OUTPUT CUT DEAL IS WAY TO STOP SLIDE IN OIL PRICE

The world’s biggest oil producers came together to stabilise markets in April.

Saudi’s King Salman bin Abdulaziz Al Saud, US president Donald Trump and Russian president Vladimir Putin carried out a joint phone call to review efforts by the Organisation of the Petroleum Exporting Countries (OPEC) and other producers, on the “importance of joint co-operation among the producing countries to maintain stability of the energy markets in order to support the growth of the global economy.”

At the meeting of OPEC and other producers, the parties agreed to curtail crude oil production by 10 million barrels per day (bpd), starting 1 May 2020, for a period of two months. From 1 July until the end of the year, members will cut by around 8 million bpd. From 1 January until the end of April 2022, members have committed to cutting production by 6 million bpd.

“The baseline for the calculation of the adjustments is the oil production of October 2018, except for the Kingdom of Saudi Arabia and The Russian Federation, both with the same baseline level of 11 million bpd,” the group said. “The agreement will be valid until 30 April 2022, however, the extension of this agreement will be reviewed during December 2021.”

The agreement aims to stem the slide in crude oil prices.

“The supply cut will give demand time to improve as quarantines in parts of Europe are partially lifted, but more importantly, it gives producers more time to prepare supply chains and activity plans, reduce costs and avoid an uncontrolled dismantling of parts of the industry,” according to Rystad Energy.

In late April, however, crude oil prices collapsed as traders fled May contracts for U.S. West Texas Intermediate amid rising inventories and muted demand outlook.

On April 20, which would likely go down as a historic day in crude oil markets, U.S. benchmark West Texas Intermediate plunged 306%, falling below zero for the first time in its history to settle at a discount of -$37.63 a barrel. At one point it was trading at -$40.32 a barrel. However, Brent crude – which is used by the rest of the world including Saudi Arabia as a benchmark -- settled at US$19.33 a barrel, down 24% on the day.

While the dramatic plunge speaks to the dislocation in markets, primarily due to technical reasons, it also highlights concerns about reduced oil demand as the pandemic persists. To get out of the predicament, oil exporters that struck the curtailment deal in April, will have to adhere to the agreed cuts.

While the producers have made major efforts to cut supply, global demand has been reduced amid a lockdown that has been in effect in much of Asia, Europe and North America.

The International Energy Agency (IEA) estimates that global oil demand will fall by a record 9.3 million bpd in 2020.

“The impact of containment measures in 187 countries and territories has been to bring mobility almost to a halt. Demand in April is estimated to be 29 million bpd lower than a year ago, down to a level last seen in 1995. For 2Q20, demand is expected to be 23.1 million bpd below year-ago levels. The recovery in 2H20 will be gradual; in December demand will still be down 2.7 million bpd y-o-y,” the IEA said in its latest report.

However, analysts hope that demand will recover robustly in the second half as lockdowns are lifted and industries and economies start roaring again. In China and South Korea, much of the coronavirus restrictions are lifted as authorities cautiously restart their economies.

Of course, low oil prices do not benefit either producers or consumers as it could lead to a disincentive in investment over the longer term.

The IEA forecasts global capital expenditure by exploration and production companies in 2020 is forecast to drop by about 32% versus 2019 to USD 335 billion, the lowest level in 13 years.

“This reduction of financial resources also undermines the ability of the oil industry to develop some of the technologies needed for clean energy transitions around the world,” the IEA says.

In March, Saudi Aramco announced strong 2019 results, reporting net income of USD 88.2 billion.

The company said that its free cash flow stood at around USD 78.3 billion, compared to USD 85.8 billion in the previous year, on the back of lower income, but offset by lower capital expenditures and favourable working capital movements.

“The balance sheet showed a gearing ratio of -0.2% at the end of 2019, demonstrating the company’s strong and prudent financial framework,” Aramco said.

Aramco’s capital expenditure was around USD 32.8 billion last year, but the company expects to spend between USD 25 billion and USD 30 billion in light of current market conditions and recent commodity price volatility.

“The recent COVID-19 outbreak and its rapid spread illustrate the importance of agility and adaptability in an ever-changing global landscape,” according to Saudi Aramco president and CEO Amin Nasser. “This is central to Saudi Aramco’s strategy and we will ensure that we maintain the strength of our operations and our finances. In fact, we have already taken steps to rationalise our planned 2020 capital spending.”