEC+ meeting when the group agreed extending the current cuts would likely be the most beneficial action.
- Based on the geopolitical and economic forces impacting the decision for the upcoming OPEC+ meeting on November 30th and December 1st, RARE PETRO predicts the current production cuts of 7.7 MMBPD will be extended past January. Any production cut extension higher than the currently planned 5.8 MMBPD will continue to be bullish for crude oil prices moving into 2021.
Introduction
Reduced economic activity related to the COVID-19 pandemic has caused changes in energy demand and supply patterns in 2020. It will continue to affect these patterns in the future as a second wave of lockdowns has arrived. As reported previously, back in April, members of the OPEC+ group came to the agreement to cut overall crude oil production by 9.7 MMBPD for May and June, and from July through the end of 2020 cut production by 7.7 MMBPD. Moving forward they plan to cut production by 5.8 MMBPD from January 2021 through the end of April 2022 [1]. Before production cuts were to be decreased in July, the group came together and determined it would be in their mutual best interests to continue output cuts of 9.7 MMBPD in July to bring more stability to the global oil and gas markets. With a nearly two million barrel per day jump in the group’s production just around the corner, many are again calling for an extension to the current level of production cuts. The OPEC+ group met on November 17th during a technical meeting that ended with widespread support for a three-month extension for the current level of oil production cuts [2]. Although global demand is returning worldwide, a second wave of lockdowns actually had other members favoring even more drastic measures, which included cutting deeper come January. While a plausible case can be made that a second wave of lockdowns may not completely derail the global oil industry as the first wave did, as investigated in Opinion Piece: Fearing The Second Wave, it will no doubt have an extended result on global demand returning to pre-pandemic levels. Even though many countries in the OPEC+ group rely on oil revenues to support their national economies, the group will most likely continue overall production cuts at 7.7 MMBPD instead of lowering to 5.8 MMBPD in January.
Current Supply
In order to understand why OPEC+ is considering extending output cuts, the global supply picture must be taken into consideration. According to analysts at the U.S. Energy Information Agency (EIA), global oil supply rose by 0.2 MMBPD month-over-month to 91.2 MMBPD in October [3]. While this is welcome news for producers around the world that rely on oil revenues to keep their countries afloat, the group also estimates that world oil supply in November may rise by over 1 MMBPD as the United States recovers from hurricanes and Libya continues to bounce back. This dramatic uptick is what the OPEC+ group is concerned with. If total production returns too quickly, it has the potential to rapidly disrupt the global oil industry and send markets into a tailspin. The EIA estimates that output from producers outside of OPEC+ is set to fall by 1.3 MMBPD in 2020 and rise by 0.2 MMBPD next year which includes U.S. supply falling by 600 MBPD in 2020 and by 655 MBPD in 2021 [3]. While the overall picture remains promising, the short-term production implications are what have members of the OPEC+ group on edge.
Current Demand
Similar to investigating the current level of supply, demand must also be considered to understand the balance between supply and demand of global petroleum. This is where things get interesting. Weak historical data and the resurgence of COVID-19 in Europe and the United States has led most major analytics firms to revise down their near-term global demand outlook. OPEC for example noted global oil demand is projected at 90 MMBPD this year, a drop of nearly 11 MMBPD for the year compared to their January projections, with expected growth of 6 MMBPD next year [4]. Similar to the predictions of OPEC, the International Energy Agency (IEA) predicts global oil demand will be 91.3 MMBPD in 2020, which is 8.8 MMBPD lower than in 2019 and below the average level for 2013 [5]. Furthermore in 2021, the IEA expects demand will recover by 5.8 MMBPD to 97.1 MMBPD, about 3 MMBPD below the pre-COVID level in 2019 [5]. Table 1 summarizes these projections for the major reporting groups.
While 2020 and 2021 averages paint bleak pictures, it is important to note that global petroleum stocks fell for three consecutive months in August, September, and October before again starting to report builds. The draws were mainly due to the fact that an average of 95.3 million barrels per day of petroleum and liquid fuels were consumed globally in October as estimated by the EIA [3]. This figure indicates the world was consuming 4.1 million barrels per day more than could be supplied before a second wave of lockdowns swept across the globe. Consumption is certainly trending in the right direction as October was up from both the Q3 2020 average of 94.1 MMBPD and the Q2 2020 average of 85.3 MMBPD [3]. While the EIA forecasts are highest at 92.9 MMBPD for 2020 and 98.8 MMBPD for 2021, it goes to show that it is nearly impossible to precisely estimate the future of global energy demand in an ever-changing world.
Four Scenarios
The OPEC+ ministerial monitoring committee held a technical meeting on November 17th to consider four scenarios of developments to the oil market in 2021. It included various options of crude production cuts, but the group did not come to a consensus on a path forward. The first two scenarios suggest the oil production cap agreement will be implemented as initially planned, meaning that starting January 1, 2021, OPEC+ nations will restore production by 1.9 MMBPD [6]. Under both scenarios, the drawdown in global crude oil stockpiles will continue, but the total will remain well above the five-year average. In the first scenario, the milder pandemic effect scenario, oil inventories would be projected 125 million barrels higher in 2021 than the five-year average [6]. For the second scenario, the more severe pandemic effect scenario, inventories would be projected 470 million barrels higher than the five-year average [6]. In both scenarios the market may face a glut upwards of 1.9 MMBPD at times leading to occasional builds. The last two scenarios involve extending the production cut agreement by three to six months causing crude drawdowns to be more significant. Scenario three estimates if the cuts are extended through March to the end of the first quarter, global inventories are expected to only end up being 73 million barrels higher than the five-year average at the end of 2021 [6]. In addition, the market will face a deficit of 0.9 MMBPD on average. In scenario four, if the cuts are extended through Q2 at the end of June, total supply will be just 21 million barrels higher than the five-year average which translates into a daily supply deficit of 1.4 MMBPD [6]. Discussions on all four scenarios are aimed at bringing oil stockpiles back to a five-year average in order to create support to an imbalanced market. Although no decisions have been made, most OPEC+ members agree that extending production cuts for at least three months seems like the most correct course of action.
Level of Compliance
Before diving into the logistics behind continuing on their April path or extending production cuts into the future, it is important to understand why OPEC+ believes the market is still out of balance. Even before that step, the group needs to decide whether or not all parties will commit to the agreement. While participants had nearly a month to prepare for the historic cuts, compliance in May was unsatisfactory for the leaders of the group, many of whom pledged additional cuts to support the global supply/demand imbalance. After a mere 85% compliance in May, the OPEC+ group has maintained near perfect compliance to their proposed cuts at 106%, 94%, 97%, and 99% from June through September respectively [7]. October compliance also remained impressively high at 96%. Compensation cuts by 13 producers that had previously violated their quota levels remained scant, putting pressure on the alliance to do more to prop up an oil market still reeling from the impact of the coronavirus. According to Reuters, Russia’s cumulative overproduction was seen at 531,000 bpd and Iraq’s at 610,000 bpd [8]. Even so, their combined six month overproduction at just over a million barrels does not seem to raise any red flags.
OPEC+ Exemption Production
With members of the OPEC+ group maintaining nearly perfect compliance for the last 5 months and demand appearing to steadily outpace supply, why does the group wish to extend cuts as demand slowly starts to return to the global stage? A huge reason to extend production cuts lies in the accelerated production from countries initially exempt from cuts. When OPEC+ first agreed to production cuts, three members were excluded from the deal. Due to strict U.S. sanction severely limiting their production, Iran was exempt from making any additional production cuts and the socio-political turmoil that has rocked both Libya and Venezuela in recent years granted them reprieve as well. Production in Libya was down nearly a million barrels at the start of the global pandemic as their production dropped from 1.186 MMBPD last November to 796,000 BPD in January 2020 before slipping to 82,000 BPD in June, according to OPEC’s Monthly Oil Market Report [9]. While still exempt from any production cuts, Libyan oil production has now reached 1.215 million barrels per day in mid-November [10]. Even more problematic, Libya demands to continue to be exempt from the production cuts until its production stabilizes around 1.7 MMBPD [10]. This reality has added nearly a million barrels per day into the global production mix at a time when OPEC+ is desperately trying to remove barrels from the market.
Unfortunately, Iran is reported to have exported 1.5 million barrels a day of its crude in September which amount to 68% of its pre-sanctions exports [11]. Yet, a U.S. Congressional report was boasting that U.S. sanctions have caused Iranian crude exports to decline to an estimated 227,000 BPD. While unconfirmed, combined with Libya these two OPEC members are creating a headache for the entire group as their total increased output nearly equals what other member groups are attempting to bring back onto the market in the next month. Luckily for the global production picture it does not look like the situation in Venezuela is getting any better, and there is little to no hope their production will return before the world recovers from the global pandemic.
Saudi Aramco Dividend Dilemma
The second major reason for a production cut extension has to do with one of the most powerful members of OPEC+, Saudi Arabia. On November 17th, Saudi Aramco raised $8 billion from the sale of U.S. dollar-denominated bonds to meet a dividend pledge to shareholders [12]. Earlier this month, the company posted a 45% fall in net income for the third quarter, generating free cash flow of only $12.4 billion, compared with the roughly $18.75 billion it requires every three months to meet its dividend pledge [12]. Aramco pledged last year to pay an annual $75 billion dividend to shareholders to lure them to an initial public offering and now, the financial position of the world’s largest oil producer has darkened as it contends with a fall in crude prices caused by the coronavirus pandemic.
By investigating Saudi Aramco’s Q3 production data, the media team at RARE PETRO has estimated the average Brent price needed to break-even on their dividend obligation. Table 2 shows if Saudi Aramco continues to produce an average 8.982 MMBPD during Q4, which would constitute a production cut extension, an average Brent price of $49.86 is required to cover their dividend payments. With Brent crude oil spot prices averaging $40 per barrel in October, down $1/bbl from the average in September, prices need to start climbing rapidly if Saudi is to make their dividend payments [5]. Unfortunately, the EIA expects high global oil inventory levels and surplus crude oil production capacity will limit upward pressure on oil prices. These assumptions mean Brent prices will remain near $40/bbl through the end of 2020. That being said, the EIA also expects that as global oil demand rises, forecasted inventory draws in 2021 will cause some upward oil price pressures which could raise the average above $47/bbl in 2021 [5]. Therefore, the only way for Brent prices to climb to levels where Saudi can make their dividend payments is to control global crude oil inventories by extending OPEC+ cuts.
Russian Comments on Production Cuts
Russia, who is not a member of OPEC, turned out to be one of the first countries in the world to come to the conclusion about the need for cooperation between oil-producing countries, and came up with an initiative to start negotiations with key oil producing countries. With their cooperation, the OPEC+ group has made historic production cuts in 2020. Through October Russia was committed to increasing their production to support their national economy. According to Russia’s Minister of Energy, Alexander Novak, “the fuel and energy sectors provide a comfortable existence for the world’s population and opportunities for the development of the world economy. Therefore, in the face of global challenges and a constantly changing world, it is extremely important to combine the efforts of countries to maintain a balance in this industry” [14]. Russia realized that international cooperation is the path to energy security of the planet, but remained optimistic that they would be able to gradually ease production cuts from January as planned, despite surging coronavirus cases in many countries. According to Novak, “despite the second wave of the pandemic in a number of countries, my colleagues and I continue to be optimistic and expect we can gradually raise production as per the agreement without harming the market” [14]. Unfortunately, the impact on energy demand relating to movement restrictions from a second wave of the COVID-19 pandemic is forcing them to reconsider. After the meeting on November 17th, it became clear Russia was leading the charge in an attempt to bring balance to the market. In a meeting release provided by OPEC, Russia and the 13-member OPEC+ group came to the consensus that extending production cuts would be the most beneficial action the group could take, regardless of the negative impacts the move would inevitably make on various national economies [1].
Conclusion
There is no denying global oil demand is on the rebound, and unfortunately it is going to be slowed by a new round of lockdowns gripping the United States and Europe during the second wave of the global pandemic. As discussed in our previous Opinion Piece: Fearing The Second Wave, it is unlikely these new government mandates will have as disastrous of an effect on the global oil and gas industry compared to the first wave. It will certainly slow progress towards balancing oversupply and reaching pre-pandemic levels of global petroleum consumption. This is precisely the reality OPEC+ is coming to terms with. They came together earlier this year to make historic cuts to bring balance to oil markets, and their actions certainly saved an industry on the brink of collapse. Now with national economies relying on much needed oil revenues, the group is struggling with the decision to continue limiting production. The problem lies in producers outside the group who are taking advantage of crude being pulled from the market and producing at will. Regardless of the fact that global demand is currently outpacing supply, this trend will not continue for much longer. With Libya and Iran producing unrestricted, U.S. production slowly ramping up, a second wave of lockdowns hampering demand growth, and Saudi Aramco falling short of revenue required in Q3 for its dividend; OPEC+ would not benefit from continued depressed prices. RARE PETRO expects OPEC+ to continue cutting 7.7 MMBPD instead of lowering the benchmark to 5.8 MMBPD in January. This prediction will be tested when a final decision is announced after their next meeting on November 30th and December 1st. No matter how many barrels of oil the production cut extension actually removes from the market; any move by OPEC+ to keep cuts above 5.8 MMBPD beyond January should be received favorably and may give some life to oil prices.
References
[1] https://www.opec.org/opec_web/en/press_room/5891.htm
[3] https://www.eia.gov/outlooks/steo/report/global_oil.php
[4] https://www.opec.org/opec_web/en/press_room/6229.htm
[5] https://www.iea.org/reports/oil-market-report-november-2020
[6] https://tass.com/economy/1224583
[12] https://www.wsj.com/articles/aramco-raises-8-billion-bond-to-fund-dividend-pledge-11605647854