Will OPEC's biggest production cut in history be enough?

Trump calls for oil production cuts ‘very positive initiative’ for industry longer-term: Trafigura CEO

Trafigura CEO Jeremy Weir provides insight into the ongoing oil price war between the Saudi Arabia and Russia and his outlook for OPEC’s virtual meeting.

Oil prices are bouncing back from the depths of despair as it appears the oil production warring factions, Saudi Arabia and Russia, under severe geopolitical and oil price pressure, are going to set aside their differences and move to a production cut, rescuing the battered energy industry.

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Ticker Security Last Change Change %
USO UNITED STATES OIL FUND L.P. 5.30 -0.07 -1.30%

The size of the cut has yet to be determined, but the market is rising on expectations.

OIL SPIKES AS MARKET PREPS FOR MASSIVE PRODUCTION CUT

Ticker Security Last Change Change %
XLE ENERGY SELECT SECTOR SPDR ETF 35.04 +0.82 +2.40%

It is looking more likely that OPEC and its coconspirator Russia will embark on the most significant oil production cut in history. Reports suggest that OPEC Plus – that includes non-OPEC Russia – will cut anywhere from 10 million to 15 million barrels of oil production a day. Russia reportedly is on board to cut output by 2 million barrels, easing concerns that they were not going to join cuts.

Algeria's oil minister is saying that OPEC will decrease by 10 million barrels a day and Kuwait's oil minster is suggesting the cut could go as high as 15 million barrels a day.

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Yet despite a potential production cut that would exceed 10 percent of the global output, many feel that the effort, while no doubt impressive, will be too little too late in a world where estimated demand destruction is almost 20 million barrels a day. While that may be true in the strictest sense, it underestimates the power of the market and its ability to react to market shocks.

The shutting down of the global economy due to the coronavirus has hit energy demand, unlike anything the world has ever seen.  If you take the numbers on face value, one would suggest that the global oil market, even with a massive oil production cut, would still be oversupplied.

If the production reduction is 10 million barrels a day, the world would still be producing more oil than it consumes considering demand destruction is 20 million barrels a day. Based on that model, global oil storage might be filled by the end of May.

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If global storage did run out, then oil prices would most likely collapse to record-low rates. Those low prices could cause the global economy severe pain as it would bankrupt many oil companies and reduce future output, laying the groundwork for a coming price spike that could further extend the economic pain caused by the coronavirus.

Yet that is assuming production and demand numbers remain stagnant. The reality is that powerful market forces are already at work that should ally some of those worst-case scenarios.

The energy industry in the U.S. and around the globe have already reacted to the severe price collapse and, even without a fancy meeting, have already made significant progress in cutting back oil output. It is estimated the U.S. oil production may already be ready to drop by over 2 million barrels of production a day.

In the last two weeks, we have seen a historic drop in U.S. oil rigs, an indicator of future oil production. In the previous two weeks, oil rigs fell by 102 rigs. Baker Hughes, the company that tracks oil and gas rigs, reported that the total oil and gas count came in 361 platforms below the level they were at a year ago, leaving the fewest number of active rigs since January 2017.

Ticker Security Last Change Change %
XOM EXXON MOBIL CORPORATION 45.17 +1.32 +3.01%
CLR CONTINENTAL RESOURCES 13.87 +1.50 +12.13%

Major oil producers are announcing large investment cutbacks. One of the most prominent players in the U.S. shale patch, Exxon Mobil, announced it was cutting its 2020 capex budget by 30 percent and lowering cash operating expenses by 30 percent (capital investments will fall to about $23 billion from a previously announced $33 billion). They were not alone. Apache Corporation, Total S.A., BP and Continental Resources are the first names along with a slew of others that are cutting back.

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The other assumption in these gloomy forecasts is that demand will stay as bad as it is. Yet while the demand losses may get worse before they get better, the truth is we are already pricing in the fact that demand will get better. China, the epicenter of the coronavirus, is coming back to life and is importing a lot of oil. We also see hopeful signs that the coronavirus is running its course in other countries, raising hope that those economies will soon start to reopen.

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I would expect that as global economies come back from this virus assault, there will be pent-up demand that should start eventually drawing down those ample inventories.

If you are looking for hopeful signs, you can look at the higher prices in the oil futures market because the market is predicting much better economic times. If you look at oil prices further out in the future, they are saying that we are going to get through this.

I, too, share the oil market's optimism, and I believe that the U.S. and the world will not only get through this crisis but will be stronger and more unified because of it.

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Phil Flynn is senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. He is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets. His precise and timely forecasts have come to be in great demand by industry and media worldwide and his impressive career goes back almost three decades, gaining attention with his market calls and energetic personality as writer of The Energy Report. You can contact Phil by phone at (888) 264-5665 or by email at [email protected]

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