Last week’s emergency three-day OPEC meeting in Vienna in response to news that China’s oil demand has fallen by 20% due to the coronavirus lockdown has yet to bear fruit.
While Saudi officials have proposed an extension to the current agreement from March to the end of the year along with a further short-term cut in production of around 600,000 barrels per day, Russia is yet to respond.
The response is unknown and may come anytime over the weekend or even in the next three weeks as the picture of China’s economic slowdown becomes clearer, but the headlines beg the question of whether Russia’s acceptance of the quotas maps into compliance.
Data from the IEA, compiled and analysed by Bloomberg, showed that while OPEC adherence increased to 166% in December, non-OPEC conformity slipped to just 58%, with Russia meeting only 66% of its production cut quota.
Saudi Arabia has practically propped up the proposed output quotas throughout 2019 with output cuts exceeding their limit by 50% or more through the year, whereas Russia’s track record isn’t as unblemished.
Russia only met its production cuts for 3 months in 2019, predominantly due to the contamination of the Druzhba pipeline.
Chart 1: Historical compliance to OPEC+ production cuts
You may be asking why OPEC still includes its latest member, Russia, and why no consequences to their adherence have been visible. Well, the simple answer is that OPEC needs Russia.
This is especially the case with the US now regarded as the largest oil producer in the world – a title enabling the US to be self-sufficient and a net exporter of crude. The logical follow on question is why production cuts by Russia, and in turn a higher oil price, aren’t in Russia’s best interest.
In short, it is, but it isn’t as important from a fiscal standpoint for Russia as it is for Saudi Arabia. Russia’s budget is more resilient to a lower oil price than Saudi Arabia’s due to the diversification of its natural resources.
With less pressure on the government’s finances, and with the knowledge that Saudi Arabia will continue to scale back production as oil prices fall, Russia can continue to produce at an elevated rate in the sound knowledge that oil prices will be supported.
Chart 2: Oil futures curve shows OPEC+ meeting in itself was positive for crude, despite no decision
We are no experts on OPEC+ politics and cannot give any guidance on the likely Russian response to Saudi suggestions or its timing, but we can read the market.
The WTI futures curve has not only fallen on the front-end due to the coronavirus spread, as shown by spot oil prices falling, but the curve has also flattened substantially.
This suggests that participants are less confident in the longer-term prospects of crude rebounding.
However, the OPEC+ meeting in Vienna has been a credible response, with the futures curve now sitting at a higher level than it did on Monday just prior to the event. The futures curve is still some way off from where it was trading before the coronavirus outbreak, but this marks progress.
It may also suggest that oil is primed to rebound significantly if the policy response by China and other affected governments is sufficient, and met with a similar response in supply conditions.
Author: Simon Harvey, FX Market Analyst at Monex Canada.