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Bloated: OPEC’s latest move is not a cure for the global oil glut

That agreement helped stabilise the price, pushing it up above $US30 a barrel by mid-May. That was still a long way short of the price at the start of the year, when oil was trading at just under $US70 a barrel.


Coming into the weekend’s virtual meeting of OPEC+ members the cartel faced two issues. One is that, despite the production cuts, the heavily-reduced demand as a result of the pandemic has resulted in a massive increase in oil inventories, with global storage capacity stressed.

That surge in oil stocks was one of the factors in the meltdown in the May futures market that saw the oil price, bizarrely, fall to minus $US37.63 a barrel. This year has seen close to a billion barrels of oil added to global inventories.

Beyond that overhang of stocks, the Saudis, to compensate for some producers that had failed to live up to their April commitments, had made additional cuts of their own. That non-compliance is not unusual – “cheating” on their OPEC agreements is the norm for some producers.

Iraq, Nigeria, Angola and Kazakhstan were the major miscreants, so much of the focus of the weekend “meeting” was to gain commitments from them to not only make good on their renewed promises but to cut even more deeply to make up for their previous failures to deliver as big an output reduction as they had agreed to.

By maintaining the existing production cuts OPEC is hopeful that, with demand starting to pick up – particularly from China – as large parts of the developed world start to reopen their economies, supply and demand will come into balance.

The bloated inventories will weigh on the price until well into next year, if not longer

Second waves of the pandemic as social and business activity picks up would be the obvious threat but there’s also another factor beyond OPEC’s control.

When the co-operation between the Saudis and Russians, which had been in place since about 2016, fell apart earlier this year, part of the Russian explanation for not wanting to cut output further was that the beneficiary of production cuts was the US shale oil sector.

The Saudi response to the breakdown of the talks with Russia was to flood the market with oil to drive the price down (which was only too effective) and drive US volumes from the market.

The US sector is experiencing some distress. A large part of the funding for US onshore oil and gas companies comes from the junk bond market and the combination of the slump in oil and gas prices and the impact of the coronavirus on the risk appetite of investors in riskier, highly-leveraged assets has destabilised the sector.

Global oil storage facilities are near capacity after a massive increase in oil stocks.

Global oil storage facilities are near capacity after a massive increase in oil stocks.

One of the hallmarks of the US producers is their flexibility. They respond very quickly to price signals. When the price plummeted there was a near-immediate response, with production of up to about 2 million barrels a day shut in.

Now that the price has stabilised at levels that enables some producers to be, if not profitable then at least cashflow-positive, there is an expectation that most of that output will come back into the market over the next couple of months.

The effectiveness of the OPEC+ efforts to bring supply into balance with demand may also be threatened by a ceasefire in Libya’s civil war, which could bring hundreds of thousands of barrels per day of production back into the market. The civil war had reduced Libya’s out by more than a million barrels a day.

If OPEC is to regain some semblance of control over the market the cuts will probably have to remain in place beyond July; those producers that fell short on their commitments previously will have to deliver on their promise to compensate for the shortfalls over the next three months; the recovery in US production will need to be relatively weak and the post-pandemic economic recovery will need to be relatively strong.

To start to make inroads into the vast inventory levels – the world’s storage capacity was essentially fully utilised as supply overwhelmed the rapidly-shrinking demand as the coronavirus spread earlier this year – supply is going to have to be kept below the recovering demand for quite some time.

How much of the oil in storage overhangs the market isn’t clear, given that some of the excess inventories have been added the national strategic reserves of the US, China, India and others and therefore may not come back into the market.


Nevertheless, it is probable that the production constraints will remain in place well beyond the current agreement, which will be reviewed beyond July.

The bloated inventories will weigh on the price until well into next year, if not longer, and an oil price that has traditionally provided a signal of the health of the global economy will remain muted and distorted until those inventories start to shrink and will continue to export distress into the already-destabilised oil and gas sectors.

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