Consensus estimates indicate that the full extent of the Covid-19 pandemic will wipe out at least 18.5 mmb/d of oil demand in 2020 alone. Some analysts have gone even further, suggesting that the number could go as high as 30 mmb/d. As supply reacts to demand, there is no doubt that producers must throttle back production to avoid a destructive oversupply that has already decimated crude oil prices. OPEC+’s new two-year supply deal promises to take 9.7 mmb/d off the market through June 2020, then declining gently. At its best, this will only account for half of the demand shortfall, leaving an excess of at least another 9 mmb/d. In the extraordinary OPEC+ and G20 meetings that surrounded the coordinated deal, it was stated that the free market producers – mainly the US, Canada, Brazil and Norway – would make up a further cut of 5 mmb/d through natural ‘market adjustments’. The question, then, is how?
For the OPEC nations, this is relatively easy. Most are oligarchies, controlled environments where difficult decisions can be implemented swiftly. In many cases, there is only a single firm controlling its vast oil wealth. Thus, Saudi Arabia, though it may have joint ventures with foreign firms, has full control over the entire Saudi crude oil production mechanism. The dictate to reduce production by 2.5 mmb/d is a (relatively) straight forward matter of recalibrating the Kingdom’s integrated production infrastructure. This applies to OPEC states as well, such as Kuwait, the UAE and Angola, where Kuwait Petroleum, ADNOC or Sonangol have tightly integrated crude production infrastructure where control of national output levels is centralised.
Even in countries within OPEC or OPEC+ where the industry is more competitive, this holds true. In Russia, Rosneft, Gazprom and Lukoil may all compete with each other, but they will not ignore an order from the Kremlin to reduce output proportionately in accordance to the supply deal. In OPEC countries such as Iran and Iraq, the small number of national producers makes collusion easier. This even applies in countries within OPEC+ where free market ideals hold more strongly. Petronas may not be able to dictate the output levels of PTTEP, Shell or ConocoPhillips’ Malaysian assets, but it owns enough control in key assets to influence the national output level. Ditto for Azerbaijan, Kazakhstan and Oman, even if the state oil firms there have extensive partnerships with supermajors such as BP, Chevron and Shell.
Adherence aside, it should be relatively easy for the OPEC+ club to meet their target of 9.7 mmb/d if the temptation to cheat doesn’t take hold. But what about the large free market producers? The pact between these countries and OPEC+ calls for the former to reduce production ‘naturally’ according to market pressure. That, again, is relatively easier for Norway and Brazil, where the reins of production are concentrated in the hands of Equinor and Petrobras. But what about the thorn in the oil industry’s side, the USA? There is no American state oil firm, and neither is there a federal body tasked to coordinate national output levels. It can happen on a state-level, like the Alberta state government in Canada or the Texas Railroad Commission – but players in these markets still cannot be compelled to follow through. The US oil industry is a matrix of many, many private players large, medium and small, each driven by a capitalist drive for profit, which is counter intuitive to controlling output.
So, in the absence of top-level control, each player in the US is left to their own devices to control their own output, in hope that each of its rivals will do the same to allow an optimal level of national output. A true expression of game theory. So what is going to happen?
Well, the first – and quickest – way to reduce output is to target onshore wells, particularly in the shale patch. This can happen voluntarily, or enforced through the growing number of bankruptcies. In North Dakota, where the shale revolution took root early, some 6200 wells have been shut, almost a third of all wells. Stopping wells temporarily is easy, but halting them forever is considerably tougher. So the question facing these producers is: which wells to shut, and for how long? For most, the target will be painted on newer wells, where the marginal cost to extract abundant oil is lower, essentially saving the crude for a better price. And running older, less productive wells, with the idea of closing those fully once the resources expire, rather than going through the expensive stop-and-restart process in newer wells. It is a strategy that supermajors ExxonMobil and Chevron have taken in the US shale patch, who announced that they would be slashing rigs in the prolific Permian Basin by 75% (to 15 sites) and 71% (to 5 sites) over 2020. Closures will be on the newer, more prolific wells – a testament to shale’s steep production drop-off curve and, as ExxonMobil put it, ‘better off deferring higher production rates into a period with better pricing.’ This strategy seems to be replicated across the American club of producers, from the giants to regional players such as Continental Resources. And once again, the American shale patch’s flexibility can run both ways, as easy as it is to close down an onshore shale rig (compared to a vast offshore rig), it is equally easy to restart them once market conditions change.
In April alone, estimates from the IEA show that the US, Canada and Brazil accounted for most of the month’s 2.2 mmb/d decline in production. That’s nearly half of what was requested of the free market oil producers. With the OPEC+ deal entering force in May and US oil prices in the doldrums, it would seem that there is enough political will and market pressure to enforce nearly 15 mmb/d of output cuts across the industry. That will go a long way to supporting prices in their current weak state. The hope is that this bitter pill won’t have to last long, and once demand improves and economies re-open, oil producers from across the spectrum will be able to return to business as usual. Or, at least, business as usual in the new normal.
In this time of COVID-19, we have had to relook at the way we approach workplace learning. We understand that businesses can’t afford to push the pause button on capability building, as employee safety comes in first and mistakes can be very costly. That’s why we have put together a series of Virtual Instructor Led Training or VILT to ensure that there is no disruption to your workplace learning and progression.
Find courses available for Virtual Instructor Led Training through latest video conferencing technology.
Something interesting to share?
Join NrgEdge and create your own NrgBuzz today
Source: U.S. Energy Information Administration, Short-Term Energy Outlook (STEO)
In its January 2020 Short-Term Energy Outlook (STEO), the U.S. Energy Information Administration (EIA) forecasts that annual U.S. crude oil production will average 11.1 million b/d in 2021, down 0.2 million b/d from 2020 as result of a decline in drilling activity related to low oil prices. A production decline in 2021 would mark the second consecutive year of production declines. Responses to the COVID-19 pandemic led to supply and demand disruptions. EIA expects crude oil production to increase in 2022 by 0.4 million b/d because of increased drilling as prices remain at or near $50 per barrel (b).
The United States set annual natural gas production records in 2018 and 2019, largely because of increased drilling in shale and tight oil formations. The increase in production led to higher volumes of natural gas in storage and a decrease in natural gas prices. In 2020, marketed natural gas production fell by 2% from 2019 levels amid responses to COVID-19. EIA estimates that annual U.S. marketed natural gas production will decline another 2% to average 95.9 billion cubic feet per day (Bcf/d) in 2021. The fall in production will reverse in 2022, when EIA estimates that natural gas production will rise by 2% to 97.6 Bcf/d.
Source: U.S. Energy Information Administration, Short-Term Energy Outlook (STEO)
EIA’s forecast for crude oil production is separated into three regions: the Lower 48 states excluding the Federal Gulf of Mexico (GOM) (81% of 2019 crude oil production), the GOM (15%), and Alaska (4%). EIA expects crude oil production in the U.S. Lower 48 states to decline through the first quarter of 2021 and then increase through the rest of the forecast period. As more new wells come online later in 2021, new well production will exceed the decline in legacy wells, driving the increase in overall crude oil production after the first quarter of 2021.
Associated natural gas production from oil-directed wells in the Permian Basin will fall because of lower West Texas Intermediate crude oil prices and reduced drilling activity in the first quarter of 2021. Natural gas production from dry regions such as Appalachia depends on the Henry Hub price. EIA forecasts the Henry Hub price will increase from $2.00 per million British thermal units (MMBtu) in 2020 to $3.01/MMBtu in 2021 and to $3.27/MMBtu in 2022, which will likely prompt an increase in Appalachia's natural gas production. However, natural gas production in Appalachia may be limited by pipeline constraints in 2021 if the Mountain Valley Pipeline (MVP) is delayed. The MVP is scheduled to enter service in late 2021, delivering natural gas from producing regions in northwestern West Virginia to southern Virginia. Natural gas takeaway capacity in the region is quickly filling up since the Atlantic Coast Pipeline was canceled in mid-2020.
Just when it seems that the drama of early December, when the nations of the OPEC+ club squabbled over how to implement and ease their collective supply quotas in 2021, would be repeated, a concession came from the most unlikely quarter of all. Saudi Arabia. OPEC’s swing producer and, especially in recent times, vocal judge, announced that it would voluntarily slash 1 million barrels per day of supply. The move took the oil markets by surprise, sending crude prices soaring but was also very unusual in that it was not even necessary at all.
After a day’s extension to the negotiations, the OPEC+ club had actually already agreed on the path forward for their supply deal through the remainder of Q1 2021. The nations of OPEC+ agreed to ease their overall supply quotas by 75,000 b/d in February and 120,000 b/d in March, bringing the total easing over three months to 695,000 b/d after the UAE spearheaded a revised increase of 500,000 b/d for January. The increases are actually very narrow ones; there were no adjustments for quotas for all OPEC+ members with the exception of Russia and Kazakshtan, who will be able to pump 195,000 additional barrels per day between them. That the increases for February and March were not higher or wider is a reflection of reality: despite Covid-19 vaccinations being rolled out globally, a new and more infectious variant of the coronavirus has started spreading across the world. In fact, there may even be at least of these mutations currently spreading, throwing into question the efficacy of vaccines and triggering new lockdowns. The original schedule of the April 2020 supply deal would have seen OPEC+ adding 2 million b/d of production from January 2021 onwards; the new tranches are far more measured and cognisant of the challenging market.
Then Saudi Arabia decides to shock the market by declaring that the Kingdom would slash an additional million barrels of crude supply above its current quota over February and March post-OPEC+ announcement. Which means that while countries such as Russia, the UAE and Nigeria are working to incrementally increase output, Saudi Arabia is actually subsidising those planned increases by making a massive additional voluntary cut. For a member that threw its weight around last year by unleashing taps to trigger a crude price war with Russia and has been emphasising the need for strict compliant by all members before allowing any collective increases to take place, this is uncharacteristic. Saudi Arabia may be OPEC’s swing producer, but it is certainly not that benevolent. Not least because it is expected to record a massive US$79 billion budget deficit for 2020 as low crude prices eat into the Kingdom’s finances.
So, why is Saudi Arabia doing this?
The last time the Saudis did this was in July 2020, when the severity of the Covid-19 pandemic was at devastating levels and crude prices needed some additional propping up. It succeeded. In January 2021, however, global crude prices are already at the US$50/b level and the market had already cheered the resolution of OPEC+’s positions for the next two months. There was no real urgent need to make voluntary cuts, especially since no other OPEC member would suit especially not the UAE with whom there has been a falling out.
The likeliest reason is leadership. Having failed to convince the rest of the OPEC+ gang to avoid any easing of quotas, Saudi Arabia could be wanting to prove its position by providing a measure of supply security at a time of major price sensitivity due to the Covid-19 resurgence. It will also provide some political ammunition for future negotiations when the group meets in March to decide plans for Q2 2021, turning this magnanimous move into an implicit threat. It could also be the case that Saudi Arabia is planning to pair its voluntary cut with field maintenance works, which would be a nice parallel to the usual refinery maintenance season in Asia where crude demand typically falls by 10-20% as units shut for routine inspections.
It could also be a projection of soft power. After isolating Qatar physically and economically since 2017 over accusations of terrorism support and proximity to Iran, four Middle Eastern states – Saudi Arabia, Bahrain, the UAE and Egypt – have agreed to restore and normalise ties with the peninsula. While acknowledging that a ‘trust deficit’ still remained, the accord avoids the awkward workarounds put in place to deal with the boycott and provides for road for cooperation ahead of a change on guard in the White House. Perhaps Qatar is even thinking of re-joining OPEC? As Saudi Arabia flexes its geopolitical muscle, it does need to pick its battles and re-assert its position. Showcasing political leadership as the world’s crude swing producer is as good a way of demonstrating that as any, even if it is planning to claim dues in the future.
It worked. It has successfully changed the market narrative from inter-OPEC+ squabbling to a more stabilised crude market. Saudi Arabia’s patience in prolonging this benevolent role is unknown, but for now, it has achieved what it wanted to achieve: return visibility to the Kingdom as the global oil leader, and having crude oil prices rise by nearly 10%.