Demand destruction: Oil supply cuts versus COVID-19
The drop in oil consumption in 2020 will likely dwarf the dip during the Great Recession.
By ATB Economics 16 April 2020 2 min read
Last weekend’s historic OPEC+ deal to cut oil production was good news for the oil industry. So why have oil prices not improved?
It’s a bit like holding your breath in a cloud of smoke. It helps, but you still need to get clear of the smoke and recover. In this case, the smoke is the large drop in oil demand brought on by the COVID-19 pandemic.
The OPEC+ deal calls for a voluntary production cut of 9.7 million barrels per day (mb/d) in May and June. The level of the cut then falls to 7.7 mb/d for the rest of the year and to 5.8 mb/d out to April 2022. At about 10 per cent of total global output, this is the largest production cut in history.
It is not, however, enough to rebalance the market. The problem is that oil consumption is down by an even greater amount. Estimates vary, but current oil demand has likely fallen by over 20 mb/d.
All that extra oil is piling up in the world’s storage tanks, oil tankers and pipelines. The OPEC+ deal and reduced output in other countries (mostly the United States and Canada) will buy us some extra time before we run out of storage space. Again, estimates vary, but it looks like the cuts will give us until sometime in June before global storage capacity is maxed-out.
At that point, prices will fall and production will be involuntarily shut-in while we wait for global oil demand to get back up to its pre-pandemic levels.
It’s an ugly scenario. The light at the end of the tunnel is that, if the pandemic recedes by mid-year, oil demand will start to recover this summer and the supply cuts will help drain the glut of oil in storage. How many Alberta oil companies and jobs will survive between now then is a big question with a federal aid package à la support for the auto sector during the Great Recession a critical, but still unclear, factor.
A note on COVID-19: The COVID-19 pandemic is having a major impact on the economy here in Alberta and around the world. The Owl will report on these impacts when good information is available while continuing to track regularly scheduled releases of economic data and long-term trends. Please go to atb.com for COVID-19-related updates from ATB Financial.