Oksana Antonenko and Patrick Osgood, Senior Analyst
On 12 April, members of OPEC+ (leading OPEC and non-OPEC producers) agreed to an unprecedented cut in oil output – nearly 10m barrels per day (bpd) – in an effort to rescue unstable global oil markets from COVID-19’s assault on demand. The implementation of the deal will have a profound geopolitical impact, with many challenges along the way.
- The agreement will not bring a return to pre-pandemic price levels. Markets view the OPEC+ deal as inadequate and its long-term sustainability remains in doubt.
- The low levels of compliance seen with previous agreements are liable to be repeated. Russia, in particular, will likely try to side-step its commitments.
- The impact of cuts and the continuation of low prices will be uneven, disproportionally affecting already struggling oil-exporting countries.
- The deal offers a precarious opportunity for Saudi Arabia and Russia to improve relations with each other and with the US, but it must first survive the tough implementation period as countries continue to compete aggressively for market share.
Key challenges
The recent agreement wraps up a brief but turbulent period following the collapse of a 6 March OPEC+ agreement, which had been expected to last three years. In a move aimed at putting pressure on US shale producers, Russia sent oil markets into a tailspin, rejecting deeper production cuts proposed by Saudi Arabia as a bulwark against falling demand resulting from COVID-19. Price uncertainty, compliance challenges and an uneven impact will put the new agreement under pressure from the start.
Price uncertainty
The agreement will not bring the oil price close to pre-pandemic levels given the dearth of demand and glut of oil reserves. After a brief surge in the oil price following the deal’s announcement, markets have discounted the cuts as inadequate and prices have been pushed back down – to an 18-year low for US oil prices on 15 April. As the pandemic spreads and economic disruption and lockdowns increase, oil demand is likely to remain quiet through the third quarter of 2020 at least. Competition for market share will continue, with Saudi Arabia still poised to offer price discounts on its exports to Europe and Asia. Countries that traditionally sell oil at a premium rate – like Nigeria and Iraq – will struggle to maintain higher prices given the oversupply.
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Compliance challenges
Compliance with the 6 March OPEC+ agreement was uneven at best. This situation will likely be repeated in the new agreement, which requires countries to implement deeper production cuts while facing economic and health crises. Russia, especially, has a poor track record with compliance: it increased rather than cut its oil production during the last OPEC+ agreement period. The current deal requires Russia to make the deepest cuts among all oil producers by reducing its production from 11m bpd to 8.5 bpd in May and June. Some oil experts believe it is technically impossible for Russia to cut production to this level in such a short time period. Many of its old wells will likely have to be permanently closed while others will require significant servicing (at a cost) to re-open on any return to increased production. Thousands (possibly hundreds of thousands) of jobs will be on the line in its extractive and oil processing sectors.
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Russia is not the only country where compliance is uncertain. Smaller producers like Iraq, Nigeria and Mexico, which are more acutely sensitive to the ongoing economic disruption, will likely struggle to scale back production. Mexico used its veto power in the OPEC+ meeting to block the original agreement and managed to bargain down its quota. If demand and oil price do not significantly recover in the next two months – as is expected – some countries are likely to abandon the second phase of the agreement, threatening its sustainability. The US, which is not a formal signatory of the agreement, may decide to up its shale production if prices recover in the second half of the year, reviving Russian and Saudi fears about seeing their market share tumble.
Impact on the most vulnerable producers
The impact of the production cut agreement and a sustained low oil price will remain disproportionately greater for oil-exporting countries that were struggling to manage their economies even before the pandemic wreaked havoc on the global oil market. Some of the world’s most unstable countries – Iraq, Libya, Sudan, Syria and even Yemen – cannot significantly cut production without suffering major budgetary shortfalls and even greater domestic instability. In some countries like Venezuela, criminal and militant groups that run oil smuggling operations will be seeking out loopholes to expand sales. Countries like Nigeria and Angola will struggle to reduce production at a time when their international currency reserves are low. Algeria, Iraq and Ecuador may see new waves of social unrest as oil production cuts increase unemployment and further suppress real incomes.
Oil geopolitics: US-Saudi Arabia-Russia triangle
For Saudi Arabia and Russia, the deal offers an opportunity to improve relations with each other and with Washington. But sustained cooperation throughout the challenging implementation period is far from certain.
The very fact of the production cut agreement represents a geopolitical victory for US President Donald Trump, who actively promoted the deal and effectively pressured both Moscow and Riyadh to abandon their oil price war and return to the negotiating table. While Trump was held back from formally joining a cartel agreement due to US anti-monopoly restrictions, as well as from forcing the fragmented, privately owned US shale industry to accept formal production cuts, the US has nonetheless given the impression that it is shouldering some of the pain from market stabilisation measures. Yet the US may be forced to play a more prominent role as enforcer, tracking the agreement’s implementation and reapplying pressure, including more sanctions or threats of oil import tariffs if compliance is not taken seriously.
The agreement is also a marked achievement for Saudi Arabia. As the chair of this year’s G20, it will take credit for the G20 energy ministers’ agreement. Riyadh also succeeded in negotiating a good deal for itself by insisting its recently increased production levels should be considered the baseline when calculating its new production quota. This means cuts will remain modest when compared with pre-6 March levels.
For Russia, the deal is an uncharacteristic retreat: it refused to accept a cut of 1.5m bpd in March but agreed to cut 2.5m bpd in April, and while the March OPEC+ agreement gave it some wriggle room in enforcing the cuts, the current deal places Russian compliance under greater international scrutiny. Still, not all is lost. The April deal offers an opportunity to safeguard its market share in Europe, as well as to continue diplomatic efforts to improve relations with the US with the aim of securing sanctions relief. Russia’s active involvement as a power broker in the G20 energy dialogue also helps burnish its image as a global powerhouse.
The agreement is unlikely to help normalise Saudi-Russia relations, which have been badly shaken by the recent clash. More needs to be done to rebuild confidence on both sides. Saudi Arabia would have to abandon its attempts to win part of Russia’s market share by continuing to offer price discounts, particularly in Asia, which Russia cannot match due to its higher production costs. Failure to do so may prompt Russia to ignore its commitments. Saudi Arabia has the capacity to quickly increase production if Russia decides not to comply. In the medium term, however, Saudi Arabia remains more vulnerable than Russia to sustained oil prices below USD 70.