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April 17, 2020

Landmark OPEC+ deal can do little to prop up oil prices in the near term

By GlobalData Energy

In a landmark deal, Saudi Arabia led Organization of Petroleum Exporting Countries (OPEC) and its partners, such as Russia (OPEC+), agreed to reduce oil production by 9.7 million barrels per day (mmbd) in May and June 2020 to stabilise falling oil prices globally. The US-brokered deal is the biggest production cut agreed in the history of OPEC/OPEC+ and represents about 10% of global crude supply.

Although the deal is welcoming, it may not be enough to lift oil prices and provide respite to oil-producing countries. IEA estimates that the crude demand would drop by 29mmbd in April 2020 due to Covid-19 fallout and the agreed production cuts would not be able to offset a third of global oil demand lost due to the pandemic.

The deal has been welcomed by major oil-importing countries such as China, India and South Korea, apart from other G20 countries. These countries are likely to buy cheaper crude to fill their strategic petroleum reserves. Still, all these could be inadequate to tighten the market and support prices.

The targeted production cuts of 9.7mmbd seem over-ambitious and may not turn in to reality even if the key OPEC members, such as Saudi Arabia achieve their share of production cuts. In addition, it might be challenging for OPEC members to fully comply with the cuts given their dependence on oil. Mexico, which was initially given a target of 0.4mmbd production cuts, could only reduce by 0.1mmbd.

The OPEC+ deal might not lead to a reduction in crude inventories piling up in major oil-producing countries. Oil consumption is not likely to increase in the near term due to Covid-19 induced lockdowns and travel restrictions. Oil prices depend on global economic scenario, which determines oil demand. Currently, global economic outlook is bleak and even after the Covid-19 threat fades, it may be unlikely that the global economy rebounds quickly. This is likely to result in a slower increase in oil prices.

The only silver lining from the OPEC+ production cuts deals is that it might have prevented a total collapse of the oil market due to plunging demand and the spectre of excess crude production by Saudi Arabia and Russia. However, a huge drop in demand, poor economic outlook, and insufficient production cuts mean the oil prices may remain suppressed in the near-term.

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