Will the OPEC++ oil deal do any good?

If you are an oil and gas professional I want you to make a little mental exercise with me. Close your eyes, lean back and think very hard if you have ever seen such crazy times in your trade. Be honest and try really hard. Because you wont find any.

This definitely is the most “out-of-whack” state I have ever seen the oil business in. Even if I include my childhood I would not see anything that matches up.

But it’s not only me. Some days ago I spoke to a friend of mine who spent his entire life in oil & gas. He is retired now and he confirmed that he had seen madness, but nothing compared to what’s going on right now.

Yes, yes, there were a few surprises hitting us lately. I define as a surprise a development that could not have been reasonably foreseen. COVID-19 would qualify as such a surprise. Sure, we must always somehow be prepared for a new pathogen messing us up. But this is some general state of readiness. When it actually does kick you in the groin, it still comes as a surprise.

Yet, the demand shock resulting from COVID-19 is not the worst problem we have now.  Because as bad as the situation might eventually turn out to be, demand and the market will come back. Sooner or later. One way or another.

No, this hits us at a time when the world is enjoying the effects of the mother of all highs from financial stimulus money for 12 years now.  Thats the real calamity.

NIRP is stimulus money. Quantitative Easing is stimulus money. It’s all no better than the printing of money in the basement of the Central Bank. Thats how it was done in earlier times. Today, we have much more sophisticated mechanisms. And as we are better at cheating, the damage also becomes astronomical.

Did anyone think that the party would never end?

The core problem of what’s happening to us right now was building up over time and we had time to prepare. There were warning voices. That said, we seem to be pretty good at ignoring those that give us messages we don’t like very much.

Does anyone remember the fall of the oil price of early 2016? We had already gotten a taste of what was in the offing. And oil prices have been hanging on by their teeth ever since then. Because it is generally seen as action by OPEC+ that kept the oil price above 50 USD for most of the time since then. 

I don’t agree with that premise but let’s leave it as is for the moment.

What we know since then is that the energy fabric of the world has become tenuous. Consumption depended more and more on factors we could not reliably measure anymore. 

With lots of players trying to game the field. And some of them not for oil sake but to achieve other objectives. Like for example trying to convince the world that a miracle growth machine is still going strong.

The world economy showed cracks for a long time. At the same time, oil exporters have grown addicted to lots of cash for their wares. There was a time when a country like Saudi Arabia balanced its budget on USD 30.- oil. Thats old history today. 

Exporters of oil have gotten used to the idea that they have something magic inherent to themselves. They also believe that this stuff gives them the right to declare traditional economics dead. 

The rest of the world slogged on but everyone looked with envy to those oil exporters and, of course, to China. Those countries must be doing something right. Pretty much nobody saw them for what they are. Not entrepreneurs but clearance sellers of raw commodities or labor.

Take the commodity away and see what happens.

So, everyone laid it on and expected the world to grow forever when much of our growth has been virtual for quite a while. We should have shrunk to size in 2008 instead of throwing money at the problem. We should have cleaned up our economies. We should have left many companies go bust instead of keeping them alive with lots of fiat money. We should have reformed our economies, go the hard way and reinvigorate the entrepreneurial spirits. Instead, we have empowered managers and banks.

And now we need to hope that a club of oil producers saves the world. 

New iPhones are no renewal. Monster projects that can only survive on cash injections from the taxpayer are no renewal. They are value destruction schemes. I wanted to say money destruction but our money has been devalued by our relentless money printing anyhow. So whats to be destroyed anyhow?

We are in an age when in a couple both work full time and they can barely make ends meet. 

Enough ranting about the world economy. I needed to let off some steam.

How is that important for the current oil malaise? And where will things go over the next months, years or longer?

We have way too much oil in the system. Thats safe to say. And OPEC++ wants to take care of that situation – as they thought in the past that they can do. But their magic wands are broken.

Because I doubt their capability in doing so. Just look at what we have on our hands. Anyone talking about a cut of 10 MMbbl/d of capacity just 3 months ago would have had an appointment with a mental institution in short order. If OPEC+ would have declared such a thing and if the market would have taken it seriously, the price for a barrel would have skyrocketed. 

Maybe even 3 digits. It’s a huge volume. We need to assume that the cut would be real but even if there is rampant cheating, thats a lot.

No more.

The COVID-19 crisis has shaved off around 30 million bbl/d of demand – give or take. Thats a third of world demand or just a sliver more than OPEC’s entire production. Gargantuan.

Compare that to our 10 MMbbl/d OPEC++ has just decided to cut. Pathetic – ain’t it.

I always talk about OPEC++. That’s not a typo. OPEC+ is the old group of OPEC, Russia and some others but excluding developed nations such as Canada or Norway. OPEC++ includes those producers as well. But not all of them.

To make it a really effective group it would have to include all significant producers of oil. Yes, I am talking about producers and not only exporters. The 6th producer by volume is none other than China. China, of course, consumes all its production at home. 

That being said, they are a big producer and if all others cut back while China pumps oil at will they shoulder the cost of a crisis that was of Chinas making. If the world oil market faces an existential threat, everyone should be expected to chip in. 

Back to oil production. 30 minus 10 is still 20 MMbbl/d too much oil production. And this assumes that the deal holds up and nobody cheats. Which would be a premiere. OPEC nations are known for cheating on their quotas and when times are tough, the incentive to do so is just higher. If the 10MMbbl/d hold up, I still don’t expect that to be more than a 7-8 MMbbl/d cut in real life. At the very best.

But we need more than a 30 MMbbl/d cut to create a semblance of balance in the oil market.

And there is another problem on the horizon. Oil storage almost hits tanktops everwhere. Strategic reserves are very full and many commercial tank farms refuse to take new cargo. Tankers are full and parked on the water waiting for orders and even oil pipelines are full to the brim. 

This exceptional state of affairs needs to be cleared if the oil market is to meet some semblance of normality. This means cuts off even more than those 30 MMbbl/d to clear the storage tanks. Even if there was a real cut of 50 MMbbl/d until storage clears up, I don’t expect that to happen before Christmas.

The deal we got now is too little, too late. Saudi Arabia seems to have an inkling of what’s in the offing and wants to talk about further cuts at the next OPEC meeting in June. By that time, the body of OPEC should have started to rot as when there is no more place to put oil, natural cuts will come. 

So – time for the bad news. The oil market will blow up. There is nothing that can be done about it. Preventing it would need a level of international cooperation thats impossible get. It’s impossible for a very short term, let alone for the term required to re-balance the situation.

But demand will come back you say. Yes, it will. Just don’t expect it to come back to the levels we saw before COVID-19 that quick. The world has used the COVID-19 crisis to clear some fantasy numbers and get their populations to accept lower living standards.

It will take time to come back to where we were. Too much time for the old oil world to survive. Those next 12-18 months will see the outlines of a new oil world take shape. I don’t expect everyone to make it to the other side. And OPEC may well be among the corpses. 

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