What happens next in the oil market depends on how quickly and completely the global economy emerges from lockdown, and whether the recessionary hit lingers through the rest of this year and into 2021.
The OPEC+ deal, finalised on Sunday, envisages production cuts of 9.7 million bpd in May and June, with the cuts tapering through the rest of 2020, 2021 and the first quarter of 2022.
It assumes further reductions will come about as a result of price-driven cuts to the output of the United States and other major oil producers not formally associated with the deal.
Even so, inventories of crude and refined products will start at a very high level, which will take months to whittle away, assuming consumption returns to near-normal quickly.
The bigger question is how much economic output and petroleum consumption will be lost permanently in the second half of the year and into 2021 as a result of the recession.
Some businesses will re-open and return to near-normal rapidly once the lockdown ends, but others will operate at severely reduced capacity, and some will not re-open at all.
Millions of employees have been furloughed and could return to their old jobs quickly, but millions more have become unemployed and may not find new work for some time.
In the face of the largest economic shock since before World War Two, businesses and households are moving to reduce non-essential spending and conserve cash.
But the second and third-round effects of that cash conservation imply a very large hit to aggregate demand and oil consumption which will persist through the rest of the year and into 2021.
Following the standard prescription of economist John Maynard Keynes, governments and central banks can use a combination of fiscal and monetary policies to make up the deficit in demand and jumpstart the economy.
But even Keynesian stimulus will take time to fill the demand gap and return petroleum consumption to something like near normal.
U.S. petroleum consumption has fallen by around one-third over the last four weeks as the coronavirus epidemic and lockdowns have brought much of the economy to a halt.
The volume of petroleum products supplied to the domestic market was just 13.8 million barrels per day (bpd) in the week ending April 10, down from 21.5 million bpd in the week ending March 13.
The sudden slump in petroleum consumption, as factories, retailers and offices are shuttered and transportation systems close, has no parallel in the history of the oil industry.
Consumption has fallen most severely for jet fuel (-73%) and gasoline (-48%) but middle distillates such as diesel have also been hit (-31%) and even propane and propylene are off (-29%).
U.S. refineries have so far reduced crude processing by around 3.2 million bpd or 20%, causing crude stocks to surge, but even that has not been enough to prevent a build up of unused fuels.
Total stocks of crude oil and petroleum products, excluding the strategic petroleum reserve, have surged by almost 84 million barrels over the last four weeks, according to the U.S. Energy Information Administration (EIA).
The last three weeks have seen consecutive increases of 21 million barrels, 33 million barrels and 27 million barrels, three of the five largest weekly rises since the data began in 1990.
The 1.34 billion barrels of crude and petroleum products in storage, excluding stocks held in the strategic petroleum reserve, are a record for the time of year (“Weekly petroleum status report”, EIA, April 15).
Similar reductions in oil consumption are likely to be occurring across the other advanced economies, though data for other economies in North America, Europe and Asia will only become available much later.
Britain’s Office for Budget Responsibility, the government’s independent fiscal monitor, has estimated the country’s output could fall by 35% in the second quarter of 2020.
The estimated reduction in Britain’s output is broadly similar to the reported reduction in U.S. petroleum consumption and suggests oil use across the entire OECD could be down by a third this quarter.
OECD consumption is around 48 million bpd so a one-third reduction translates into the loss of 16 million bpd from the advanced economies alone.
Non-OECD economies consume a further 52 million bpd. Consumption losses there are harder to measure, though probably smaller in percentage terms, since many simply cannot afford to lockdown completely.
But if non-OECD economies see consumption decline by 20% or 10 million bpd, a conservative estimate, then total OECD and non-OECD losses could be as high as 26 million bpd.
The implication is that global oil storage has been filling at around 100 million barrels every four days, which is clearly unsustainable for any extended period.
Emerging storage and logistics constraints have sent prices for physical crude and products such as gasoline and diesel tumbling to massive discounts compared with prices for future deliveries.
In this context, production limits announced on Sunday by the enlarged OPEC+ group of oil exporters, led by Saudi Arabia and Russia, should slow the accumulation of inventories and push back the storage wall.
The production accord ended the volume war between the world’s two largest oil exporters and came after strong political pressure from the White House.
But production cuts had become inevitable, with exporters struggling to find buyers willing and able to purchase extra barrels, forcing them to sell to middlemen able to put the crude into immediate storage.
The OPEC+ deal provides a face-saving end to an output battle which produced only losers and no winners, except middlemen with access to tank farms and floating storage.