OPEC-Plus 10 mmbd production cut: Is it sufficient to revive oil prices?

A dilemma caused by OPEC strategic blunder at a wrong time plunged oil prices below $20/bbl, sending tsunami waves across the world. This strategy was formulated to harm US shale oil producers in particular. Notwithstanding, it hurt everyone not sparing anyone irrespective of major oil companies, shale oil producer and national oil companies. However, it causes more financial damage to OPEC members than others as more than 90% of their GDP is associated with oil-based revenues. Though the extent of economic fallout varies from country to country depending upon the cushion of sovereign funds. It may not be a big deal for Saudi because of huge sovereign funds but it severely affected other OPEC members and probably they are not on board to continue with this strategy.    

This strategy may have worked if there was political will, courage, and resources to hold oil prices to $20/bbl or below continuously well over 24 months. It may have helped to achieve their objective but not without harming and putting the whole oil industry permanently on the verge of collapse, including US shale oil. I believe it was wrong timing when the world is already suffering from the effects of COVID-19, but for OPEC this is the perfect timings to achieve their objectives.

A tiny virus that is hard to detect under powerful microscope had a havoc and did not spare any nation – forcing most of the countries to partial or be on a complete lock-down for months. The hardest hit has been in Europe and North America. Both the regions have the capacity to recover from the aftershocks but it may cause permanent damage to most of the developing countries. 

Fever testing facilities, insufficient infrastructure, hospitals, doctors, nurses, masks, protective gears and the required financial resources to deal with this havoc virus. Therefore, they are not sure about how bad it has affected their population and how bad the fallout of this pandemic on their economies is not fully known; it’s too early to tell. It may take longer time to recover from this dilemma. As we are aware most of the energy demand is associated with developing Asia a home of 60% global population, therefore, one could expect a weaker global oil demand at least a year or two or till these economies are fully recovered.

The surplus caused by over producing during the past few weeks than what is required may take many months to clear. No rocket science is required to assess this grim situation caused by COVID-19 and manmade crisis. Most of the countries are partially or in complete lock down and so are most of the industries. Aviation industry is nearing bankruptcies – only fewer flights are operating, only few vehicles are on the road – less oil is consumed. Knowing all these parameters still if one conjecture that global oil demand may have reduced by 10 mmbd is wrong assessment. Therefore, 10 mmbd cut in production is probably a few drops taken out of sea to clear the surplus. A surplus caused by over producing and weaker global oil demand. It means oil prices will remain very low for many months – maybe well into 2021 depending upon the speed of full recovery of global economy from the aftershocks of COVID particularly developing Asia. During the crisis, against global oil demand of 50-6 mmbd if you continue to produce 90 plus mmbd how you are going to clear the surplus! In order to absorb this surplus, it requires more than 10 mmbd production cut at least during the recovery period. If they continue to implement 10 mmbd production cut policy it means lower oil prices stretching over months, if not years. Eventually you are forced to shut down production due to brimming inventories and weaker global oil demand, therefore, think rationally and not wait for the worst possible scenario.

The other possible scenario which is unlikely is that if COVID hits the supply chain - oil production site including refineries and other petrochemical industries – partially halting production and refining operations or manmade crisis that could threatening supply. This may have a devastating impact on oil prices. Such news probably will instantaneously increase oil prices into thirties-forties and if problem persists over many weeks, it will eventually increase to over $50/bbl irrespective of surplus. The higher oil prices at this critical juncture may be good news for dying oil industry that is already on the ventilators but it would be nail in a coffin for developing countries. Higher oil prices probably push recovery period into years from the aftershocks of COVID-19.  If this happen US shale oil once again mushroom and absorbing considerable market share. This means OPEC once again at a square one position despite having gone through marathon unnecessary painful period!