Saudi Arabia and Russia have called a truce in their oil price war, partly in response to the U.S. president’s intervention. They agreed to restore balance to an oil market ravaged by the collapse in demand due to the coronavirus pandemic and a surge in supply well beyond the requirements of a weak market.

The two oil giants stepped back from a bruising tussle that sent global oil prices tumbling in the largest drop since the 2008 global financial crisis, causing collateral damage to global financial markets already weakened by the slowdown in business activity and trade. Indeed, such is the surplus that U.S. benchmark crude West Texas Intermediate futures for May delivery fell below zero for the first time ever on April 20.

The de facto co-leaders of the OPEC+ group called an April 12 emergency virtual meeting, just weeks after a Vienna gathering in early March ended in disarray over Russia’s refusal to cut its production in response to a dramatic slump in demand. Moscow adopted a wait-and-see approach rather than trim output further and allow U.S. shale oil producers to benefit at its expense. OPEC had proposed a further production cut of 1.5 million barrels per day (mb/d), which in retrospect seems like a drop in the ocean given the scale of the demand destruction revealed in recent data.

The 23 oil producers of OPEC+ decided to administer shock treatment. They agreed on April 12 to cut their collective production by 9.7 mb/d, an unprecedented reduction that was nearly thwarted by Mexico, which finally agreed to a much smaller output reduction with the United States offering to pick up the slack. Other producers not party to the OPEC+ cooperation agreement, including the United States, set aside their antipathy to cartels and threw their weight behind the deal with voluntary cuts, although these too fell short of a full pledge.

A meeting by teleconference of G-20 energy ministers held on April 13 under Saudi Arabia’s 2020 presidency gave indirect support to the OPEC+ effort without specifically endorsing the deal. A communique issued by the G-20 referred to recognition of “the commitment of some producers to stabilize energy markets.” However, during the G-20 energy talks, there was discussion by other oil producers regarding their contributions. As prices have collapsed, the world’s biggest international oil companies have announced cuts in spending. These, along with the deteriorating economies of some producing areas, will result in supply reductions through attrition.

U.S. Energy Secretary Dan Brouillette told G-20 ministers that U.S. oil production might fall by nearly 2 mb/d, or 10% of output in 2020.

The International Energy Agency, in a departure from its longstanding policy of non-interference in markets, is encouraging some of its members to stock up on oil to help absorb the surplus.

U.S. President Donald J. Trump, who was instrumental in bringing Saudi Arabia and Russia back to the negotiating table, was quick to take to Twitter to congratulate the Saudi and Russian leaders for what he called the “big oil deal.” The OPEC+ agreement, he said, would save hundreds of thousands of jobs in the United States, workers in the U.S. oil industry, and particularly the shale oil patch, where some damage has already been done by the collapse in oil prices. The U.S. Energy Information Administration, in its Short Term Energy Outlook published before the OPEC+ meeting, said it expected the first annual decline in U.S. oil production since 2016. It also forecast that the United States would “return to being a net importer of crude oil and petroleum products in the third quarter of 2020 and would remain a net importer in most months through the end of the forecast period.”

Until recently, the U.S. administration was considering anti-cartel legislation directed at OPEC. That it would now join a collective effort to manage the oil market points to the exceptional circumstances that have upended market fundamentals. Even with an agreement that will remove some 10% of global supply, the market remains on shaky ground. The impact of the agreed cuts, which may reach 20 mb/d, should voluntary contributions and purchases for stockpiling kick in, is unlikely to be felt immediately given that Saudi Arabia and its Gulf Arab allies ramped up production to historically high levels in April. That oil is on the water headed to markets saturated with oil and inventories brimming with petroleum products.

When presenting the IEA’s latest Oil Market Report on April 15, its Executive Director Fatih Birol told reporters that April may yet go down as the “worst-ever month for the oil industry,” with demand in April at a staggering 29 mb/d below 2019 levels, the lowest since 1995. Overall demand for the whole of 2020 is expected to fall by 9.3 mb/d year-on-year, erasing a decade of growth. The IEA expects oil supply to fall by a record 12 mb/d in May when the OPEC+ agreement is implemented.

The market’s response to the OPEC+ agreement was not encouraging. Global benchmark Brent blend crude oil futures, which had recovered slightly to trade above $30 per barrel (/bbl) in the run-up to the OPEC+ meeting, fell after the deal was announced, signaling that traders considered the reduction inadequate, given the expectation of a much larger drop in demand. The North Sea’s Brent blend crude oil was trading either side of $28/bbl on April 17, down from just above $31/bbl on April 12. By April 21, it had fallen below $20/bbl, shedding more than $50/bbl since early January. U.S. WTI crude futures went into sub-zero territory on April 20, one day before the May front month contract was due to expire, largely on the back of a lack of storage for physical delivery of barrels into the contract. The contract fell to a record low of minus $40/bbl before recovering slightly before the market’s close.

This less than enthusiastic market response prompted Saudi Arabian Energy Minister Prince Abdulaziz bin Salman and Russian Energy Minister Alexander Novak to hint they would be ready for further action if required. The two countries will “continue to closely monitor the oil market and are prepared to take further measures jointly with OPEC+ and other producers if these are deemed necessary,” they said in a joint statement after an April 16 telephone call.

OPEC insiders believe oil prices will start to recover in May and are calculating that the cumulative cuts, including voluntary reductions by the United States, Canada, and Brazil, plus promises from some G-20 countries to buy oil for strategic stocks, may amount to 19.5 mb/d.

OPEC, in its Monthly Oil Market Report published on April 16, also forecast a significant drop in demand but by a slightly smaller number than the IEA projection. It sees oil demand falling by 20 mb/d in April and by 6.8 mb/d for 2020 as a whole.

The OPEC+ agreement comes into effect on May 1 and is a sliding scale of reductions over two years. The 9.7 mb/d reduction will be in effect until June 30, after which the group will adjust supply by 7.7 mb/d from July to December. From January 2021 to April 30, the group pledged a 5.8 mb/d reduction. The baseline for calculating each country’s share is October 2018 production levels, except for Saudi Arabia and Russia, which were given the same baseline of 11 mb/d.

Because Saudi Arabia and its Gulf Arab allies Kuwait and the UAE are producing above the baseline figure, the cumulative cut by the OPEC+ will be higher. Saudi Arabia supplied 12.3 mb/d to the market in April, so by taking its production down to 8.5 mb/d from May 1, it will effectively deliver a 3.8 mb/d reduction. Altogether, the total adjustment from the OPEC+ will rise to 12.5 mb/d as the three scale back their output to agreed levels. As always, much will depend on the level of compliance by all parties to the agreement. OPEC+ ministers will meet via videoconference on June 10 to determine whether further action is needed.

Citi Research, in an April 12 analysis provided to subscribers of its Global Commodities Focus, noted that “the cuts are too little but not too late.” It said the timing of the agreement means it is too late to prevent stocks from surging above one billion barrels between mid-March and late May and prevent spot prices from falling into single digits. While the agreed cuts are massive and unprecedented, they will likely do little to stem a dramatic price collapse in the weeks ahead, its analysts said. “However, they should equally dramatically positively affect fundamental balances and oil prices for the rest of the year, even if there is slippage on the producer side….” The report sees a rebalancing of markets shortly into the third quarter of the year as demand recovers, and oil is drawn from inventories. It expects prices to recover to the mid-40 dollars a barrel or higher by year-end.

It is difficult to predict the next move by OPEC+, considering the continued uncertainty surrounding the coronavirus pandemic and a looming global economic recession. Prince Abdulaziz, speaking to a select group of journalists after the deal was concluded, refused to speculate on what action may or may not be required in the months ahead.

The IEA said in its April Monthly Oil Market report that while measures by OPEC+ and the G-20 countries would not rebalance the market immediately, by lowering the peak of the supply overhang and flattening the curve of the stock build, they would help a “complex system absorb the worst of the crisis.” It expects a gradual recovery starting in June, although demand would still be some 15 mb/d lower than the previous year.

The cuts in production both by OPEC+ and voluntary action being considered by some G-20 countries would impact the market in three ways. The initial OPEC+ cut would provide immediate relief from the supply surplus in the coming weeks and cap rises in inventories. Further, the United States, China, South Korea, and India have offered their strategic storage capacity to industry to store unwanted barrels or are considering increasing their strategic stocks to take advantage of lower prices. The IEA added that it was still waiting for more details on planned production cuts and the use of strategic storage. Other producers, with the United States and Canada likely to be the biggest contributors to supply cuts, could see output fall by around 3.5 mb/d in the coming months, due to the impact of lower prices, according to IEA estimates.

“The loss of this supply combined with the OPEC+ cuts will shift the market into a deficit in the second half of 2020, ensuring an end to the build-up of stocks and a return to more normal market conditions,” the IEA also said in its April report. It cautioned there might be some limits to how much a saturated market and already stretched storage infrastructure could accommodate.

“Never before has the oil industry come this close to testing its logistics capacity to the limit,” the IEA said.

The April IEA report pointed out to the G-20 ministers that although low prices may be good for consumers, “they are of little benefit to the approximately four billion people living under some form of the coronavirus lockdown.” Furthermore, low prices threaten the stability of an industry central to the functioning of the global economy.

Even with demand falling by a record amount this year, oil companies still face the challenges of investing to offset natural production declines and to meet future growth, said the IEA. It sees global spending by international oil companies in 2020 likely to drop by around 32% to $335 billion, the lowest level in 13 years.