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APRIL 13, 2020

Equity Research - OPEC and Resurrection

On Sunday afternoon OPEC+ announced a deal had finally been struck to bring the group back from the dead. The agreement officially calls for members to cut oil production by 9.7M barrels per day (b/d), but Gulf States led by Saudi Arabia suggest that through over-compliance the total volume removed could be as high as 12.5M b/d. This deal caps off what will likely go down as one of the most tumultuous two weeks in energy sector history. 

The oil markets have been plagued by a combination of a severe contraction in demand due to Covid-19 and a price war resulting in excess supply. On April 2, after speaking to leaders of Saudi Arabia and Russia, President Trump tweeted out “I expect & hope that they will be cutting back approximately 10 Million Barrels, and maybe substantially more.” Within minutes that one tweet drove Brent crude prices up over 40%. Extreme price volatility has been the hallmark of oil prices ever since. Last Thursday OPEC+ members held an emergency meeting with the goal of implementing a new round of production cuts designed to help offset the Covid-19-related drop in demand. Under the proposed terms each OPEC + member would cut oil production by ~23%. A final decision from OPEC was predicated on all members agreeing and G20 countries stepping up to help the cause. Initial indications were that G20 countries such as the United States, Brazil, Norway, United Kingdom, and Canada, would contribute an additional 5M b/d in cuts. Just when it looked like everyone was on board, Mexico spoiled the fiesta by refusing to take their allocated 400,000 b/d in production cuts and instead offering only 100,000 b/d. As a result, G20 energy ministers went into Friday’s emergency meeting without knowing if OPEC+ actually would consummate an agreement. The G20’s final statement called on members “to take all the necessary measures to ensure the balance of interest between producers and consumers, the security of our energy systems and the uninterrupted flow of energy”. Going into the holiday weekend oil markets were left with no final OPEC+ agreement and vague language from the G20. On a Saturday afternoon phone call, Saudi Arabian officials were berated for 2 ½ hours by a group of Republican Senators who threatened to end all military support for the Kingdom unless production was cut. Mexico, who has hedged all of its production for 2020 and received a promise from President Trump to pick up their “slack” stuck to their guns through the weekend. On Sunday afternoon the Saudis finally relented and consented to an OPEC+ agreement of 9.7M b/d (10M – 300k from Mexico) in production cuts. OPEC+ recognizes that oil traders have already priced 10M b/d of cuts into the market and are now trying to sweeten the pot by saying that actual cuts will be in excess of the stated amount. There is still no real clarity from the G20 countries as to the extent to which they intend to participate and how any such cuts will be measured. 

Brent prices traded higher on Sunday night, but considerable uncertainty remains. Any cuts to global production are certainly a positive, but in the whole scheme of things still fall short of offsetting a decline in global demand which may be as high as 35M b/d. Global oil storage is within months of filling up. If that happens, oil prices would crumble as excess production is unable to find end markets. Market forces would then force producers with higher costs and/or limited access to markets to shut in production as a means of balancing the market. The bull thesis would be that Covid-19 lockdowns soon run their course and oil demand quickly rebounds. Under this scenario, OPEC+ and G20 cuts would help to balance the market and a better day for surviving U.S. energy companies could be envisioned in 2021. In the end OPEC+ has been resurrected, but a great deal of uncertainty remains.  Until greater clarity emerges, investment in much of the energy sector should be viewed with caution.

This is part 2 of the 2-part series on oil prices 2

A tumultuous week for OPEC was followed by a weekend of chaos, leaving glo…

March 09, 2020 BMO Wealth Management - U.S.

On Sunday afternoon OPEC+ announced a deal had finally been struck to brin…

April 13, 2020 BMO Wealth Management - U.S.
Current Market News: Equity Research - OPEC + Resurrection
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