As OPEC+ oil cuts go into force, Russia could make or break the deal

London — The OPEC+ supply accord goes into effect Friday, and Russia's performance could well determine whether it succeeds in speeding the oil market's recovery from the coronavirus crisis.

The deal calls for the 23-country OPEC+ alliance to cut an unprecedented 9.7 million b/d of crude production over May and June, tapering down to 7.7 million b/d for the rest of 2020 and then 5.8 million b/d for all of 2021 through the first quarter of 2022.

Given the precedent in previous OPEC+ agreements, compliance by Saudi Arabia and its Gulf allies with their production quotas does not appear in doubt, and indeed they have signalled in the past week that they have already begun ramping down their output.

Russia, however, faces serious scepticism over its willingness to play ball, having consistently flouted its cuts in the past. Its quota is 8.5 million b/d, the same as Saudi Arabia's, which will require it to slash some 2 million b/d — or about one-fifth — of its recent crude production.

"Moscow has failed to deliver on pledged output cuts since the start of the OPEC+ alliance more than three years ago," Stephen Brennock, an analyst with brokerage PVM Oil Associates, said. "Put simply, Russia has turned cheating with quotas into an art form."

Massive blow

Failure to comply would undermine the OPEC+ alliance's ability to counteract the massive blow to global oil demand caused by the coronavirus pandemic. Saudi Arabia, which has papered over previous lackluster discipline by its OPEC+ counterparts by massively overcomplying with its quota, will likely want to see evidence of good conduct first before it might agree to similar deeper cuts, analysts say.

"The more Russia cuts, the more Saudi will cut and the more the rest of OPEC will respect quotas," Paul Sankey, managing director of Mizuho Securities, said.

The rhetoric so far from Russia indicates a more earnest effort this time.

Russian energy minister Alexander Novak said Wednesday that the country will lower its output 19% in May compared to February's level.

Russia reported crude and condensate production of about 11.3 million b/d that month, so a 19% cut would come out to 9.15 million b/d. Subtracting out the condensate would put it close to its crude quota.

"The current parameters of the agreement fully meet Russia's interests from the point of view of the impact on the Russian economy and budget," Novak said at a governmental meeting earlier this month. "The heads of Russian oil companies fully support the parameters of the new deal and noted that the market today needs decisive measures to achieve balance."

Saudi energy minister Prince Abdulaziz bin Salman, who has not been above naming and shaming countries that have violated their quotas, told reporters after the deal was signed that he will be keeping an eye on production figures.

"By June we will know who performed and who did not perform," he said.

Iraq struggling

Beyond Russia, Iraq, another serial quota buster, has had a difficult time selling the deal domestically, putting its commitment in doubt.

Once internal consumption, the Kurdistan Regional Government's share of production, and payments to international oil companies are factored in, its quota of 3.75 million b/d would leave about 1.75 million b/d to generate revenues for the federal government, according to S&P Global Platts calculations. At current oil prices, 2020 revenues would come in less than a quarter of 2019 levels, squeezing an already strained budget.

Several members of parliament have objected to Iraq's agreed production cut, saying oil minister Thamir al-Ghadhban, as a member of a caretaker government, did not have the authority to commit the country to the OPEC+ deal.

Meanwhile, in Nigeria, yet another member that has consistently flouted its quota, oil officials have soberly acknowledged that lack of demand for its crude along with inadequate storage capacity means it will be forced to reduce its output involuntarily, never mind the OPEC+ deal.

State-owned Nigerian National Petroleum Corp. has slashed its May official selling prices to try and clear its glut of unsold crude, while also sharply cutting its June loadings.

When 100% isn't enough

Even with 100% compliance, OPEC+ is in for an uphill battle to lift prices. Officials have said they are banking on involuntary cuts by producers outside the group, along with purchases of oil for various countries' strategic petroleum reserves coordinated by the International Energy Agency, to take some 7 million b/d of supply off the market on top of the OPEC+ cuts.

That is still insufficient to offset the 20 million b/d or more of demand destruction wrought by the pandemic this quarter that many analysts project.

S&P Global Platts Analytics estimates that the market has seen about 2.1 million b/d of economically induced production losses — nowhere near the level needed to prevent crude storage tanks from overflowing in the next few weeks.

"Despite the forthcoming OPEC+ production cuts, more production needs to be cut, particularly in the US and Canada," Chris Midgley, S&P Global Platts' head of analytics, said. "Lower prices are still needed in the coming month or two to force supply to close the 15 million to 20 million b/d gap in balances."