The Art of a Failed Oil Deal

Mish

West Texas Intermediate crude fell below the $20 mark again today. The Oil pact has failed already.

After a brief one-day wonder rally, and a choppy one at that, Crude is back below $20 despite OPEC, the US, Mexico and other nations agreeing to production cuts.

Yesterday, the Wall Street Journal was crowing about The Art of an Oil Deal.

President Trump has been chasing a diplomatic victory, and he got one this weekend when he brokered a deal between the Organization of the Petroleum Exporting Countries (OPEC) and Russia to limit their production that may also limit the bloodbath in the U.S. shale patch.

OPEC and Russia have agreed to curtail their production by 9.7 million barrels a day—about 10% of global output—in May and June amid a steep falloff in demand due to the coronavirus that is expected to exceed 20% of last year’s consumption.

So credit to Mr. Trump for using U.S. global influence to mitigate the mayhem. Russia and Saudi Arabia have agreed to take on the bulk of the cuts. After Mexico balked at an order to cut its production by 400,000 barrels a day, President Trump volunteered the U.S. to cover 300,000 barrels of its share.

These cuts won’t be enforced by the U.S. government and will come out of the two million or so that domestic production is forecast to fall. OPEC says sanctions on Venezuela and Iran, in addition to expected reductions by producers such as Canada, could lop off 20 million barrels a day from global supply this year, which, voila, would match demand estimates.

This math may be as illusory as a desert mirage, but it allows the Saudis to save face. And while some over-leveraged shale producers may still fail, the deal should also put the kibosh on calls for tariffs or quotas.

Deal Immediately Failed

It took all of one day for the deal to fail.

It had to.

No one is forcing the cuts and no one will, except the market, of course.

Real Deal

Here's the Real Deal: As soon as storage facilities fill up, nations will have to curb production.

Trump did not negotiate a thing that was would not have occurred on its own by brute force of the market.

A cut of 9-10 million barrels was not enough. So the price fell after a brief market surge.

Hooray, the Saudis saved face. But what good did it do? The cuts were coming because they had to.

Voilla!

If demand destruction amounts to 20 million barrels per day, guess what?

Production will ultimately fall by 20 million barrels per day, deal or no deal.

The WSJ editorial board did get one thing right: It's an illusion.

Mike "Mish" Shedlock

Comments (48)
No. 1-14
Sechel
Sechel

I posted the latest iEA report earlier. I concluded a few things

Demand is too low for any cut in production to have an impact
This deal may help oil prices in the 2nd half if the economy stabilizes

U..S. can't cut its production it would violate anti-trust. What we promised is that we'd sell less oil if the price was lower. Duh! We're already cutting high cost production in response to low prices. By the way this is something that is difficult for Russia to do as their oil wells are old and its very expensive for them to shut and restart

Russia had previously declared war on U.S. shale. Saudi Arabia was a U.S. proxy in that war. Russia capitulated because they now have their own Covid-19 problems.

OPEC deals never hold. There will undoubtedly be cheating and the deal will fail only to be replaced by a new one, but Trump made history. Never before has a U.S. president pushed for an OPEC price deal to raise prices.

And now that the U.S. is a net energy exporter why on Earth are we purchasing oil for the strategic oil reserves? Seems like a huge slush fund that someone is profiting off of.

the Impetus for Trump getting involved was a push for relief by Trump's friend Harold Hamm who originally wanted tariffs which would have benefited him more since he's stuck with high priced shale

tokidoki
tokidoki

The Fed should print money and buy oil for the Strategic Reserve.

So easy, Powell could do it. If he does not do it, all those shale companies will be thrown to the wall, and unemployment will increase.

wootendw
wootendw

I still expect Trump to put a tariff on imported crude. It will probably a variable one that attempts to keep the price of crude - to US refineries - at around $40 or so, enough to keep some frackers and smaller companies in business that would otherwise fail. The tariff would have to be applied, not only to oil states, but also to crude from US-owned crude oil facilities abroad. If Trump does this and balances it out with tax cuts elsewhere, I won't even be bothered by it.

There used to be a hypothesis that anti-trust laws were needed because larger companies could undersell their smaller competitors, drive them out of business and buy them up. No hard evidence for this hypothesis ever emerged and even Ida Tarbell only touched on the notion in her "History of the Standard Oil Company".

However, some OPEC countries really could destroy the US crude oil industry through underselling, even if they didn't buy up what was left of it. Although I am anti-DoD (due to warmongers), much of our 'defense' runs on oil and it makes no sense to depend on OPEC nations for a commodity so vital.

Tony Bennett
Tony Bennett

"U..S. can't cut its production"

...

Correct.

Three reasons why US producers will pump away:

  1. As long as price for a barrel greater than variable cost you continue to pump. You lose money, but not as much if you stopped.

  2. Capping and opening a well is expensive. Cheaper to keep on pumping.

  3. Many wells are on leased land (with USG a big land holder) under favorable terms to producer. Per leases the land holders are paid royalties on what is pumped and allow only for production to be stopped for reasonable length for maintenance. If pumping stopped, leases can be voided.

flubber
flubber

Honest question here....Isn't storage capacity going to be overwhelmed if everybody keeps pumping oil?

I would imagine usage has crashed over the past month. I was talking to an airline pilot and he said their flights have been cut by 75%. Auto traffic in my city is very, very, light. Why pump if fuel isn't being used?

Mish
Mish

Editor

Tariffs on oil are a silly threat, 100% guaranteed to immediately backfire. I would like to suggest they are so stupid that even trump can see it, but we are dealing with Trump.

May write a post on this angle. The WSJ really missed the boat with that article

Tony Bennett
Tony Bennett

Oh, forgot to add

Sounds Inflationary

Zardoz
Zardoz

Art of the Deal, baybee!

frozeninthenorth
frozeninthenorth

90% of the time these "deals" to cut production end in failure. This time around the problem is not only excess production -- but a serious fall in demand! It's a greek tragedy -- you could see that one coming a mile away. I guess the dumb money moved in -- since Trump has promised to reopen the economy...immediately.

Six000mileyear
Six000mileyear

Low oil prices are more of a stimulus that any interest rate cut the Fed can come up with.

Felix_Mish
Felix_Mish

Who makes oil storage facilities and how long does it take to crank such things out?

Dubronik
Dubronik

I would love to see the Clown in the White house to put tariffs on oil. It would be so comical....

Sechel
Sechel

Not sure when it happened, but somewhere along the way the strategic oil reserves went from being part of national preparedness, an asset for the military and a way to blunt the power of OPEC into a giant slush fund. There's no way the country needs that much oil for a future crisis, not when we're energy independent and probably when you consider where the price of oil is compared to where we've been buying it taxpayers are probably sitting on huge unrealized losses. The Reserves now are a slush fund.

Sechel
Sechel

Oil is now at $13.38. Makes you wonder why Trump thought it smart to intervene in the oil markets and lose even more prestige and political capital on what is clearly a failed attempt to prop up the price of oil


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