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Limited Spare Capacity Could Lead To An Oil Price Spike

Iraq oil production

Oil prices have continued to languish below $50 per barrel as a glut of crude oil and gasoline persist even as global demand continues to rise.

The IEA still predicts that oil consumption will expand by another 1.4 million barrels per day in 2016, while production stagnates. That dynamic suggests that the market is converging towards some sort of balance, although the speed with which that takes place is hotly debated.

But in the short-term the record levels of crude oil and refined products sitting in storage have prevented oil prices from rebounding. The U.S. had 525 million barrels of crude oil inventories at the end of August and 232 million barrels of gasoline. Both figures are sharply higher than the running five-year average and higher than even year-ago levels. And inventories are only down slightly from their peaks hit earlier this year. Until oil and refined product inventories start to draw down much more forcefully, oil prices will struggle to rise above, say, $50 per barrel.

 

(Click to enlarge)

While extraordinary levels of crude oil and gasoline inventories seem to point to a frustratingly oversupplied market, there is a case to be made that the world could soon suffer from the opposite problem.

Several oil analysts believe that the near record low for spare production capacity around the world actually suggests that the oil market is a lot tighter than it seems at first glance. “Yes, storage tanks are higher than they’ve ever been, but you’ve got to consider that collectively with how much spare capacity that you have,” said Jackie Forrest, vice-president of energy research at ARC Financial Corp., according to The Financial Post.

Most of the world’s spare capacity is located in Saudi Arabia, the one country that has the ability to substantially ramp up or down output over the course of a few weeks. But Saudi Arabia, in a battle for market share, ratcheted up production to a record high this summer, exceeding 10.6 million barrels per day, which dumped more supply on the market but left it with less spare capacity. OPEC as a whole has pushed output to a record high. The IEA and the EIA both estimate that OPEC’s spare capacity has dipped to just 1.4 million barrels per day, about half of what it was a few years ago and extraordinarily low by historical standards. The last time spare capacity was this low, it was between 2004 and 2008, a period of time that saw a dramatic run up in oil prices.

 

(Click to enlarge)

Meanwhile, investment in new sources of supply has come to a screeching halt because of the meltdown in oil prices. Wood Mackenzie estimates that the oil industry discovered the least amount of new oil in almost 70 years in 2015, and is on track to discover even less this year. The industry has also slashed spending by an eye-popping $1 trillion for the period between 2015 to 2020, ensuring that the pace of new discoveries will remain unimpressive.

This sets up a possibility in the next few years in which new supplies fail to come online because so few projects have been given the greenlight over the past two years. With global demand rising, the glut will flip to a supply deficit. Record high inventories will cushion the blow, but those will be burned off over time. Normally, OPEC could step in at that point with its spare capacity to provide some extra supply. But OPEC, and particularly Saudi Arabia, has already ramped up output to such high levels. Without the ability to provide additional supply in a pinch, the markets could tighten unexpectedly. And because new projects take time to develop, the supply response will take months and even years to be realized.

“If we do get into a situation where demand keeps growing but the investment isn’t there to add the supply that’s needed, the fact that there’s very little spare capacity I think will cause the market some concern,” Jackie Forrest of ARC Financial Corp. said, according to The Financial Post.

By Nick Cunningham of Oilprice.com

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  • AMILCAR GUILLERMO ZONCO on September 05 2016 said:
    SR NICK CUNNINGAN DE OIL PRICE.COM, ME PARECE MUY INTERESANTE SU OPINION SOBRE ESTE ARTICULADO EDITADO POR UD. PERO CREO QUE PECA DE ETNOCENTRISMO DE VERMONT PUES EEUU PUEDE TENER 525 MILLONES DE RESERVA Y 232 MILLONES DE GASOLINA PERO EN EL MUNDO SE COONSUMEN 95 MILLONES DE BARRILES DIARIOS Y EEUU CONSUME LA IMPORTACION DE 8,500.OOO
    MILLONES DIARIOS, EL 9% DEL CONSUMO MUNDIAL, QUE CREO QUE NO ES TAN DETERMINANTE COMO UD. LO PLANTEA, MAS QUE LA EPOCA DE CONSUMO DORADA DE EEUU, DE 20,800.000 DIARIOS YA HA PASADO Y HOY CONSUMO CASI 19000000 SEGUN MIS CIFRAS, ES DECIR VA DISMUYENDO EL PORCENTAJE MUNDIAL, IGUAL QUE EUROPA Y JAPON, AQUI QUIEN SIGUE CRECIENDO SU CONSUMO MUNDIAL ES EL SUDESTE ASIATICO A UN PROMEDIO DE 4,5% ANUAL, LUEGO LOS DEMAS PAISES EMERGENTES PERO EN MUCHO MENOR MEDIDA, POR LO CUAL DIFIERO SU APRECIACION DE QUE INFLUYA PARA QUE NO AUMENTE EL PRECIO COMO UD. SUPONE DURANTE LO QUE QUEDA DEL 16 Y EL CORER DE TODO EL 17. SI ESTOY EQUIVOCADO POR FAVOR ESCLARESCAME, PUES POR EL LADO DE LOS PRODUCTORES LLÁMENSE OCDE U OPEP TODOS VIENEN CUESTA ABAJO, SIN EXCEPCIONES, CANADA, EEUU, MEXICO, COLOMBIA, VENEZUELA, NIGERIA, LIBIA, CHINA, NORUEGA, INGLATERRA, SOLO ARABIA SAUDITA Y RUSIA HAN AULMENTADO APENAS SI UN 3 O 4 % LO CUAL NO EQUILIBRA A LOS DEMAS.
  • zorro6204 on September 05 2016 said:
    I don't think those big budget cuts are meaningful anymore, ConocoPhillips says they are going to phase out deep sea drilling entirely, and Chevron is changing their oil focus to the Permian, where they claim to have thousands of wells that are economic below $40 or $50. Shale doesn't need big budget plans years down the road, you just go out and drill and plug in, the time to completion can be measured in weeks.

    It's a new world, I think there's plenty of oil to last until oil use declines to the point where the legacy fields can handle demand. The question is at what price will that production comes online. The recent flood of rigs when oil threatened $50 may or may not be that answer.

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