Supply Shocks – Saudi Arabia

GCC spare capacity doesn’t solve shocks—means no cushion for future disruptions

Trevor, partner at RHG, visiting fellow at the Peterson Institute for International Economics in DC, adjunct lecturer at the City College of New York, member of CFR; Shashank, leads the development and management of RHG's eocnomic models and quantitative tools, MPA from School of International and Public Affairs at Columbia University , "Can the Saudis Save the Oil Market?" 1/17/12rhgroup.net/notes/can-the-saudis-save-the-oil-market, AD 3/29/12

With more GCC spare capacity than total Iranian supply, what’s the problem? First, while there is a high degree of market confidence that Saudi Arabia’s can increase and sustain production from the current 9.8 million to 11-11.5 million barrels per day, there is considerable doubt about the Kingdom’s ability to effectively tap the remaining 500,000-1,000,000 bpd of capacity. The Kingdom is already testing historic highs in terms of overall oil output, and reaching the upper end of current production capacity will likely yield heavier and higher sulfur crudes that are poor substitutes for Iranian supply. More important, however, is the impact a significant increase in GCC output on the oil market’s ability to weather additional supply shocks. There is an inverse correlation between GCC spare capacity and global oil prices (Figure 2). In the short-term, non-OPEC supply is relatively fixed. So the market balances either through an increase in OPEC output, a reduction in demand through higher prices (demand rationing), or some combination of both. If the GCC pumps more oil to replace Iranian supply the market will have to rely on demand rationing should any number of other supply disruptions occur during the coming year. And with increased security concerns in Iraq, continued civil strife in Nigeria, oil transit disputes in Sudan and production problems in the North Sea, there is no shortage of potential supply-side risks on the horizon. Lower GCC spare capacity leaves the market more exposed to demand shocks as well. In their last oil market report, the IEA marked down their global demand estimates for 2012 by 200,000 bpd, primarily on the back of economic weakness in the Eurozone. OPEC followed suit in their January report out yesterday. Should EU growth surprise on the upside, or Chinese growth not slow as quickly as expected, there would be little room to increase OPEC output.

OPEC spare capacity insufficient –Saudi Arabia can’t increase production

Robert McNally is the founder and president of the Rapidan Group, a consulting group specializing in energy markets and policymaking. He has previously served as an oil market analyst with Energy Security Analysis, a market and policy analyst for Tudor Investment Corporation, special assistant to the president on the National Economic Council, and senior director for international energy on the National Security Council, MA in economics from Johns Hopkins, "Managing Oil Market Disruption in a Confrontation with Iran," CFR, Jan 2012, http://www.cfr.org/iran/managing-oil-market-disruption-confrontation-iran/p27171, AD 3/21/12

There is currently little margin for error in the global oil market. As an informal rule of thumb, oil market analysts believe that OPEC needs to hold at least 5 percent of global oil demand in “spare”— production capacity that is not normally used but that can be brought online quickly—in order to maintain stable prices. In today’s 90 mb/d market, that desirable spare capacity cushion is about 4.5 mb/d. According to the U.S. Energy Information Administration (EIA), OPEC’s spare capacity is 2.8 mb/d and will climb to about 3.9 mb/d this summer, which is deeply inadequate given the geopolitical landscape in 2012. Moreover, official estimates of OPEC’s spare capacity are probably inflated, and inescapably dependent on untested assumptions of Saudi total production capacity. Nearly all of OPEC’s spare capacity is held in Saudi Arabia; consequently, estimates of OPEC’s spare capacity hinge on how much Riyadh can produce relative to how much it is already producing. Saudi oil minister Ali Naimi has recently said Saudi Arabia holds roughly 2.5 mb/d in spare and that the Kingdom can produce a total of 12.5 mb/d.2 Many market participants, however, doubt that Saudi Arabia can produce that much oil. On an annual basis, Saudi Arabia has not produced more than 10 mb/d since 1981.3 Goldman Sachs estimates total Saudi capacity to be around 10.5 mb/d and other reports indicate Saudi Arabia could produce 11 mb/d only “if pushed.”4 In terms of current production levels, Saudi Arabia’s oil minister announced recently Saudi crude production is over 10 mb/d, similar to EIA’s estimate.5 If true, and considered alongside Goldman Sachs’ estimate of 10.5 mb/d in total Saudi production capacity, this would suggest Saudi spare capacity is just 0.5 mb/d (see Figure 1). Although EIA projects spare capacity will rise by over 1 mb/d by summer, a paucity of excess capacity leaves the oil market with precious little margin for error should Iranian supplies be disrupted. Moreover, the 5 percent spare capacity rule of thumb applies best when geopolitical conditions are calm, as they were through most of the 1990s, when OPEC’s spare capacity was about 5 percent and oil prices were relatively stable. Since 2003, however, OPEC’s spare capacity has been low and geopolitical disruption risks (including Iraq, Nigeria, Venezuela, Yemen, and Libya) have been high. Consequently, oil prices have been high and volatile. Given current and threatened disruptions, OPEC will need to hold more than 5 percent to reassure traders and stabilize prices. Achieving that comfort margin, however, is unlikely in the foreseeable future.

Reserves and fill-in ability questionable

M. Mahtab Alam Rizvi is Associate Fellow at the Institute for Defence Studies and Analyses, New Delhi, "Tougher US Sanctions against Iran: Global Reactions and Implications," 2/28/12 Institute for Defence Studies and Analyses, http://idsa.in/backgrounder/TougherUSSanctionsagainstIran_mmarizvi_28022012, AD 2/29/12

Saudi Arabia immediately offered its services to fill any supply gap that will emerge from the fall in Iranian oil exports due to the sanctions. It had similarly shored up oil supplies when Libyan oil became unavailable during military operations in 2011. The Saudi Oil Minister, Ali al-Naimi, said on January 7 that Saudi Arabia, the world’s largest oil exporter and the only one in OPEC with significant reserves to spare, was ready to meet any increase in demand.15 However, the Saudi claim to fill any supply gap is questionable. It is reported that nine out of the 21 oil fields in Saudi Arabia are declining. The largest oil field of Saudi Arabia and currently the largest conventional oil field in the world, Ghawar, which produced half of Saudi Arabia’s total oil production over the last 50 years, is declining.16 Yet, the IEA director for energy markets and security, Didier Houssin, has stated that “there are alternative supplies that can make up for any loss of Iranian oil exports,”17 given increased oil production by both the OPEC and non-OPEC countries in the second half of 2012. However, the IEA also warned that the growing tension between Iran and the West was causing the burden of rising oil prices on the global economy.