U.S. markets closed

Is the Biggest Production Cut Deal Big Enough to Save Oil?

Nilanjan Choudhury

Crude prices, and shares of U.S. energy firms, are expected to rebound after a group of the world's biggest producers reached a landmark deal in a marathon webinar session, to curb output amid a glut of global oil supply that has suppressed commodity prices.

Apart from effectively ending the price war between Saudi Arabia (the OPEC cartel’s biggest producer and exporter) and Russia (leader of the non-OPEC contingent), the pact aims to tackle oil’s demand slump caused by the coronavirus pandemic.  

Here is all you need to know about the deal:

Explaining the Crude Collapse & Need for Market Rebalancing

The twin bearish shocks of coronavirsus-forced demand contraction and the OPEC oil price war have triggered a spectacular deterioration in the energy market environment. So much so that the price of U.S. crude fell to $19.27 a barrel at one point recently, its lowest since 2002, while Brent crude dropped below $23 – levels not seen in 17 years.

In particular, the fast-spreading novel coronavirus outbreak has triggered an unprecedented selloff in the commodity. With major cities under lockdown and travel restrictions in place, the consumption for crude has dropped by as much as 30%.

Pressure in the oil markets were exacerbated by the no-holds-barred price war between Saudi Arabia and Russia. In early March, the two countries failed to agree on additional production cuts to boost oil market fundamentals and prop up prices. Subsequently, they decided to open the production floodgates, which combined with the demand destruction to send prices into a tailspin.

In a nutshell, it's basically too much supply but too little demand, calling for coordinated steps to rebalance the oil market.

Details of the Production Cut Deal

Member countries of the OPEC+ group, looking to shore up prices, agreed to slash output by 10 million barrels per day – the largest in history - equal to roughly 10% of current worldwide production. Riyadh is committed to reducing oil production by 4 million barrels a day from an April baseline, or about 40% of the total, while Moscow will lower production by 2 million barrels a day. The plan takes effect May 1 and the initial reduction would last for two months. Beginning July, the production cap would be relaxed to 8 million barrels per day through the remainder of this year, followed by 6 million barrels in daily cuts for 16 months starting Jan 1, 2021.

Mexico had been the main stumbling block for such a deal because the country was ready to curtail oil output by 100,000 barrels per day at most, short of the OPEC+ coalition's demand of 400,000 barrels per day. Then the U.S. stepped in, with President Donald Trump agreeing to compensate Mexico’s share by ratcheting down daily volumes by 250,000 to 300,000 barrels – something he said that his country was already doing. On its part, Mexico has promised to pay back the U.S. at a later date.

U.S. Remains on the Sidelines

It's been a catastrophic year so far for crude oil, with the American benchmark WTI suffering a dramatic 60% collapse. The price plunge has wreaked havoc on the U.S. energy industry, claiming thousands of jobs, pushing the debt-heavy companies toward default and causing a steep drop in stock prices.

The carnage sent most energy companies scurrying for cover. From supermajors ExxonMobil XOM and Chevron CVX to shale producers like Diamondback Energy FANG, Concho Resources CXO, Parsley Energy PE – all announced steps to "rationalize" their planned capital spending for the current year in response to the sudden oil price slump. Some E&P operators like Occidental OXY - carrying a Zacks Rank #3 (Hold) - slashed its dividend payout, while Whiting Petroleum WLL recently filed for bankruptcy.    

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Despite all this, America - the world’s top producer - is yet to impose any voluntary supply curbs, limiting its role to assist Mexico in meeting its OPEC+ quota. President Trump is of the opinion that being a “market-driven economy”, the country is already on course for a production curtailment of 2-3 million barrels per day. As a matter of fact, the U.S. Energy Department's latest weekly inventory release showed that domestic volumes fell by 600,000 barrels a day, while Baker Hughes puts the oil rig count at its lowest since 2016.

One will have to wait and see if the Trump administration formally asks the U.S. oil companies to contribute to the production cut. In the meantime, the OPEC+ deal assumes significance for the country as the sinking oil prices have resulted in thousands of layoffs in the oil patch at a time jobless claims are going through the roof due to the virus outbreak.

Will the Cuts be Enough for the Markets to Rebalance?

Independent energy research and business intelligence company Rystad Energy warn that even if 10 million barrels per day of oil is taken off the market, it might not be sufficient to balance supply and demand. The consulting firm estimates a massive supply surplus of 27.4 million barrels per day in April. To put it simply, with the coronavirus pandemic wiping out crude consumption throughout the globe, some see the accord as being too little too late to adequately impact underlying fundamentals.

Meanwhile, efforts are also on to include the likes of U.S., Canada, Brazil and other key producers outside of OPEC+ to formally join the pact with additional cuts that will take the production decrease target to 15 million barrels per day. While unable to offset diving global fuel demand, the agreement isn’t a total failure either.

The collective cuts are not only expected to put a floor beneath oil prices for the time being but also lower the risk of running out of traditional inland facilities to store the commodity. But unless countries start to lift lockdown measures and their economies come out of the coronavirus crisis, the oil market still has plenty to worry over.

Just Released: Zacks’ 7 Best Stocks for Today

Experts extracted 7 stocks from the list of 220 Zacks Rank #1 Strong Buys that has beaten the market more than 2X over with a stunning average gain of +24.5% per year.

These 7 were selected because of their superior potential for immediate breakout.

See these time-sensitive tickers now >>