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Opec: more of the same

Extending the cuts for nine months is designed to kill off the stock glut, but the pledge to keep going will buoy tight oil

Opec and its partners outside the group are sticking with the plan, convinced they will succeed in eliminating the global stock glut. But in extending their deal for nine months, to end-March 2017, they have accepted the market's judgement: the rebalancing process will take longer than they wanted or expected. Had they ended the deal as planned at end-2017, Saudi Arabia's oil minister Khalid al-Falih said, Opec's producers would have added "a large slug" of supply to the market, creating another hefty stock build.

Oil ministers also discussed deeper cuts in the meeting, in Vienna on 25 May, as well as a 12-month extension. But new quotas would take weeks of preparatory negotiations, which haven't happened. Iraq and possibly Iran would resist.

Yet by allowing that bullish idea to float into the market, Opec raised some expectations. When it became clear on the day that the cuts would remain at 1.2m barrels a day (and about 0.6m b/d from non-Opec), prices dropped, losing about 2% before the meeting concluded. After the news was confirmed, the drop reached almost 5%-Brent breaking through $52 a barrel and WTI falling towards $49/b.

Having engineered another sell off, Opec kept up with its recent tactical efforts to talk up prices. Falihwho said in recent weeks the kingdom would do "whatever it takes" to restore market balanceexuded confidence that another heave from Opec would do the trick. "All indications are solid that a nine-month extension is the optimum and should bring us within the five-year average by end of year," he said in the press conference afterwards, referring to the surplus in OECD stocks to its historical range.

He said, too, that the ministers had empowered Opec's compliance-monitoring committee to "evaluate the level of conformity, look at market fundamentals, assess where we are and recommend if necessary to make any adjustments". He reiterated: "we will do whatever is necessary". This would "certainly" include extending the cuts again if the fundamentals justified doing so, he said. As for the market's swift sell-off after the meeting, Falih said he wouldn't pay attention to "knee-jerk reactions".

Russia also made its commitment plain. Although it has not fully delivered on the 300,000-b/d cuts it promised, energy minister Alexander Novak, sitting next to Falih, presented the cooperation with Opec in terms of restoring "stability" to the oil market.

To achieve this, Opec and its partners are relentlessly focused on inventoriesand Falih's urge to see the OECD's stockpile drop back to the five-year average. The nine-month extension would achieve this, he insisted. Analysts tend to agree, saying that, all being equal, the Opec cuts are enough to eliminate the overhang, probably in the first quarter of 2018 if not sooner.

Shale surge

But all might not be equal. For all Opec's attention to the OECD stockpile, it seems oblivious to the impact its price-support cuts are having on the US oil sector, where production is surging.

Barclays's head of energy commodities research, Michael Cohen, said he expected Lower-48 onshore output would rise by 1.2m b/d this year. But his forecast could undershoot 300,000 b/d, he said. A consultant specialising in tight oil said outside the Opec headquarters on 25 May that if the group succeeded in keeping oil prices around $50, shale supply would rise by 100,000 b/d per month for the next 18 months.

By contrast, Opec's most recent forecast expects tight oil producers to add just 0.614m b/d in 2017.

While accepting that the stock glut will take longer to clear than it thought, Opec has also lowered its price expectations. Last year, talk was of a price recovery, or "stabilising oil prices at a higher level". At this meeting, the cuts' purpose is to keep another slump at bay.

Nigeria's oil minister, Ibe Kachikwu, tweeted on 25 May that if Opec members observed their quotas, prices "should stay along the $50 range". If so, it's a price that will do enough to please other producers but little to increase Opec income.

As for the nine-month extension itself, the extra three months (added to what was expected originally to be a six-month rollover), are largely meaningless. The group will meet again after six months and will assess what it needs to do then.

Assuming the cuts last the distance, it means Opec still needs to figure out an exit plan. If tight oil supply grows as quickly as analysts now expect, the expiry of the Opec deal at the end of March 2018, implying the addition of Opec's 1.2m b/d, could overwhelm balances again.

Opec thinks by then demand will have cleaned up some of the excess tooFalih pointed to a range of consumption-growth forecasts, as high as 1.6m b/d. But more likely is that Opec will, in nine months, face the same scenario that it faced today in Vienna. It will have to decide if it wants to keep restraining supply, or even deepen its cuts, to stave off a price collapseall the while conscious that any price support will simply give Texan drillers the confidence to keep pumping more oil.

Above all, the meeting on 25 May has given no detail on how Opec will end its cutsthough Falih told journalists this should "not be interpreted that we will not have a strategy". Opec would not "abandon the market" but would decide nearer the date what to do.

Although the extension of the deal might help draw down stocks in the second half of 2017, Barclays's Cohen says the lack of clarity about an exit strategy could end up being bearish. "If Opec does not manage the message clearly when and at what pace its oil will return, it risks sustained oil-price weakness as market participants price in a surge in eventual Opec output when the deal ends."

The extension Opec has agreed now also has the effect of a put. The group has shown its willingness to keep cutting if stocks don't clear as quickly as it wishes. To producers in North America this will be taken as a greenlight to pump at will, even if this inflates stocks and weakens prices-they can assume that Opec, so consumed with its plan to bring down the inventory, will just make more room for their crude.

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