On Sunday, the OPEC+ coalition of major oil producing nations announced a major production cut with the goal of reducing the oil supply by 9.7 million barrels per day (mmbd) in May and June. It took a week of tough negotiations to achieve this historically large supply reduction. It is expected to be accompanied by a further 3.7 million barrels per day of production cuts by the US, Canada and other nations, reflecting reduced supply in reaction to weaker global demand.
The market reaction was muted and oil prices retreated on Monday morning. The simple fact is that financial markets are forward looking, so an announcement of roughly a 10 million barrel per day reduction was already priced in to the value of crude. Moreover, there is widespread acknowledgement that the supply reduction pales in magnitude to the dramatic plunge in global demand. For example, US petroleum consumption was averaging around 21 million barrels per day in 2019, but it has fallen to around 14.5 million recently. America typically accounts for roughly 20 percent of world oil consumption.
Goldman Sachs Group Inc. described the outcome as “historic, yet insufficient”. And, we agree. Oxford Economics is estimating that about 64 percent of the world economy is in lockdown to contain and stomp out COVID-19. Oil inventories are likely to rise until the global economy comes out of its government-enforced shutdown. And, inventory capacity is limited.
Andrew Botterill, Deloitte’s National Oil and Gas Leader, and I coordinate our energy and Canadian economy forecasts. Andrew’s take is, “the market knows that there is just no way to cut enough given the massive demand destruction. The globe will continue to fill storage in the coming months, and Canadian prices will continue to see tough circumstances being so firmly committed to the US market that has also seen amazing demand decreases. Oil and gas companies are going to make dramatic production decreases and layoffs in the coming weeks to try and battle these huge price differentials.”
Our current economic forecast anticipated that OPEC would come to its senses and cut supply, while other countries would scale back production. We have assumed that low oil prices will persist through the summer and rise late in the year, but with West Texas Intermediate crude oil only recovering to the US$35-39 range by year end. This weak oil price outlook contributes to the near-5 percent contraction in the Canadian economy, with oil-producing provinces Alberta, Newfoundland and Labrador and Saskatchewan experiencing an even greater recession. The national recession will be almost double that in 2008-09, while Alberta will experience something like the combined contraction in 2015-2016.
On the public health front, our Deloitte Recovery Dashboard is showing sign that the curve of net cases is being starting to be bent in Canada – particularly in Western Canada. This is encouraging and we expect the trend to broaden over time. It will still take time before the containment efforts can be relaxed, but now is time for policymakers and businesses to prepare for that eventuality.
On a more concerning note, President Trump said today that it is his decision about when to reopen the US economy. Legal experts disagree, as under the 10th Amendment of the US Constitution, state governments have power to police citizens and regulate public welfare. Developments in the US’ approach to the pandemic have a fundamental impact on the Canadian economy and to businesses that operate on both sides of the border. We are hoping that a political debate between levels of government will not decide when to return to work. Mixed messages to American businesses would also not be desirable. It is essential that containment not be relaxed too soon, leading to a potential second round of infection. The politics of who determines when containment gets relaxed may not turn out to be an issue, but can influence our perspective on the future of the economy. To prepare for any eventuality, we are currently modeling scenarios where Canada and the US are both successful on containment in parallel to one another, but also considering scenarios where Canada is successful and America has a more difficult time.
