A historic OPEC+ deal to curb oil output faces many obstacles

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MORE THAN one month after the onset of a bitter price war, the world’s biggest oil producers came to a truce. On April 12th the Organisation of the Petroleum Exporting Countries (OPEC), led by Saudi Arabia, and its allies, led by Russia, said they would limit production by nearly 10m barrels a day from May through June, the largest cut ever. What is more, the countries said they would continue to restrain production, albeit less strictly, for two full years.

The historic scope of the deal is a testament to the severity of oil’s current crisis. Covid-19 has prompted an unprecedented plunge in oil demand, as workers stay home, planes are grounded and economic activity screeches to a halt. That has threatened oil companies the world over, including in America, which in 2018 became the biggest producer of crude. The new oil deal is a victory for President Donald Trump, who had pushed Saudi Arabia and Russia to support prices. “This will save hundreds of thousands of energy jobs in the United States,” he tweeted on April 12th. However any stability for oil producers will be fleeting, if it comes at all.

In the short term, the deal moves too slowly to make up for the sudden drop in oil demand. The OPEC+ agreement will take effect in May. Already, demand in April is expected to plunge by about 20m barrels a day. The deal could have a greater impact later this year. Supply would be constrained as demand starts to pick up, pushing prices higher. However two problems may arise.

First, demand may not pick up quickly. If countries see a resurgence in covid cases, economic activity and movement may halt once more. Even without a lockdown, an increase in working from home, a decrease in international travel and greater localisation of supply chains may suppress demand.

The second problem is that supply cuts may not materialise at the level set out by OPEC, not to mention the level hoped for by Mr Trump—the president on April 13th said that the agreement aspires to cut production by 20m barrels a day, not 10m. That depends on the compliance of an unwieldy cast, including members of the OPEC alliance and other oil-producing member countries of the G20. Historically, they have shown little appetite for adhering to strict limits on output.

Countries such as Russia, Iraq and Nigeria have regularly exceeded the quotas allowed by previous deals. America will curb production by about 2m barrels a day by the end of the year, expects the Department of Energy—but that is because companies will decide to do so for financial reasons, not because Mr Trump controls production. On April 14th the Texas Railroad Commission, the agency that regulates the state’s oil-and-gas industry, will meet to discuss curbs on output. However, many big oil companies resist such restrictions—the law allows for such a curb, but it would surely face litigation.

If oil remains cheap, then state-controlled companies outside America may chafe at production limits, which would be failing at their expressed purpose of raising prices. If prices rise, it seems possible that production in America will tick back up. That would undermine support for production limits within Russia and other members of the OPEC alliance, which would yet again find themselves ceding market share to American shale.

Non-compliance may in turn prompt the entire deal to unravel—in the past week Saudi Arabia almost scuttled the deal when one country, Mexico, balked at its terms. America’s ability to intervene is limited, despite Mr Trump’s assurances. The president said that America would help “pick up the slack” for Mexico, by reducing its own production further. But it is unclear how that additional cut will materialise, if at all.

Citigroup, a bank, reckons that prices could rise to the $60s or $70s in 2021, if OPEC and its partners adhere to the terms of its deal. Citi, however, thinks it more likely that production by the alliance’s members will pick up by the end of the year. The bank thinks the price of Brent crude, the international benchmark, will average $36 this year and $56 in 2021. That is certainly higher than current levels, but volatility will remain a hallmark.

Indeed it seems probable that oil suppliers will find themselves alternating between co-ordinating output and battling for market share. For a glimpse of the future, Mr Trump might be advised to look not at the OPEC deal but at official selling prices posted immediately after the deal by Saudi Aramco, the kingdom’s state-controlled oil giant. The company slashed prices for oil headed to Asia in May, according to S&P Global Platts, a price-reporting outfit, even as it let prices rise for other destinations. That suggests a keen interest in defending Saudi market share in Asia, the world’s main driver of oil demand. The global oil-price war is not over, but on hold.

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