VACCINE FOR OIL MARKET

The price war in the global oil market played a joke with all parties to the conflict. There is no winner in this battle of giants, although Saudi Arabia ultimately managed to pursuade Russia to return to the negotiating table and to conclude a new agreement on reducing oil production in the OPEC+ format. As expected, the agreements were concluded on much more stringent conditions and for a decent period. Unfortunately, the coronavirus pandemic and the ambitions of the world powers have prevailed over common sense. Therefore, the worst fears of market participants regarding the collapse of oil prices have become a brutal reality, and therefore the effect of the OPEC+ transaction can be expected only in a few months.

Reduction inevitable

COVID-19, which sharply reduced demand for oil, coupled with the controversial actions of several major oil producing countries to increase production, ultimately led to an oversupply of oil on the market and, as a result, provoked a record decline in prices for these raw materials. In particular, Saudi Arabia, Kuwait and the UAE significantly increased production in April due to the failure of the previous OPEC+ deal. As a result, market has an excess of oil - about 30 million bpd, and now it will take a lot of effort and time to get rid of it. At the same time, oil refineries are in no hurry to buy oil due to the lack of demand for gasoline and other petroleum products due to the coronavirus pandemic and restrictions imposed by the authorities of states around the world to curb its spread.

But as we say, nothing unites the people better than a disaster. In order to avoid collapse in the oil market, 23 oil-producing countries made a videoconference on Sunday, April 12 and agreed to collectively limit production. At the same time, a number of large manufacturers outside OPEC+, including the USA, Canada, Norway and Brazil, promised to show solidarity with the efforts of the cartel and voluntarily reduce production, without formally fixing their obligations.

Under the terms of the new deal, in May-June 2020, OPEC+ countries agreed to reduce oil production, excluding condensate, by 9.7 million bpd from July to the end of 2020 by 7.7 million bpd, then until May 2022 to 5.7 million bpd. For Russia and Saudi Arabia, the decline in May-June will be 11 million bpd.

The agreement is valid until April 30, 2022, but its extension will be considered during December 2021. The next OPEC+ meeting is scheduled for June 10 in a webinar format to determine further possible actions necessary to balance the market.

Russian Energy Minister Alexander Novak said that in addition to the participants in the OPEC+ deal, ten more countries announced their readiness to support efforts to balance the oil market.

“Thus, in total, during the first months of the agreement, the producing countries can reduce the daily oil production by about 15-20 million bpd. This will allow us to eliminate the consequences of a decrease caused by the coronavirus pandemic, stabilise global markets, avoid filling storage facilities and sharp volatility of oil quotas,” Novak said.

The Saudi Minister of Energy, Prince Abdul-Aziz bin Salman, said that together with other countries, OPEC+ non-member states, total reductions in May will reach 19.5 million bpd compared to April, of which to OPEC+ will have 12.5 million bpd. Another 7 million bpd is expected to be removed from the market by other producers - partly through a decrease in production and partly by the injection of oil into strategic storage facilities, which helps to increase demand.

US President Donald Trump called the agreement excellent for all three (Russia, the US and Saudi Arabia) and thanked Russian President Vladimir Putin and King of Saudi Arabia Salman bin Abdel Aziz al Saud.

It should be noted that the US played an exceptional role in the completion of the current OPEC+ deal, not only initiating negotiations between Russia and Saudi Arabia, but also taking on part of Mexico’s obligations, which turned out to be not ready for a large reduction in oil production and almost wrecked the whole deal.

Price anti-record

After the conclusion of the OPEC+ deal, oil prices began to gradually slide down. Just the day after the agreement was reached on April 13, the cost of the June Brent futures on the London ICE Futures exchange reached $31.99 per barrel.

On April 20, the price of May futures for WTI (West Texas Intermediate) fell to negative values. As a result of trading on the New York Trading Exchange (NYMEX), the price of WTI fell to minus $40.32 per barrel, as traders sought to sell these contracts before their expiration in the absence of free capacity for physical storage of oil.

World oil production is about 100 million bpd, while demand for it under present conditions, when 2/3 of the world's population is isolated, can drop to 70 million bpd.

The world's oil storage facilities are already 65% full, said Kayrros analyst Anthony Half. According to him, due to overproduction, 50 million barrels of oil are delivered to storage facilities weekly, and at this rate, all the free space will be exhausted in the world by June.

The volume of oil, which is located on tankers in the sea, has grown from March 1 by 76% - up to 153 million barrels, according to data from the analytical company Kpler. This corresponds to the volume of global oil production in 1.5 days.

Late decision

An analysis of the current situation in the oil market suggests that OPEC+ member states should have agreed to reduce production in April to make sure that the market does not get additional volumes of oil amid extremely low demand during the pandemic.

Apparently, they came to the same conclusion, since Kuwait, Algeria and Nigeria had already announced the start of production decline even before the OPEC+ deal became effective in order to reduce the current imbalance between supply and demand in the market.

In addition, some OPEC+ countries organised an informal video conference on April 22 to discuss "the current dramatic situation in the oil market." The meeting was attended by OPEC members Algeria, Nigeria, Venezuela, Iraq and Angola, as well as Kazakhstan and Azerbaijan, which are not members of the cartel. Participants discussed the issue of an immediate reduction in oil production, without waiting for May 1, but no specific agreements were reported.

International Energy Agency (IEA) also called on OPEC+ countries not only to start cutting production “as quickly as possible”, but also to consider the deepening of these reductions.

“We continue to see extraordinary shocks in the oil markets this ‘black April’ for industry. Reducing the supply of OPEC+ is a solid start [to balance the market], but not enough to immediately restore the market balance due to the scale of falling demand,” Fatih Birol, head of IEA, wrote on his Twitter page.

Thus, IEA has three proposals for OPEC+. First, those countries that have made recent decisions to reduce production should act as soon as possible and consider even deeper cuts. Secondly, the financial authorities of countries should consider taking measures to prevent fluctuations in market performance. Third, IEA offers countries with strategic oil reserves to help remove excess barrels from the market.

In general, many analysts consider the declining volumes declared by oil-producing countries to be inadequate in order to balance the market in the near future, since the gap between supply and demand remains too large. The fall in demand in May is estimated at 25-30 million bpd.

However, taking into account the problems associated with concluding the last OPEC+ transaction, it is difficult to believe that participants can agree to additional reductions in oil production, unless Riyadh voluntarily chooses to reduce production above the agreed volumes, following the example of previous transactions.

Azerbaijan in action

What is the role of Azerbaijan in the new deal? The country's active participation in stabilising the oil market is not surprising. With every new deal, the media is following with interest the quota of Azerbaijan. Under the terms of the new OPEC+ agreement, Azerbaijan agreed to reduce daily production from the level of October 2018 (718,000 bpd) by 23% in May-June 2020, by 18% in July-December 2020 and by 14% in January 2021 - May 2022.

Thus, during May-June, Azerbaijan will have to reduce oil production by 210,000 bpd. Given that the lion's share of oil production in the country is provided by the Azeri, Chirag and Guneshli (ACG) fields, we can safely assume that a certain part of the reduction will be fulfilled by the ACG consortium and the rest - by SOCAR.

International Monetary Fund expects that daily oil production in Azerbaijan in 2020 will be 0.67 million bpd, and in 2021 - 0.65 million bpd (against 0.71 million bpd in 2019).

For Azerbaijan, the oil price factor is significant. In the state budget for 2020, the oil price is set at $55 per barrel. According to the results of the first quarter, it is impossible to estimate the loss of Azerbaijan from low oil prices, since the average price of Azerbaijani oil was $59 per barrel. A clear picture will appear only in the second quarter. Nevertheless, President Ilham Aliyev, summing up the results of the socio-economic development of Azerbaijan in the first quarter of 2020, said that the volume of these losses could be up to $1 billion. “If the oil price does not rise to the desired level, we will have additional losses, which could be about $700 million, or maybe around $1 billion,” I. Aliyev said.

Fitch predicted that production and investment in the oil and gas sector in Azerbaijan is likely to decline with continued low oil prices. In addition, a sharp drop in oil prices will significantly reduce fiscal revenues from oil flowing into the State Oil Fund.

In a word, Azerbaijan’s participation in the OPEC+ deal was inevitable, because, according to local authorities, this is a unique format of cooperation, the decisions of which had a positive impact on the oil market and prices.

“I want to note that Azerbaijan has always played an active role within OPEC+. I also want to recall that it was me who suggested the idea of cooperation in OPEC+ format at a panel discussion of the World Economic Forum in Davos. Now it helps to reach agreement not only among the OPEC+ participants, but all oil-producing countries. I believe that this is a rare format of cooperation that imposes additional obligations on each of the countries, including Azerbaijan. Our oil production will be reduced this year as part of our commitment to this format of cooperation,” Aliyev said.

Projected growth

The majority of experts expect OPEC+ agreements to support oil prices in the medium term as quarantine measures are removed and demand recovers and expect an average return on prices of $45-55 per barrel in 2021.

“Although production cuts since May 1 are massive and unprecedented, they are likely to do little to prevent a sharp drop in prices in the coming weeks. Nevertheless, they should have a significant positive effect on the balance of supply and demand, as well as oil prices in the remainder of the year,” Citibank analysts say. The bank also increased its forecast for the price of Brent for 2021 from $38 per barrel to up to $56 per barrel.

Fitch predicts the average price of Brent crude oil in 2020 at $35 per barrel, in 2021 - $45 per barrel, in 2022 - $53 per barrel. Goldman Sachs forecasts that in 2021 the average price of Brent will be at $52.5 per barrel.

Apparently, the coronavirus pandemic caused serious damage to the global economy, the restoration of which will take years. Still, we hope that the main lesson learnt was ‘the power is solidarity!” Today, this quarantine slogan is more relevant than ever for the situation on the oil market.