Analysis: How Robust Is the Opec-Plus Deal?

What are the main takeaways from this deal?
• Most importantly, the deal saw Saudi Arabia end its price war and return to market management.
• While underlying tensions with Russia have been put aside for now, it is unclear whether these were fully resolved. What is clear is that Moscow’s return to Opec-plus was a tactical response to the coronavirus crisis rather than a strategic shift in its long-term approach.
• The contribution of G20 producers will be largely market-led (i.e. would have happened anyway), rather than part of a coordinated effort to cut. Saudi Arabia is bound to be frustrated that its attempt to forge a global response did not gain the hoped-for traction. The message is that oil market management remains primarily Saudi Arabia’s responsibility.
• Mexico’s refusal to go along with full production cuts hints at challenges — and frustrations — ahead for Saudi Arabia if discipline erodes once the immediate crisis is over, as well as the mounting problems it faces generally in maintaining a broad approach to market management.
• The fact that the deal hinged on strong personalities — US President Donald Trump, Saudi Crown Prince Mohammed bin Salman and Russian President Vladimir Putin — is both good news and bad. It allowed negotiation of a deal of unprecedented scale. But it also creates scope for problems down the line compared with a more technocratic approach. Trump over the past week showed a love of dealmaking but little attention to detail, while Prince Mohammed initially showed a lack of flexibility and diplomatic leadership that he has been criticized for before. This does not bode well for keeping such an ambitious and challenging deal on track beyond the next few months.
• Price wars bear a heavy cost. This one lasted just over a month. True, Russia, Saudi Arabia and the US all seemed to blink at once. And Moscow will surely think twice about walking away from Opec-plus again in such a provocative way. But the outcome exposed questions about Saudi Arabia’s capacity to sustain a price war over the longer term, in terms of its own financial staying power and, perhaps most importantly, the strains it put on its strategic relationship with Washington – on which its security depends (OD Apr.11’20).
Was the outcome a surprise?
Yes and no. Energy Intelligence 10 days ago said the odds were stacked in favor of an agreement, but that this was more likely to involve an emergency deal of ad hoc commitments (IOD Apr.6’20). Thursday’s Opec-plus agreement was more ambitious than expected in its two-year duration, the level of detail and the scale of cuts, particularly from Saudi Arabia and Russia. It demonstrated a serious intent to address the coronavirus-related surplus, rather than just a political deal that reflected market realities. The G20 agreement on Friday, on the other hand, was a collection of vague promises.
The achievement of pulling together the initiative — including ending the Saudi-Russian price war — should not be understated. But there were strong drivers pushing in this direction (IOD Apr.6’20). These included political and economic pressures on President Trump, US pressures on Saudi Arabia (in the context of Saudi reliance on US protection), Riyadh and Moscow’s limited staying power under low prices, and the extreme market conditions. Large volumes of production would have had to be shut in as demand dries up and the world runs out of storage, regardless of what Opec-plus decided.
Two big obstacles stood in the way of a deal: (1) the strong, unpredictable personalities involved, namely Trump, Prince Mohammed and Putin; and (2) the extent to which the US would play along. Russia had consistently said the US must participate, while Washington resisted formal participation for legal, political and cultural reasons.
The first factor turned into a positive: Trump played a key role in bringing Russian and Saudi leaders together, and Putin and Prince Mohammed were central in forging a deal. On the second, Russia and Saudi Arabia ultimately accepted that the US would remain driven by market forces.
Has Russia returned to the Opec-plus fold?
Again, yes and no. The Opec-plus deal was the creation of Saudi-Russian talks — and, as such, a major achievement given the bitterness of their recent relations.
Despite some public bravado, Moscow was desperate for a deal. Its economy and financial reserves were under extreme pressure from the price war and coronavirus crisis, job losses were rising, and public anger was mounting.
But for Moscow, Opec-plus is still fundamentally a situational alliance — a temporary arrangement that responds to specific conditions. That’s why it pushed for, and got, a loose Opec-plus charter agreement last year that basically says participants will meet regularly to discuss oil markets and take joint action if needed.
This difference of views on the alliance underpinned the Russia-Saudi breakup last month. Put simply, Saudi Arabia views Russian participation in ongoing market management as essential, while Moscow does not want to make a long-term commitment.
The Saudi response to the breakup, combined with extreme market conditions and US pressure, brought Russia back to the table. Some bad feeling or mistrust seems bound to remain between Moscow and Riyadh. But some officials will continue to work to mend fences amid greater shared interests in areas such as security.
What was Trump’s role in all this?
The US president’s role as a dealmaker appears to have been critical in getting Saudi Arabia and Russia to return market management. Moscow even accepted market-driven reductions in US oil production as a valid contribution to the international effort. It is not clear what the US president may have offered Russia in return — but for Moscow, there would have been clear incentives if Trump offered some sort of sanctions relief or a fresh approach to their strained bilateral relationship. The US president also got involved in breaking the deadlock over Mexico.
Will the Opec-plus deal really last two years?
In terms of market optics, there are clear advantages in presenting this as an ambitious, long-term deal. The reality is that the cuts over the next couple of months are what matters – and anything after that is an open question, given the sheer unpredictability of the coronavirus, the scale of the hit to both the world economy and oil demand, and the fragility of the alliance.
The Saudis clearly wanted a longer-term arrangement, and would love to lock Russia and others into production restraint for a full two years. The big risk is that compliance will erode as soon as the immediate danger passes. Russia, in particular, has a poor track record, raising questions about whether it will really cut its pledged 2.5 million b/d throughout May and June, and comply fully beyond that. This will be worth watching closely as a litmus test of the deal’s staying power.
Once oil prices start rising and European refiners come back to life, they will want to buy crude again — creating temptation for Russia to push output back up. Mexico’s reluctance to sign up also does not bode well. Before long, Saudi Arabia and its Mideast allies could be doing the heavy lifting again, pushing buried tensions back to the surface.
The agreement includes a review clause for December 2021 — but given the volatility and uncertainty of market conditions right now, that seems an implausibly long timeframe. The group’s next meeting on Jun. 10 should give a better idea of the likely longevity.
Will the deal fix the oil market?
The scale of demand destruction in the immediate term is too big for anyone to manage. Rather, the deal should be viewed as limiting the damage – in terms of bloated inventories – and allowing markets to stage a modest recovery medium-term.
Preliminary Energy Intelligence analysis suggests global oil inventories will still increase by more than 730 million barrels this year, rising roughly 8% above last August’s record 9 billion bbl. The cuts basically aim to prevent even larger inventory builds, which could otherwise hang over the market and depress prices for another two years.
This week’s deal could in theory drain that inventory build by mid-2021, although this would require a strong rebound in demand growth and pretty strict compliance with the deal. Another year of market pressure seems likely, but things would have been much worse without this agreement – with prices likely diving to single digits near-term.
What happens to oil prices now?
Whatever prices do this week, April and May will remain treacherous, as lockdowns create more refining run cuts and storage logjams despite the coordinated supply cuts. Energy Intelligence analysis suggests the risk of sub-$30 Brent will be limited to the peak imbalance in these months, however, with markets starting to turn from end-May or June as demand claws back. A persistent rebound above $40 would likely depend on both acceleration of demand growth in the second half and strong compliance by Opec-plus