Monday, 28 September 2020 | 01:12
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OPEC+ Cuts Tapering Reflects Recovering Oil Demand

Friday, 17 July 2020 | 23:00

The OPEC+ agreed tapering of oil production cuts from August should support a gradual market rebalancing and may help reduce price volatility, Fitch Rating says. We expect OPEC+ to continue to periodically adjust the two-year deal reached in April 2020 to avoid large production surpluses or deficits. This supports our expectations of gradual oil price recovery in the medium term incorporated in our ‘through-the-cycle’ rating approach.

The second phase of the OPEC+ agreement, which was agreed yesterday after a one-month delay, will scale back production cuts from 9.6 million barrels a day (MMbpd) to 7.7MMbpd between August 2020 and January 2021. Based on the original agreement, cuts are expected to taper further to 5.8MMbpd between January 2021 and April 2022. In practice, the tapering will be implemented more slowly as countries that produced more than their commitments in the previous period, including Iraq and Nigeria, have agreed to compensate for their insufficient compliance by producing less oil in August and September.

The market is transitioning from a substantial oversupply in 1H20 to a deficit in 2H20, driven by improving demand as many counties are relaxing their coronavirus lockdown measures. OPEC+ faces the challenge of balancing the need to achieve higher oil prices through production cuts by its participants and a risk of losing its market share to US shale, where the level of investment activity will continue to be closely correlated with prices.

A sustained price recovery is contingent on demand recovering to pre-coronavirus levels, normalised inventories and resumed economic growth. We expect the market to rebalance in 2020-2021, and Brent average prices to improve from USD35 a barrel in 2020 to USD45/bbl in 2021 and USD53/bbl in 2022. The main risk to this scenario is a potential second wave of the coronavirus resulting in more lockdowns, which could lead to oil prices remaining depressed for longer. Although this is not our base-case scenario, re-introduction of restrictive measures in certain countries and regions, including some US states, points to the health crisis not being under control yet.

Demand has started to recover recently: the yoy decline was 12% in June compared with 21% in April, according to the US Energy Information Administration (EIA). We assume oil demand will return to 2019 levels by the end of 2021, absent the second wave of lockdowns. We expect OPEC+ to reduce its quotas if the demand recovery reverses.

US oil production fell by 2MMbpd-2.5MMbpd from its peak registered at the beginning of this year, but has since stabilised. The level of investment activity in the sector remains low: the number of active drilling rigs has declined by 73% this year. We expect the shale oil producers to primarily focus on efficiency gains, but with oil prices at USD40/bbl and above some producers may be tempted to increase production, although in the short term such growth is likely to be only modest.

As a result of the coronavirus crisis, we have taken 54 negative rating actions in the oil and gas sector between 1 March and 10 July, including 22 one-notch downgrades, 12 multi-notches downgrades and 20 Outlook revisions to Negative. Most of these actions were in North America, followed by other region
Source: Fitch Ratings

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