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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for Oilprice.com with over a decade of experience writing for news outlets such as iNVEZZ and SeeNews. 

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Is There Enough Spare Capacity To Absorb An Oil Shock?

While oil market participants have been focused on above-average global oil stocks and faltering demand growth, OPEC’s spare capacity has been rising because of the production cuts aimed at drawing down stocks and bolstering oil prices.  

Thanks to the production cuts being extended into 2020, OPEC now sits on more than 3 million barrels per day (bpd) of spare production capacity, which makes the cartel, as well as the International Energy Agency (IEA), confident that the market can withstand a sudden major supply outage. The risks of such an oil supply disruption have increased in recent months with the flare-up of tensions in the Middle East and the Strait of Hormuz—the transit lane of 21 percent of daily global petroleum liquids consumption.

Despite assurances from organizations and agencies, some analysts say that even with OPEC and allies vowing to take 1.8 million bpd off the market, the world’s spare capacity is below the capacity seen in periods of previous major disruptions in 1979 and 1990, Paul Sheldon, chief geopolitical adviser at S&P Global Platts Analytics, tells S&P Global Platts’ Paul Hickin.

“Global spare capacity is currently well below the levels of those periods, even with OPEC+ production cuts in place, so in that respect markets are relatively susceptible to an outsized, disruptive, geopolitical event,” Sheldon told S&P Global Platts.

Yet, in 2019—unlike in 1979 or in 1990—two major forces are countering the efforts of the OPEC+ coalition to tighten the oil market and boost oil prices. Those are U.S. shale production growth thanks to the shale revolution of the past decade, and weaker oil demand growth as economic growth cools, especially in the world’s top oil importer China, which just saw its second-quarter economic growth slowing to the slowest pace in 27 years.

“A clear message from our first look at 2020 is that there is plenty of non-OPEC supply growth available to meet any likely level of demand, assuming no major geopolitical shock, and the OPEC countries are sitting on 3.2 mb/d of spare capacity,” the IEA said in its June report, suggesting that the market will be well-supplied.

In the July report, the IEA noted the heightened tension in the Middle East, but said that “For now, maritime operations in the region are close to normal and markets remain calm due to economic weakness, high oil stocks and a significant spare production capacity cushion.” Related: A Surprising Innovation In Energy’s Hottest Market

The tension in the Middle East continued to simmer throughout July, culminating in Iran seizing a British tanker. Despite the increased geopolitical risk to oil supplies, the market reaction was muted due to the stubborn glut, faltering demand, and most of all, rising U.S. shale production.

The oil market has changed so much over the past five years that fast-growing non-OPEC oil production is limiting oil price gains from major events such as Iran seizing an oil tanker, Morgan Stanley says.

The IEA said it was closely following “developments in the Strait of Hormuz, including the recent seizure of a UK-flagged oil tanker, and stands ready to act if needed.”

“Consumers can be reassured that the oil market is currently well supplied, with oil production exceeding demand in the first half of 2019, pushing up global stocks by 900,000 barrels per day,” the IEA said in a statement.

Countries members of the IEA hold 1.55 billion barrels of public emergency oil stocks, said the Paris-based organization which was created after the Arab Oil Embargo in the 1970s.

“In addition, 650 million barrels are held by industry under government obligations, and can be released as needed. These IEA emergency stocks are large enough to cover any disruptions in oil supply from the Strait of Hormuz for an extended period,” according to the organization.

Organizations and industry observers are fairly certain that a currently well-supplied market and spare capacity within OPEC—increased over the past two years because of the cartel’s production cuts—can cushion a major blow from an oil supply outage. Weaker demand growth this year and continuously rising U.S. production also support the view that the market is well supplied, although they weigh heavily on oil prices, capping gains even when tankers are seized in the Middle East.

By Tsvetana Paraskova for Oilprice.com

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  • Mamdouh Salameh on August 02 2019 said:
    Despite the fact that the global oil market is currently facing a relatively large glut and that member countries of the International Energy Agency (IEA) hold 1.55 billion barrels (bb) of public emergency oil stocks in addition to 650 million barrels held by industry that can be released as needed, a disruption of some 20 million barrels a day (mbd) passing through the Strait of Hormuz will create a huge oil shock possibly leading to oil prices hitting $130 a barrel. The reason is not a shortage of oil but the panic and confusion that will surround such an eventuality with global oil tankers shunning the Strait of Hormuz.

    A case in point is the second oil crisis of 1979 during the Islamic Revolution. By December 26, 1978, when all oil exports from Iran ceased, the global oil market had a shortfall of only 2 mbd or no more than 3% of the global oil supplies. Why should a 3% loss of supplies have resulted in a 150% increase in the oil price? THE ANSWER WAS PANIC.

    For more background information, please refer to Dr Mamdouh Salameh’s “Oil Crises, Historical Perspective” published in the Encyclopedia of Energy , Volume 4, 2004 Elsevier Inc., pp 639-641).

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School

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