OPEC+ has tricky balancing act keeping $40/b oil price floor

OPEC+ will not want to undo the stability it has brought to crude prices. The oil exporting alliance must now find a way of increasing production while not flooding a fragile global market.  Whether it pulls it off could depend on the strength of demand from its key Asian customers.  

After having slashed output by 9.7 million b/d since May, OPEC and its partners in a coalition led by Saudi Arabia and Russia,  relaxed their cuts to 7.7 million b/d as of August 1 and through the end of the year.

But where will all this extra crude go? Asia is the primary target market for much of the alliance’s heavy sour crude and OPEC+ is optimistic that they will snap it up as their economies recover. Asian refineries tend to be more complex and sophisticated and therefore better equipped to handle more sulphurous Middle Eastern and Russian grades.

However, one of the alliance’s biggest buyers is India, which is seeing the coronavirus pandemic still take its toll. Provinces are implementing partial lockdowns to contain the spread, which could mean India’s oil demand showing a contraction for the first time in almost 20 years. S&P Global Platts Analytics sees oil demand falling 405,000 b/d this year.

Indian refiners may have no option but to cut run rates given the domestic crunch and poor export margins. According to India Oil Corp. Chairman Shrikant Madhav Vaidya, who oversees the country’s largest state-run refiner, the company’s run rate is expected to average 70 per cent-75 per cent in 2020. “We won’t get back to normal times in the near future,” he said.

While OPEC+ is hopeful that other Asian refiners will have a greater appetite for its crude, huge questions remain. 

Demand for jet fuel – the product hit worst by COVID-19 – remains grounded, while other transport fuels are also highly sensitive to changing demand patterns. As such, many refiners are reluctant to import more crude for fear of over-committing until the recovery is on much surer footing.

Much rests on the shoulders of China, which has been hoovering up a lot of Middle East crude to take advantage of low oil prices. China’s July oil imports fell from record highs hit in June, as huge stockpiles and low refining margins raise doubts over how long this aggressive buying will last.

Signs of waning Chinese crude oil demand and requirements for the third quarter have directly hit price differentials for various OPEC+ export crude grades, as well as the Platts benchmark Dubai price structure.

But the extra crude that OPEC+ will pump is unlikely to translate into the full 2 million b/d on the global market.

For starters, those countries that failed to meet their quotas since May – namely Iraq, Nigeria, Angola and Kazakhstan – are under intense diplomatic pressure to make up the difference in August and September.

Iraq has already pledged to cut output by an additional 400,000 b/d in the next two months to compensate for its overproduction. While there is scepticism Iraq will deliver given its history of flouting quotas, there is also hope that OPEC’s No. 2 producer will do enough to appease its colleagues.

Overall, the production cuts in August could look more like 8.5 million b/d than 7.7 million b/d if all the so-called compensation cuts are implemented across the board.

Then there is the claim that some of the extra crude produced by Saudi Arabia, Russia and others won’t find its way out to the global market but instead be used domestically. 

OPEC+ sees a scenario that, by the time the fourth quarter arrives, the global oil market is returning to some kind of normal. Certainly that’s the view of Saudi Aramco President and CEO Amin Nasser who said this week he sees oil demand recovering to 95 million b/d by the end of the year. 

Road fuels, with gasoline and diesel making up around 60% of oil demand pre-COVID-19, are the biggest drivers of the recovery. But jet fuel at just 8% will be the hardest portion to regain.

Platts Analytics sees Dated Brent struggling to remain above $40/b over the next couple of months as supply is on the rise, while demand growth faces a slowdown on a worsening COVID-19 scenario. There is also the question of how quickly the battered US shale industry will rebound and what that recovery will look like.

OPEC+ will not want to undo its good work in putting an oil price floor under the market at around $40/b over the past couple of months even though it will be keen to unwind from the deal. Indeed, it still has fresh memories of the impact of a collapse in its deal from March that culminated in record low prices in April.

The alliance will know that there is a still long way to go to clearing the glut of oil stocks kept both on land and at sea. And there is still a long way to go before Asian demand can be relied upon again. OPEC+ may have some tough calls to make to keep managing the market effectively in the months ahead.
London-based Paul Hickin is associate director at S&P Global Platts. Views are his own.