Outbreak, Oil Shock, and OPEC++

Updated: Apr 14, 2020


April 9, 2020

OPEC Outlines Tentative Production Cut Agreement

At an “emergency virtual meeting” OPEC+ outlined an unprecedented agreement for production cuts of 23% or 11 MBPD, but many analysts are suggesting it could fall through if other OECD nations don’t agree to cuts as well (the newly termed OPEC++).

Ultimately we need more clarity on this “outline of an agreement” and many are suggesting this could be clarified during tomorrow's G20 energy meeting as to whether or not the OPEC+ reduction would require US production cuts as well. The tentative agreement would be the largest ever oil output cut agreed on by OPEC+.

According to Financial Times, Russia is saying that it will not agree to a cut unless the U.S. agrees to mandated cuts beyond natural declines in production. Senior Energy Expert, Ellen Wald says "the US is extremely unlikely to do this, because a mandated cut is impractical in the US, violates free market principals and would most likely be challenged in court by oil companies. Russia is setting the U.S. up as the scapegoat for a failed agreement, laying blame on the U.S. because the U.S. won’t do something that it can’t do."

"The US can reduce production but it’s going to have to be done indirectly and voluntarily and we’ve seen that in some of the announcements made by Exxon and Continental Resources who is planning to cut their production about 30% in the short term." said Dan Eberhart, CEO of Canary.

There are about 9,000 Independent US Producers.

In a free market, we must recognize how game theory applies to US oil & gas producers. Due to various acreage positions, mineral lease obligations, debt repayment covenants, depletion, and future development potential, it’s impossible for industry-wide curtailing to happen with full accordance. Just ask OPEC+ how that's worked out for them.

With an estimated reduction of 20-30 MBPD in oil demand as a result of the COVID-19 outbreak, even if the 11 MBPD cuts are exercised, it would not be enough to stabilize Crude markets.

Crude Oil Storage Tank Farm in Cushing, OK

Buy Low, Sell High

“The US may be out of storage in the next 4-6 weeks, and several midstream companies have sent letters to producers asking them to slow or stop production, which is completely unprecedented because it goes against the pipeline companies own interest.” Said Eberhart In my view, this would only happen if storage is near full and prices are expected to fall further, where midstream players expect to buy the remainder of their storage at less than current prices, otherwise fork out extra cash for premium storage, FPSO's or face negative differentials where sellers must pay a premium to sell the product. Rig count is down 118 rigs, or 15% in the past two weeks and I expect it to fall another 100-125 in the next month. Typically in low price environments, operators cut rigs, and allow for wells to naturally decline. But, with today’s unprecedented supply glut, additional measures are necessary such as curtailing or shut-in of the most uneconomical producing wells. The DOE projects that US production will start falling significantly, dropping to roughly 11 MBPD by EOY and staying there in 2021 (roughly 1.8 MBPD below levels at EOY 2019). As Saudi and Russia continue their economic dumping, Harold Hamm says tariffs on crude imports are not a solution. Free markets should ultimately lead to a more efficient market and higher prices when the demand shock abates as people go back to driving and flying.

"At the end of the day, we can thank American ingenuity for unlocking affordable and efficient shale energy that has revolutionized global markets, reducing dependence on foreign oil and increasing national security. I'm confident we'll keep innovating as we've always done."

- Jon Clark, Petroleum Engineer

This Week's Oil Price Action

On 4/2, oil jumped 25% after Trump tweeted expecting a 10 MBPD production cut, finding sellers at $28.12 - $29.15. A week later, on 4/9, OPEC announces tentative production cut, and oil drops 17% after facing sellers entering the same area of supply with a HOD (high-of-day) of $28.36.

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US Rig Count

Since early March, US upstream operators have been announcing immediate or upcoming cuts to their rig counts. The number of rigs being released has materialized in a significant way, with the US count down more than 200 rigs in the last month, or 26%, as of April 8. In the last year, the active rig count has fallen by 42%. WTI front-month prices settled at $25.09/bbl on April 8, up 24% in the last week, but down 25% in the last month and down 59% YOY. On April 9, OPEC+ agreed to cut 10 MMbo/d in production in May and June, a move aimed at raising prices amid the coronavirus pandemic. Saudi Arabia will reduce its current 12 MMbo/d output by 3.3 MMbo/d, and Russia will trim 2 MMbo/d off its 10.4 MMbo/d production. Beyond June, the consortium will keep 6 MMbo/d off the market until April 2022.

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