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OPEC+ and Russia’s ‘no deal’ shocks the oil markets

The oil markets were shaken further on 6 March and oil prices plummeted after talks between Opec+ and Russia on whether to cut oil production in the wake of the coronavirus outbreak collapsed, with no agreement made. Russia rejected calls to cut production by a proposed 4%. Although Saudi Arabia had backed proposals to extend production cuts to the end of the year, Saudi Aramco announced plans to cut prices and boost production to 12.3mn b/d just days after the talks failed. Oil prices subsequently fell by some 30%. The market is now facing the prospect of unrestrained production once the current Opec+ agreement expires at the end of March.

Commenting on the news, Espen Erlingsen, Rystad Energy’s Head of Upstream Research, said: ‘Without OPEC+, the global oil market has lost its regulator and now only market mechanisms can dictate the balance between supply and demand.’

Meanwhile, Wood Mackenzie’s Senior Vice President, Corporate Upstream, Tom Ellacott noted that: ‘The price collapse could be the trigger for a new phase of deep industry restructuring – one that rivals the changes seen in the late-1990s.’

He continued: ‘This is not the first time we’ve seen a price war – the last was as recently as 2015/2016.  But this time, oil demand is also weak as the coronavirus outbreak depresses global economic growth. The macro-economic backdrop is completely uncharted waters for oil and gas companies.’

However, Ellacott noted that the oil and gas industry’s financials are in much better shape, thanks to the actions taken following the last price collapse. ‘At current activity levels, we estimate that many companies need an average Brent price of $53/b to break even in 2020, including dividends at expected current levels and announced buybacks.’ But gearing levels remain high for many players, limiting their ability to absorb any sustained oil price weakness through the balance sheet. Indeed, Wood Mackenzie estimates that up to $380bn of cash flow would vanish from forecasts if Brent prices average $35/b for the remainder of the year. This represents an 80% drop relative to a continuation of the $60/b it has averaged year-to-date.

Fraser McKay, Head of Upstream analysis, said: ‘Sustained prices below $40/b would trigger a new wave of brutal cost cutting. Discretionary spend would be slashed, including buybacks and exploration. But given the lack of excess in the system, the cuts to development activity will be necessarily fast and brutal. US tight oil development activity, though not as flexible as many believe, will react immediately. Unsanctioned conventional projects will also be delayed, and in-fill, maintenance and other spend categories scaled-back.’

Ellacott added: ‘More highly leveraged players will be forced to make the deepest cuts to stave off bankruptcy… There is much less obvious excess spend to cut this time around after five years of disciplined investment and austerity. Raising capital is also much harder now, especially for US independents, and upstream M&A market activity is at record lows. In addition, many companies have already made most of the obvious asset sales.’

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