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The unprecedented OPEC+ deal in April, which led to drastic output cuts, is now entering its most dangerous phase, with oil demand and prices recovering. At the time, President Donald Trump claimed credit for the breakthrough, even though the U.S., the world’s biggest oil producer, wasn’t part of the agreement. Now the American president could play a pivotal role in its fate, not by calling the leaders of Saudi Arabia and Russia, but by acting decisively — or failing to act — to contain a resurgence of the Covid-19 outbreak in the U.S.
A second surge in virus cases, mostly in Sun Belt states, could undermine the recovery in U.S. oil demand if people curtail travel and leisure or if lockdowns are reimposed. It could even hit supply, if the growing number of cases in Texas leads to renewed restrictions on oilfield activities.
Back in April, Trump’s masterstroke was to persuade the leaders of the world’s other two oil super-producers to slash output, while leaving his own industry free to respond to market forces. In effect, he persuaded Crown Prince Mohammed Bin Salman — the de facto leader of Saudi Arabia — and Russian President Vladimir Putin to create an oil-price environment in which the U.S. shale oil industry could at least survive, if not thrive, while avoiding any restrictions on U.S. production levels.
Of course, stopping the rout in oil prices served the interests of Saudi Arabia and Russia, too. The chart below shows just how badly Saudi Arabia was hit by the collapse in oil prices in April, which coincided with its record-breaking production surge.
The kingdom’s oil export revenues slumped to their lowest on record, despite the volume of crude leaving the country surging to its highest ever monthly total.
Initially, Trump’s market-driven output policy — read: plunging prices — delivered a big drop in U.S. production, one that during May was potentially much bigger even than the official weekly data suggested, as I wrote here. But that decline shows signs of tapering out.
Meanwhile members of the OPEC+ group of countries that agreed in April to slash production are facing even deeper restraint until at least the end of July. Countries that failed to implement in full the cuts they promised for May have been persuaded to pledge even deeper reductions in the coming months to make up for the shortfalls. They include Iraq, Nigeria, Angola and Kazakhstan, which collectively will deliver an additional 410,000 barrels a day of cuts in August and 660,000 in September, just when the rest of the group will start to ease their own reductions.
Maintaining full compliance with the agreed output cuts — which are starting to bring oil supply and demand into balance and set up a much-needed period of worldwide drawdown in inventories — will be made even harder if U.S. producers start to open the taps.
At a little below $40 a barrel for U.S. benchmark West Texas Intermediate crude, prices are not yet high enough to put drilling crews back to work digging new holes. They may be high enough to encourage some producers to frack wells that they have already drilled, but left uncompleted. They are almost certainly at a level where some will reactivate production that they shut in at the height of the crisis in April.
Weekly data from the U.S. Energy Information Administration don’t yet show U.S. production bottoming out. The big rebound in the number for the week ending June 20 reflected the return of Gulf of Mexico production shut in as a result of Tropical Storm Cristobal, not a pickup in onshore pumping.
But the EIA’s latest Drilling Productivity Report does show output from the Permian Basin, which accounts for more than two out of every five barrels produced in the U.S., leveling off in June and July at about 4.27 million barrels a day. What happens after that, and what it will mean for the balance between supply and demand, is still far from clear.
What’s happens next could hinge on the epidemic in the U.S. It could be that soaring infection rates across the southern states will discourage people from traveling for the holidays, just when it looked like gasoline use was beginning to pick up. A combination of weak demand and rising supply could put oil prices under pressure again and raise questions within OPEC+ as to why the group is propping up prices for the benefit of American oil companies. But if those same outbreaks get really bad, or contagion gets out of control and spreads, forcing state authorities in Texas and elsewhere to dramatically curtail economic activity again, they could send production rates tumbling anew alongside a second drop in demand. It’s a lot of uncertainty to handle in addition to the equally unclear response of the American oil sector.
Nobody said managing the oil market through this pandemic was going to be easy, but a deal that doesn’t include the world’s biggest producer makes it even harder.
