Will coronavirus rein in OPEC+ cheaters?

It's been a remarkable turnaround. Just a few weeks back, oil analysts were writing obituaries for OPEC+, an alliance between the Organization of the Petroleum Exporting Countries (OPEC), led by Saudi Arabia, and a handful of other oil producers, helmed by Russia – as Riyadh and Moscow engaged in an ugly price war. And now, the alliance is gearing to embark on the biggest coordinated output cuts on record.

The alliance has agreed to cut production by a staggering 9.7 million barrels of oil per day (bpd), or 10% of total global supply, in May and June in a desperate bid to calm the oil markets battered by a dramatic drop in demand caused by the coronavirus outbreak and sweeping measures to contain the disease.

Compliance issues

Even before the production cuts officially roll in on Friday, analysts have begun weighing in on a persistent problem that has plagued the 23-member OPEC+ since its inception in 2016, notably that of poor compliance. Several of the alliance members, including Russia, have been notorious for failing to comply with their pledged output cuts, much to the frustration of Saudi Arabia, forced to do much of the heavy lifting.  

But with oil prices collapsing, even trading below $0 a barrel in the US last week, and the world fast running out of storage space, experts say there is hardly any incentive to overproduce.

"In the short term, high compliance can be expected from most players, simply because the cuts are in most cases a must out of commercial and logistical reasons rather than a political question," David Wech, managing director at JBC Energy, told DW. 

"In other words, the lack of sales markets and brimming tanks would anyway force supply cuts."

The pandemic, which has brought the global economy to a virtual standstill, has destroyed up to 30% of global oil demand. This has led to a historic oversupply, putting pressure on global storage capacity, which some analysts predict could fill up to the brim by June. The dire prospect prompted some OPEC members, including Saudi Arabia and Kuwait, to kick off cuts last week itself.  

Russia  a repeat offender

Much of the compliance with the OPEC+ output cut would depend on the performance of non-OPEC members, which have a sketchy compliance track record. The 10 countries, including Mexico and Kazakhstan, have agreed to assume around 40% of the total cuts.

The spotlight is likely to be centered on Russia, which has pledged to reduce production by a fifth, or 2 million bpd, to 8.5 million bpd, levels last seen in the early 2000s. That's ambitious, considering Moscow has struggled to comply even with much smaller targets in the past. 

It complied with OPEC+ targets only for three months last year and that too largely owing to a monthslong contamination crisis surrounding its Druzhba pipeline.

But the situation is desperate this time around. Russia has the least amount of available storage capacity — about 8 days — among the three largest oil producers, according to IHS Markit. Saudi Arabia has 18 days, and the United States has 30 days. Weak demand in Europe, Russia's main export market, is further compounding problems for the country's oil producers. 

"Voluntary production decrease is a necessity under the current market situation. Otherwise, it will happen naturally in the next few months as crude oil storage facilities run out of capacity," Darya Kozlova, head of regulatory affairs at Moscow-based Vygon Consulting, told DW, adding that such unplanned shutdowns could damage a significant number of oil wells run by Russian companies.

Kozlova expects Russian oil output to fall by 10-20% in 2020, if prices averaged between $10 and $15 a barrel.

Russian oil producer Tatneft, which mainly supplies Europe, has preemptively cut its output by around a fifth this month, Reuters reported.

'Improbable' pledge

But complying with its quota will be a tall order for Russia, particularly in May and June.

Bjarne Schieldrop, chief commodities analyst at Sweden's SEB Markets, told DW that Russia's scheduled oil cargoes for May indicated that it would only reduce production by 0.6 million bpd.

"Russia cutting all the way down to 8.5 million bpd sounds improbable," he said. "It is difficult for Russia to cut deep and fast without damaging production. So, we think that it is likely that Russia will underdeliver on pledges also this time around."

A vast majority of Russian oil wells are old, mature wells, which are more complicated to shut in and bring back online than the wells in the Persian Gulf. The process is not only expensive but also risks causing permanent output losses.

Samuel Burman of Capital Economics said Russia would find it difficult to coordinate a supply cut of this magnitude due to the multiple private companies involved. He, however, expects compliance by Russia to improve later this year due to weak oil demand in Europe.

Other 'cheaters'

Burman also expects better compliance from repeat offenders Nigeria, Iraq and Kazakhstan over time.

Lack of storage capacity makes Nigeria particularly vulnerable to a slowdown in demand. The country has just 1.5-2 days of daily production storage available, IHS Markit said. 

Burman told DW that he saw both Iraq and Nigeria cutting production by 10% by the end of June.

Schieldrop expects sub-par compliance by Nigeria in May and June, saying the country's loading schedule signals that it will produce closer to 2.2 million bpd, way above its pledged target of 1.4 million.

"The [OPEC+] deal was struck only 3 weeks ahead of May 1. Many of the members in OPEC+ had at that point in time already sold and contracted out all or most of their oil sales for May and June. This is normal in the oil market due to long lead times. This makes it difficult for many of the members to backpedal and reduce production in May and June," he said. 

Kazakhstan is expected to cut its oil production to close to its quota of 1.50 million bpd, only to return to its old ways later in the year. 

"It [Kazakhstan] is geographically closer to China and therefore has greater scope to benefit from the faster rebound in economic activity there than in Europe," Burman said.

Saudis to the rescue?

The OPEC+ has agreed that the 9.7 million bpd cut would be followed by a 7.7 million reduction for the remainder of 2020, then by a 5.8 million cut between January 1, 2021 and April 30, 2022.

"The compliance question will come up to a stronger extent in the medium term, but the level of uncertainty on future market developments is huge. At any rate, it can be expected that the will to cut production may not be particularly pronounced in many countries, once the biggest price and logistics pressure eases."

David Wech does not expect Saudi Arabia to cut its production by more than its share, as it has done in the past to offset overproduction by Russia and others.

"It may be a dangerous bet to assume that Saudi Arabia will do a consistent heavy lifting," he said.

With oil demand at historic lows and huge uncertainty around the coronavirus, experts say oil markets wouldn't be too bothered about undercompliance.   

"Full compliance or 70% compliance. In the short run, it doesn't matter. Surplus will still be very large," Schieldrop said.

"But in the medium term, in June/July, we are likely to see global oil demand kick back towards 90% of normal from 70-75% now. [Then] including cuts by OPEC+ in addition to non-OPEC+ production declines of 2-3 million bpd, we'll be much closer to a balanced market. Then it will matter."