Here’s the good news: Russia and Saudi Arabia — groaning under the weight of their flood-the-market petroleum war, right at a time when demand for oil has plunged more swiftly and more deeply than at any point in history because of the COVID-19 economic shutdown — have agreed to end their feud and lower their daily output of crude by slashing production by a record 9.7 million barrels per day. The expectation is that per-barrel prices will be driven higher and give some relief to struggling U.S. oil producers.
The bad news: History tells us there is an excruciating temptation to cheat on these OPEC deals, and the April 12 agreement calls for the parties to exercise forbearance for a full two years. A lot can happen in two years.
There are other reasons for fossil fuel investors to curb their enthusiasm. The Economist, which closely follows the global oil industry, observed that “President Donald Trump … argued for the pact and said the industry would recover ‘far faster’ than expected. But the grand bargain is unlikely to work. For a start the sums don’t add up. Global demand may fall by 29 million barrels a day this month, three times the OPEC deal’s promised cuts. Private firms outside the alliance may reduce output, too, but by how much is uncertain. And no one knows when demand will pick up. Oil stockpiles are rising and storage capacity could be exhausted within weeks.”
The prospects for success are made even more precarious because Russia, the world’s second-largest oil producer, has a nasty habit of ignoring the terms of the oil deals it strikes.
The Economist adds this additional complication: “The new pact involves assurances that output will fall in America but Texan frackers respond to price signals and the profit motive, not government quotas. The deal almost fell apart when Mexico refused Saudi Arabia’s terms, illustrating how one country can prompt an unraveling. And Saudi Arabia continues to offer deep discounts on crude bound for Asia, a sign of its eagerness to defend its powerful position in oil’s most important market.”
Yet another reason to be skeptical of the Saudi-Russia compact is COVID-19, which has already significantly stifled demand for oil, and it could become a long-term problem if there’s a resurgence of the pandemic’s spread, or even if shoppers, diners and office workers are slow to come back to traditional activity levels.
The oil business has gotten complicated.
Mike Consol (m.consol@irei.com) is editor of Real Assets Adviser. Follow him on Twitter @mikeconsol to read his latest postings.