OPEC and Russia Parry Mexico to Ink Historic Deal to Slash Oil Output

Major oil producers finally managed to seal a historic agreement to cut output by more than 10 million barrels a day, despite repeated, eleventh-hour brinkmanship from Mexico that threatened to scupper the whole accord for two days straight. But the biggest agreement of its kind in OPEC’s history will ultimately have a hard time stopping the rout in oil markets caused by the economic devastation of the coronavirus pandemic.

Crude prices that had jumped 10 percent earlier Thursday on hopes of such a big cut ended up falling 10 percent once markets realized that even production cuts of that magnitude won’t yet come close to balancing a market thrown terribly out of whack by the near-total shutdown of economic activity in much of the world.

In a marathon virtual meeting Thursday between members of the OPEC oil-exporting cartel and other big countries such as Russia, major oil producers agreed to broadly share the pain of cuts that will take about 10 million barrels a day off the market—almost one-quarter of their total production—in a desperate bid to prop up oil prices that have fallen more than 50 percent this year. Russia and Saudi Arabia, two of the world’s biggest oil producers, would make some of the biggest cuts—about 2.5 million barrels a day each, at least on paper—while other oil producers would make proportional cuts of their own.

The 10 million-barrel cut would start in May and last for two months, after which the group would keep cuts of 8 million barrels a day for the rest of the year, and then cuts of 6 million barrels a day for all of 2021 and into 2022.

But OPEC+, as the wider group is known, had said that the tentative deal was conditional on Mexico agreeing to cut its own production by 400,000 barrels a day, cuts unpalatable to Mexican President Andrés Manuel López Obrador, who views maximizing oil output at Mexico’s state-owned oil company as part of his nationalist economic agenda, even if it makes no economic sense. Mexico also railed against what it saw as a demand to make a larger proportional cut than countries like Saudi Arabia, since its cuts were measured against 2018, when it was pumping more oil.

That impasse threatened the entire deal. López Obrador said Friday morning that the United States had agreed to make additional oil output cuts on Mexico’s behalf, though it wasn’t at all clear how that would work, since the U.S. government cannot mandate private companies’ production decisions.

López Obrador reportedly insisted that Mexico could only cut about 100,000 barrels a day, but the Saudis pushed back at Friday’s G-20 virtual ministerial meeting over Mexico’s proposed contribution, dragging the virtual summit out longer than expected.

The Mexican president “believes that other nations will pay the price and that Mexico can free ride,” said Duncan Wood, the director of the Wilson Center’s Mexico Institute.

Despite the eye-popping size of the cuts pledged by OPEC members and other countries, the actual cuts will likely be somewhat smaller, said Kevin Book, managing director of ClearView Energy Partners, a consultancy. Both Russia and Saudi Arabia used a different starting point than the other countries to measure their pledged reductions, so the real number of barrels to be taken off the market will be closer to 8.4 million barrels a day.

Late Friday, the virtual G-20 ministerial meeting was still wrangling over the language of its final statement, with Mexico’s recalcitrance in particular slowing the approval of a common position. But most experts expect that U.S. support for Mexico—reiterated at Friday’s White House coronavirus briefing—will ultimately secure agreement along the lines the planned cuts outlined by OPEC+ late Thursday.

The G-20 meeting’s final statement didn’t make reference to specific output cuts, but signaled that Thursday’s OPEC+ agreement is the blueprint for reducing supply. “To address these challenges, we commit to take all the necessary and immediate measures to ensure energy market stability,” the G-20 ministers said in a joint statement released early Saturday. “We recognize the commitment of some producers to stabilize energy markets.” The G-20 will form a focus group to continue monitoring its response to energy-market challenges, they added.

On Sunday, OPEC+ finally nailed down the final contours of the deal, agreeing to cut 9.7 million barrels a day for the next two months, then 7.7 million barrels a day through the rest of the year, and smaller amounts in 2021 and 2022. The final cut essentially represents OPEC+ writing off the additional barrels it had wanted Mexico to cut, figuring a healthy output cut, while still smaller than the demand collapse, would be a lot better than no deal at all.

Regardless of the ultimate size and duration of the announced cuts, two things seem clear. First, while Saudi Arabia and Russia had in recent years proactively managed global oil supplies to keep prices at a moderate level, they are both now hostage to the market: OPEC and other big producers are no longer even able to pretend they are in the driver’s seat.

“These are cuts because the market is forcing them to do it—there will be nowhere to put these barrels” as global storage inventories fill up, said Amrita Sen, the chief oil analyst at Energy Aspects, a consultancy in London.

Russia over the past week had said that it would only make production cuts if the United States made cuts of its own, and that involuntary U.S. oil output reductions caused by falling prices that make many wells uneconomical don’t count. But even Russia’s hand has been forced by plunging prices and swelling oil inventories as it agreed to join big cuts even before the United States offered anything concrete.

“Russia is going to be shutting in a lot of production this summer, whether there was a deal or not,” said Bob McNally, president of Rapidan Energy Group, a consultancy. “They’re making a virtue out of necessity.”

The decision to agree to production cuts marks an unexpected turnaround for Moscow after it had pulled out of an agreement with Riyadh in March. Russia had bet its huge currency reserves and wealth fund would enable it to ride out the storm and retake market share. But the pandemic and the subsequent fall in demand for oil have left the Kremlin revisiting its earlier calculus.

“The problem is that Russia messed up,” said Elina Ribakova, the deputy chief economist at the Institute of International Finance. “Everyone miscalculated to a degree, but Russia expected a mild contraction and still thought they could gain market share.”

The comparatively modest size of the agreed cut will slow down the pace at which global inventories fill—pushing back the day of reckoning for everyone. For Moscow, agreeing to a deal now is a way to buy time to fully assess the impact on the energy market—and Russia’s own finances—due to the pandemic. In the meantime, the Kremlin will look to shore up its geopolitical and domestic positions that have been hit from the oil price war and the spread of the coronavirus.

Energy plays an important role in Russian foreign policy, and OPEC+ was a vehicle for Moscow’s increased engagement in the Middle East, and especially stronger ties with Saudi Arabia. But the Kremlin’s decision to rupture oil markets in March eroded Russian credibility, which it will be looking to regain from other big producers in the face of the current crisis.

“A lot will depend on compliance and commitment of the participants of the deal,” said Tatiana Evdokimova, the chief Russia economist at Nordea Bank. “The breakdown of the deal in March has greatly decreased trust; a big element if this deal is to rebuild trust again.”

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As with U.S. President Donald Trump’s abrupt reversal—from cheering cheap oil to urging OPEC to raise prices—domestic political considerations also helped drive Moscow into a bargain. The Kremlin has already postponed a planned referendum that could keep Russian President Vladimir Putin in power until 2036 due to the spread of the coronavirus, which could push both Russia and the world into a recession. While the deal will do little to help the state budget, reducing any form of economic pain is a top priority for Moscow against the backdrop of wider political changes coming in the country.

“The Russian government is afraid of the implications of high unemployment and real incomes declining,” said Ivan Tkachev, the economics editor at the Russian business daily RBC. “That is what they fear most.”

But even the unprecedented agreement reached Friday shows that there is no easy way to stanch the bleeding from the unprecedented collapse in global oil demand due to the pandemic. Experts figure demand has fallen by about 30 percent, even as countries such as Saudi Arabia and Russia were until recently increasing production. That has created a mammoth mismatch where supply outstrips demand by as much as 24 million barrels a day.

In a situation like that, even OPEC+’s promised 10 million-barrel cut  won’t be enough. The global overproduction is swelling inventories everywhere, and once storage is full, oil wells will be forced to shut down.

“We have a deal by OPEC+ that was secured today by the United States saving Mexico’s face. However the deal looks fragile, as there is still too small a commitment from other oil producers, including the United States and Canada,” said Per Magnus Nysveen, the head of analysis at Rystad Energy in Norway.

The problem is that global inventories are filling, and any market-driven U.S. cuts will come later in the year, while the taps need to be closed now to avoid a catastrophic situation.

“To get through May we need at least 5 million barrels a day more in cuts quickly, and all producers should now contribute their fair share,” he said.

Markets were closed for Good Friday but will render their verdict Monday on oil producers’ emergency measures; the steep plunge in prices late Thursday augurs a rough ride as the reality of the oversupply hits home.

“I think crude prices will keep falling. I’d expect prices in the teens, if not lower,” McNally said.

At the G-20 virtual meeting on Friday, U.S. Energy Secretary Dan Brouillette said, according to prepared remarks, that collapsing prices could knock between 2 million and 3 million barrels a day out of U.S. production, essentially offering that to the group as the U.S. contribution toward collective cuts. He also said that the U.S. government could snap up some excess oil to fill the U.S. Strategic Petroleum Reserve, though that will have only modest impact.

He ended by urging the OPEC cartel and other big producers to formally agree to restrain supplies and jack up oil prices to help “advance free and open markets.”

Apr. 10: This article has been updated to include later developments from the White House and the G-20.

Apr. 11: This article has been updated to include the final G-20 statement.

Apr. 13: This article was updated to reflect the final agreement.