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    Opec+ Eases Supply Cuts


The oil cartel says the step is possible thanks to a sufficient recovery in demand.

by: Joseph Murphy

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Opec+ Eases Supply Cuts

Oil producers in the Opec+ alliance agreed July 15 to taper supply cuts next month, as they were widely expected to do, releasing an extra 2mn b/d of crude back on to the market.

Benchmarks did not suffer as a result of Opec+'s decision, justifying the group's claim that demand has recovered sufficiently for cuts to be eased. From August 1 until the end of the year, Opec+ will keep 7.7mn b/d of supply offline, after withholding 9.7mn b/d in May through July. The reduction will fall to 5.8mn b/d between January 2021 and April 2022.

Brent is now trading at above $43/b, while West Texas Intermediate is at around $40.5, after falling to 20-year lows in April of under $20/b, at the height of coronavirus (Covid-19) lockdowns.

"As we move to the next phase of the agreement, the extra supply resulting from the scheduled easing of production cuts will be consumed as demand continues on its recovery path," Saudi energy minister Prince Abdulaziz bin Salman said in a video conference on July 15. "Economies around the world are opening up, although this is a cautious and gradual process. The recovery signs are unmistakeable."

Compliance with the cuts has improved significantly. Iraq, by far the worst offender, was only 100,000 b/d above its quota during June, compared with 600,000 b/d above in May. The country has also agreed a schedule of compensatory cuts in July through to September to make up for its past failings.

"The market is transitioning from a substantial oversupply in H1 2020 to a deficit in H2 2020," Fitch Ratings said in a research note this week. "Opec+ faces the challenge of balancing the need to achieve higher oil prices through production cuts by its participants and a risk of losing its market share to US shale, where the level of investment activity will continue to be closely correlated with prices."

The last Opec+ supply pact collapsed in March in part because of Russian producers' concerns about US shale drillers capitalising at their expense. As prices rise and more and more US shale wells return to profitability, though, influential voices that urged Moscow to leave the Opec+ negotiating table four months ago could make the same demands again.

It is clear that Russia does not want to hold back a single barrel more than it has to. Drawing from the practices of its US competitors, Moscow has plans to drill but not complete 3,000 wells, which will remain on standby for when supply cuts are eased further.

If Iraq and certain other Opec+ members renege on their promises, the whole deal could fall through. Starved of their expected revenues, many producers in the cartel are facing acute economic crises, which further down the line may make them unable or unwilling to maintain caps on production.

On the demand side, the big risk is a second coronavirus wave. The re-introduction of restrictions in certain countries and regions and a rapid rise in cases in some US states, bodes ill for the recovery.

Fitch sees oil prices averaging $35/b in 2020, recovering to $45/b in 2021 and $53/b in 2022, without taking into account the impact of a second wave. 

Global oil supply averaged 86.86mn b/d in June, down 2.39mn b/d from the level in May and marking a nine-year low, the International Energy Agency (IEA) said in its latest monthly report. Full-year production is expected to be 7.1mn b/d lower than in 2019. Demand, meanwhile, fell 16.4mn b/d year on year in the second quarter, and is expected to be 7.9mn b/d lower in the year as a whole, recovering by 5.3mn b/d in 2021.