OPECplus Deal Reduces Downside Risks, Surplus Not Eliminated

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Thursday, April 16, 2020 /8:01 PM / by Fitch ratings / Header Image Credit: Time


The OPEC+ deal to cut oil production by approximately 10 million barrels per day (MMbpd) does not restore the supply-demand balance, but should reduce the threat of very significant production shut-ins and downside price risks, Fitch Ratings says. Fitch expects the market to remain oversupplied and prices to remain low until coronavirus-driven lockdowns are relaxed. Additional voluntary cuts, which may not necessarily materialise, could ease the imbalances.

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Our current price-deck assumptions - including Brent averaging USD30/bbl in 2Q20-4Q20, which will lead to an average USD35/bbl for the full 2020 - remain unchanged. Prices remain low, particularly in the physical market. On 14 April 2020, Dated Brent traded at USD19/bbl, while front month Brent futures closed at just below USD30/bbl. The two benchmarks had been tracking close to each other before the coronavirus-induced volatility, but there is a significant spread now, which indicates a large physical oversupply.

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The coordinated production cuts will mitigate but not resolve the unprecedented demand fall, which is the main problem the industry faces. The International Energy Agency expects demand in 2Q20 will fall by around 23MMbpd yoy, suggesting potential overproduction of more than 15MMbpd, much bigger than in 2014-2015. The market rebalancing could take several years. In addition to the announced cuts, it will require production shut-ins, although on a smaller scale than in the no-deal scenario, and utilisation of excessive inventories. We assume Brent to recover to USD45/bbl in 2021 and USD53/bbl in 2022. This recovery could be slower if the lockdowns are rolled into 2H20 and beyond.

Production adjustments expose companies to volume risks. However, the financial performance of oil and gas companies will continue to be driven by prices more than volumes. Oil producers, even those implementing voluntary production cuts, will benefit from the OPEC+ agreement. Production of oil and gas majors, such as Shell, Total and BP, should fall by single-digit percentages compared to our previous expectations, given their exposure to both oil and natural gas, and larger focus on non-OPEC+ countries.

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We expect that Russian oil producers will need to cut oil production by around 15%-20% in the May-June period compared to the current level, and by around 10%-15% in 2H20, which will translate into their full-year 2020 production falling by around 8%-10% yoy. Russian producers with more diverse asset bases, such as Rosneft, Lukoil and Gazprom Neft, will be able to accommodate cuts more easily than producers with modestly diversified or more depleted assets, such as Tatneft and Russneft. A production recovery is likely to require additional investments once demand improves. Gazprom and Novatek's output will not be materially affected as condensate production is not covered by the deal.

Although the US has effectively coordinated the production-cuts deal, US producers have not assumed any formal responsibility to reduce output. Several oil producers in Texas and Oklahoma have asked their regulators to consider mandatory production cuts, but the industry is split on whether this is necessary. We believe that US shale production will fall due to lower investments, but will rebound once prices recover, similarly to the 2015-2017 pattern. The US Energy Information Administration expects US liquids production to fall by around 2MMbpd by July compared to end-2019, and to start recovering in 2Q21.

Middle Eastern producers, such as Saudi Aramco, ADNOC and Kuwait Petroleum, should be able to cut and later increase production with minimal additional investments, given their record of production adjustments and relatively simple geology. Norway has indicated that it would consider voluntary production cuts, which could affect the near-term production profiles of local companies such as Equinor and Aker BP, although the cuts are yet to be confirmed.


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