Analysis-Why the oil market is tight despite big OPEC+ output hikes

By Robert Harvey, Ahmad Ghaddar and Seher Dareen

LONDON, August 7 (Reuters) -OPEC+ oil producers have used high summer demand to launch their first output increases in three years, but those targets have proved difficult to hit, leaving the market surprisingly tight.

On paper, the world's largest group of oil-producing countries should be pumping an extra 2.5 million barrels of oil a day in September versus March, but the data shows that is not likely to happen.

The reason is twofold, with some countries finding it hard to pump more, while others are being instructed by OPEC+ to hold back, as punishment for producing above their quotas in the past.

"Iraq and to a lesser extent Russia are compensating for past overproduction and Kazakhstan was already producing at maximum capacity back in March," said Jorge Leon, a former OPEC official who now works as head of geopolitical analysis at Rystad Energy.

"So the higher quota does not imply higher production."

Piling on production month after month might have been expected to lower oil prices, yet Brent crude futures have risen to around $68 a barrel from a 2025 low of $58 in April.

It is also notable that prompt prices are now higher than those for six months out, a market dynamic known as backwardation.

The prompt premium is justified because rising refinery processing rates and summer demand from power plants in the Middle East are absorbing the OPEC+ hikes, said Energy Aspects analyst Richard Price.

"The market is still tight on the prompt."

The first-month Brent oil futures contract early this month was trading at a premium of $2.74 to that for delivery in six months, whereas in early May it was at a small discount and a 2025 low.

In addition to higher Middle East demand to power summer air conditioning, China has been adding to its inventories.

China's crude oil stocks rose by 82 million barrels or almost 900,000 bpd in the second quarter, according to the International Energy Agency.

"Chinese oil demand has been better than many expected at the start of the year," said UBS analyst Giovanni Staunovo. "Chinese stockpiling activity has also played a role in keeping crude prices supported."

The OPEC+ increases have also come at a time of low stocks in Organisation for Economic Co-operation and Development (OECD) developed nations, a legacy of earlier OPEC+ cuts, a trend that tends to support prices.

"Over the past three years, OECD crude inventories have stayed consistently low, especially in the U.S.," said Homayoun Falakshahi, analyst at Kpler.

European oil stocks were almost 9% below their five-year average at 394 million barrels in May, according to OPEC data published in July, while U.S. commercial crude stocks in June were also below their five-year average at 419 million barrels.

OPEC+ officials have pointed to those low levels as evidence the market needs its increased barrels.

THE OPEC+ EIGHT

OPEC+ has introduced various output curbs since the pandemic slammed demand, forcing producers to throttle back on oil no one wanted.

The tranche of cuts it started to unwind in April involve just eight members - Saudi Arabia, Russia, Iraq, UAE, Kazakhstan, Kuwait, Oman and Algeria.

Between April and June they pledged to increase output by 960,000 bpd - a net 730,000 bpd including required cuts - yet OPEC data shows they achieved an increase of only 540,000 bpd.

The production data also shows Saudi Arabia accounted for more than 70% of the net increase.

Exports rose by just 460,000 bpd from March levels, according to data from analytics firm Vortexa, while world demand grew by an estimated 1 million bpd, according to the International Energy Agency.

Saudi effectively accounted for all of the increase, as it boosted exports by 631,000 bpd over the March-June period while shipments from Russia, Iraq, Kazakhstan, Kuwait and Oman fell, Vortexa data showed. Saudi acknowledged that it exceeded its June quota but explained that much of this went into its storage at home and abroad.

Exports from Gulf producers typically dip in the summer months because of their own increased summer demand for air conditioning.

"The market is telling you it's tight. OPEC announcements need to result in more exports, when we see exports, the market will start to correct," said one veteran crude trader regarding current oil prices.

TARGETS VERSUS ACTUAL

The current gap reflects in part limited production capacity outside of Saudi Arabia and the United Arab Emirates. Russia, for example, has struggled with Ukrainian attacks on its energy infrastructure.

Yet in their monthly meetings to set output levels OPEC+ member states continue to seek higher quotas, even if immediate delivery is problematic, as they can use that extra allowance in the future should their actual capacity rise or OPEC+ request fresh curbs.

On August 3 OPEC+ agreed a further increase for September while curbs on members for past overproduction are scheduled to run until next June, ranging in total size per month from about 200,000 to 500,000 bpd."Similar to the previous months, I expect the effective volume increases to lag the quota increases," said Staunovo at UBS.

By September the OPEC+ eight aim to increase output to 32.36 million bpd versus output of 30.80 million bpd achieved in March.

(Reporting by Ahmad Ghaddar, Robert Harvey and Seher Dareen in London; editing by Alex Lawler, Simon Webb, Dmitry Zhdannikov and Jason Neely)