OPEC's production cut agreement won't stop the oil industry's free fall
Oil prices rose after news of a production cut agreement between the world's largest producers, but experts warn the move will not be enough to sustainably hold up prices or change the industry's bleak trajectory.
Driving the news: Crude futures jumped about 5% to near $25 a barrel for WTI crude after the OPEC+ alliance agreed to a 10 million barrels-per-day production cut beginning in May that ended a price war between Saudi Arabia and Russia.
- However, the COVID-19 outbreak has slammed demand to that point that experts believe a cut of 20 million to 30 million barrels per day will be needed to offset the loss in the roughly 100 million barrel-per-day market.
Why it matters: With oil prices expected to continue their fall, a tidal wave of bankruptcies, defaults and closures of U.S. oil-and-gas companies is likely in the coming weeks and months that will weigh on bond and equity markets as well as the broader economy.
What's happening: Almost 40% of oil and natural gas producers face insolvency within the year if WTI crude prices remain near $30 a barrel, according to a new survey from the Kansas City Fed.
- Even if oil prices rise to $40 a barrel — a nearly 40% jump from their current level — the percentage of firms expected to fall into insolvency only declines to 36%.
- The Kansas City Fed's survey mirrored results from the Dallas Fed last month.
Word on the street: "I don't know of any companies that can operate profitably at [$40 per barrel]," said one respondent to the Kansas City Fed's survey.
Yes, but: "Oil majors proved resilient to extreme price volatility during the last oil price crash and they have already announced similar measures to protect their cash flows during the current crisis," Moody's Investors Service said in a recent note.
Be smart: Energy companies are the biggest issuers of junk bonds, accounting for more than 11% of the U.S. high yield market.
- Even though the Fed has moved into purchases of some high yield bonds, much of the energy sector is highly levered and unlikely to meet standards for rescue from the central bank's ever-expanding world of asset purchases.
What to watch: Goldman Sachs analysts said they expect WTI crude prices will fall to $20 a barrel as downside risks overwhelm the near-term boost to sentiment.
- “Ultimately, the size of the demand shock is simply too large for a coordinated supply cut, setting the stage for a severe rebalancing."
Go deeper: A world locked down and drowning in oil