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Tight oil's surge poses a familiar dilemma for Opec

The rebalancing effort is on shaky ground. To keep cutting is a problem but to stop might be just as bad

American tight oil growth has surprised Opec again. The group's own forecasts for non-Opec supply have been well short of the reality. When Opec's secretariat publishes its market report next week expect another upgrade. But a change of policy is unlikely. Each option is fraught.

The latest forecast, from February, predicted non-Opec supply would rise by 1.4m barrels a day in 2018. It was wishful thinking. The Energy Information Administration says US supply on its own will rise by that much, to say nothing of Brazil, Canada, Kazakhstan and others. In Houston for CERAWeek, the International Energy Agency's chief Fatih Birol said non-Opec would meet most of the world's extra demand needs over the next five years. The US' secretary for the interior Ryan Zinke, sharing a stage with Saudi Aramco's chief executive, thanked Opec for "making American energy great again".

Opec's effort to rebalance the market has been impressive but is now coming up short. Stocks have fallen sharply in the past year-a result of the cuts. Brent at $64 a barrel is 34% above the price in mid-2017another result of the cuts. But the main outcome is not as planned. The price rally has ended, Opec's market share is falling, the forecast call on its oil is getting smaller, and only its rivals are thriving.

Can't stomach more cuts…

The choices for the group aren't easy. In theory, it could cut more deeply to clear the stock overhang and have done with it. This would lift the price and add more support to non-Opec producers, even putting some new long-lead projects, like the oil sands or deep water, back into the mix. In the short term, if shale producers just filled the bigger gap created by Opec, the tactic wouldn't work either. The spectre of the early 1980s disaster—when Opec kept cutting only to prop up rival production—is still in the institutional memory. None of the cutters yearn for more medicine.

The other choice is back to Naimism; to open the taps again and sweat out the rivals. Why should Opec keep cutting just so non-Opec producers can take advantage? What's the point of being the low-cost producer if you can't squeeze rivals?

Four problems get in the way of this. First, Saudi Arabia wants a higher oil price to help the valuation of Aramco ahead of an IPO. (John Kemp wrote a good column about this.) This puzzles many people, who say current oil prices aren't decisive for corporate valuations. Still, that's what Saudi officials keep telling people, including other Gulf producers. As long as the IPO is in the (increasingly distant) future, it will affect Saudi output policy.

Second, as Bassam Fattouh, of the Oxford Institute for Energy Studies, and BP chief economist Spencer Dale wrote recently, the old low-cost-producer paradigm is meaningless for some Opec producers these days. Too many need high oil revenues to fund bloated statist economies. Another period of falling prices wrought by a supply free-for-all would be painful and even politically risky.

…Can't risk a market grab 

Third, unrestrained supplyanother market grabmight destroy some Opec members. Even if Gulf producers could cope with plunging oil revenue (by running deficits, borrowing more heavily or taxing citizens), several others couldn't. If Venezuela's plight is desperate now, imagine it at $30 a barrel. The impact of another price collapse would be somewhere between devastating and deeply troubling for Nigeria, Libya, Angola, Iran and Iraq, as well as the non-Opec cutters that have joined the Opec effort.

The fourth problem is that opening the taps wouldn't restore all the supply that was cut. Venezuela has shed a whopping 600,000 b/d since the cuts began—and not because it wanted to. The losses from some non-Opec participants, like Azerbaijan and Mexico, could not be brought back quickly. Petroleum Economist estimates that of 1.8m b/d cut from supply, about 1.4m, at best, could return—more than half from just two countries, Russia and Saudi Arabia, with Gulf producers offering most of the rest. But this depends on Saudi Arabia pumping above 10.5m, a level that begins to stress Aramco's system, according to analysts familiar with the kingdom's oil sector.

In short, if tight oil's startling rise—way faster and much bigger than Opec expected—is about to kill off the rebalancing effort, Opec faces a question to which all the answers look politically painful and economically risky. Double down or give up?

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