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Opec's narrowing options

An extension to the cuts may not help the group as much as it helps Texas

Opec meets this week in Vienna and for all the back-slapping about record-high compliance with its cuts, things are not going in the group's favour. Opening the taps, as it did in late 2014, brings weak prices and intolerable fiscal pain. Tightening supply, as it has done since January, can stop another price collapse but in reality it just subsidises American shale. For now, Opec is sticking with the second of the two bad options. Texas will be pleased.

Surprises are unlikely at the meeting on 25 May. All Opec's signals to the market have been to expect a rollover of the cuts, possibly for another nine months (instead of six) or even a full year. Venezuela, as ever, would like everyone to slash more supply, but that seems unlikely. Although Saudi Arabia's oil minister Khalid al-Falih has said he will do "whatever it takes" to help bring balance back to global supply and demand, the kingdom doesn't want to shoulder yet more of the burden, especially when its rivals Iran and Iraq remain such ambivalent cutters. A rollover is the best outcome. The meeting in Vienna might be mercifully briefsome members of the Saudi delegation, including the minister for energy affairs, prince Abdulaziz, are said to not even be attending.

The outcome and the communiqué will matter to the oil market, of course, but price direction for the rest of this year will be set elsewherein Texas, on Wall Street, in North and West Africa, and by the world's fickle consumers.

Opec's main achievement after six months has been to prevent another collapse in the price. Global demand was weaker than expected in the first quarter, so keeping Brent around $50 a barrel took some doing. Compliance with the cuts was high96%, according to the International Energy Agency (IEA). The non-Opec cutters did less well, removing more than half (369,000 barrels a day) of the 0.558m b/d pledged. Russia promised 300,000 b/d but had cut just 231,000 b/d by April. It will endorse the extension.

What the cuts have not done, yet, is drain a global surfeit of stocks. The much-touted rebalancing of the marketOpec has said repeatedly in the past two years that it is nearingremains ever distant. The group's narrative until recent weeks was about another heave in the cuts to bring balance by end-2017. Now the willingness to extend the cuts into 2018 suggests another delay. No wonder: Falih wants OECD oil inventories to fall back to the five-year average but in March the surplus remained 276m barrels above that target. The IEA says stocks might have risen again in April.

Swinging shale 

What the cuts have done, though, is nourish America's oil patchand far more quickly than Opec expected. The modest price gains the group's cuts engineered this year have restored cash flow for these drillers, revived moribund firms and allowed canny ones to hedge production. Wall Street has opened its purse again. And provided Opec keeps sacrificing some of its oil supply to buoy America's, shale output could deaden the impact of the cutson the price and on stock levels.

The scale of the American recovery will shock Opec again. Although it raised its forecast for tight oil growth this year (to 0.614m b/d), the group is still probably undershooting. Between April and May, the main shale basins in the US added 124,000 b/d , a huge leap in just one month. Since October last yearwhen news of Opec's plan to cut helped spark more activityAmerican producers have lifted output by 0.8m b/d. A recent analysis by the CME Group calculated that the 174 rigs added in the US over the past four months "could easily add" another 0.6m b/d of production by the end of Q3.

And Opec's own non-cutting members are also making hay. Libya has increased its production by almost 400,000 b/d in the past six weeks. Nigeria's rose by 80,000 b/d in April, but the longer the truce lasts in the Niger Delta the better its chances of restoring up to 0.6m b/d of lost output capacity. Vessels are loading crude from the Forcados terminal, the resumption of which should on its own increase Nigerian exports by 200,000 b/d.

If the extra supply potential this year isn't enough to undermine Opec's efforts, demand might. The IEA still expects 1.3m b/d of growth this yeara baseline outlook used by countless analytical models to show when OECD stocks might return to normal levels. But the weakness in Q1 is troubling. Growth for that quarter was just 1m b/d year-on-year. For the whole year to reach the 1.3m b/d annual increase means the Q1-Q4 rise will be 2.6m b/d, says the agency. But in the past few years the average has been just 2m b/d.

This bearish scenariotight oil plus Libya plus Nigeria plus tepid demandisn't inevitable. A strong driving season in the US would perk up the outlook, for example, and much refining capacity should come back on line soon to soak up some of the supply excess. But Opec's problem these days is that too many factors are beyond its control, starting with those resilient Texan drillers. In an era when Baker Hughes can snuff out a rally by updating its rig-count spreadsheet, the market force is not with Opec.

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