It is easy to talk about when things return to normal. For the world oil market, there may be no such return. With demand still struggling, Opec needs a plan to balance short-term prices against long-term market share by the time its monitoring committee next meets on September 17.
Various Covid-19 vaccines may be on the way, but doubts remain over the reliability of testing and their eventual efficacy.
Meanwhile, the virus remains frustratingly resilient despite a fall in death rates. The growing rate of infections in India, Indonesia and Iraq appears unstoppable while Australia, Germany, Italy, Spain, Britain and, especially, France have registered a resurgence of cases after having managed to keep things under control.
However, the US, Brazil and Iran were never really on top of the pandemic.
Efforts to reopen schools and universities in many countries have led to a surge in new cases. Most office work continues remotely or at limited occupancy. As the US holiday season ebbs, these factors are causing a renewed slowdown in petrol demand. Air passenger travel is severely depressed, with continued confusion over regulations and the unpredictable appearance of quarantines and travel bans.
Blanket lockdowns in most places will probably not return but rolling closures and depressed social and public activities continue. As companies run out of cash, temporary job losses become permanent and as government financial support winds down, many countries may now be entering a more conventional, shallower but still painful recession.
China’s imports have been strong, although lower in July and August compared with the record hit in June, helping to support the market. But it is questionable how long this will continue as the country clears a backlog of deliveries bought when prices were weaker.
Chinese imports could drop by 1 million barrels per day or more, while India has picked up but is still between 500,000 bpd and 1 million bpd lower than before the pandemic. Japan’s imports are at their lowest since the 1960s, and it and South Korea are both about 600,000 bpd under pre-pandemic levels.
The forward curve continues in contango, where prices for future deliveries are higher than prompt prices. That indicates a relative surplus of current crude and an incentive to continue storing. Saudi Aramco reduced its official selling prices in an unusual Saturday release, with the premium for flagship Arab Light to Asia dropping by $1.40 per barrel.
Opec’s very deep cuts have caused some strain. A hot summer with residents unable to leave on holiday meant record electricity demand in Dubai and, most probably, across the rest of the UAE. Iraq has struggled from cuts in gas supplies to several power plants, and electricity supply deteriorated markedly. As the Middle East experiences cooler weather, such problems will ease. However, it also means less oil consumption at Iraq’s and Saudi Arabia’s power plants.
Iraq, Angola, Nigeria, Russia and Kazakhstan have been under pressure to make additional cuts in August and September to compensate for past overproduction. Baghdad has suggested this make-up period could stretch to November. However, the country has given some mixed messages about whether it will ask for an exemption from cuts in the first quarter of next year.
Later this year, two contending forces may emerge: a continued stagnation in demand as Chinese buying slows and the economic rebound stalls, versus a renewed drop in American output because of natural field declines accompanied by very limited new drilling. The world's oil consumption may not return to levels recorded late last year until 2023.
Last month, the number of active US rigs began to increase after hitting its lowest level since 1940. The temporary shut-ins because of Hurricane Laura should shortly be reversed. Still, there is insufficient drilling to compensate for the fast declines in existing shale wells and the fall in US output will probably not be halted until next year, and until prices are above $50 per barrel.
This points to the danger for Opec+ in assuming the pandemic is an aberration and that current policy only has to be maintained temporarily. To be fair to the group, it has laid out a path for sizeable but diminishing cuts of 5.8 million bpd against its baseline through next year and up to April 2022.
However, Opec+ is clearly not going to suddenly put 5.8 million bpd back on the market in May 2022. So, it will either have to trim its cuts progressively next year or a year and half from now. It will still be producing far less than what it did last year.
Even in 2019, the alliance had cut 1.2 million bpd and agreed on a further 500,000 bpd in December, before the coronavirus struck, amid concerns about weaker demand and competing supplies.
When cuts extend over such a long period, they inevitably shape upstream strategy, delaying plans to expand capacity or cancelling a proposal to give tax breaks and grants for the drilling of additional wells that are ready to produce in 2022.
Even with high compliance and the continuation of cuts, Brent crude may not rise sustainably above $60 per barrel for the next two years. That means a long and hard slog for the major producers.
However, acceptance of a new state of normality is better than trying to push prices higher in the face of reality.
Robin Mills is chief executive of Qamar Energy and author of The Myth of the Oil Crisis