How OPEC Can Boost Its Spare Capacity

Wherever OPEC Secretary General Mohammad Barkindo went this week, he emphasized the importance of building up a sizable spare capacity cushion as a safe way to help the global oil markets weather any external shocks. The problem is by no means new, as we discussed two weeks ago Saudi Arabia has been looking into diplomatic ways how to ramp up production without hurting the sustainability of its production – it is a remarkable development given that for years Saudi Arabia’s 2 mbpd spare production capacity was perceived as a lifebuoy for any market irregularity. However, where does that leave other members of the OPEC+ agreement, why is it that countries like Russia, Iraq or the United Arab Emirates remain without a sizable spare capacity despite their resource wealth? Or is their spare capacity simply underreported? Let’s take a look.

Russia is a peculiar case for anyone who analyzes spare production capacities in that up to late 2017 it always produced as much as it could. How did it happen? Well, even after Moscow joined the OPEC/OPEC+ agreement in November 2016, it never really jeopardized the fate of greenfield projects that took many years to commission and several hundred million, if not billions, of dollars to finance. All the greenfield projects that were scheduled to come online in 2016 – Vostochno-Messoyakhskoye (140 kbpd peak production rate), Suzunskoye (100 kbpd), Vladimira Filanovskogo (120 kbpd), Pyakyakhinskoye (30 kbpd) – did so as planned despite Russia’s full compliance with the 10.92 mbpd output quota. Instead, companies shut-in brownfield projects in Western Siberia and the Volga-Urals province as per the Energy Ministry’s suggestions.

Another year brought several other large-scale projects reaching the stage of official commissioning – 2017 saw the start of Yurubcheno-Tokhomskoye (100 kbpd), Kondinskoye (50 kbpd) or Odoptu-2 (30 kbpd), whilst 2018 witnessed an even more impressive lineup – the Tagulskoye (110 kbpd), Srednebotuobinskoye-2 (100 kbpd), Kuyumbinskoye (150 kbpd) fields were brought onstream or are just on the brink of it. The three years’ greenfield additions add up to a capacity increase of 1.2 mbpd when all the fields reach plateau production – for the sake of clarity we shall put it to 2022-2023. Even if one is to account for a natural output decline in mature basins, such as Western Siberia, with annual decreases averaging somewhere between 100-150 kbpd, this shrewd strategy will leave Russia in 2022-2023 with an overall production capacity some 0.5 mpbd higher than it is now.

But wait, what about those fields that were shut in November 2016 in Western Siberia? Well, they have become Russia’s spare production capacity – a phenomenon, as we have indicated earlier, simply did not exist before the OPEC+ agreement. Hence, it should come as no surprise that Russia ramped up production to the 11.356 mbpd attained this September, significantly surpassing the 11.23 mbpd October 2016 previous production cap, whilst creating a new all-time record for monthly production rates. Interestingly, in view of the Iranian sanctions and the allocation of additional volumes by OPEC+ members, Russia pledged to increase output by 200 kbpd, not 400 kbpd. That is still not the whole picture, however, as its full production capacity lies within the 11.5-11.6 mbpd interval.

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But Russia is not a member of OPEC, therefore when worried industry analysts indicate that OPEC spare capacity has fallen to ten-year lows – the EIA estimates it decreased to a “mere” 1.4 mbpd, roughly corresponding to Saudi Arabia’s spare capacity if it manages to increase production at its Khurais, Berri, Zuluf and Damman fields – members other than Saudi Arabia could lend a helping hand to the oil cartel. The United Arab Emirates is the ideal candidate – with oil reserves estimated at 98 billion barrels, it has all it takes to create a bit of free space for itself, it just needed a slight nod to act upon it.

UAE authorities declared that they will invest $109 billion in upstream projects in in 2018-2023, in addition to some $45 billion dedicated to downstream investments, among others storage facility extensions. By doing this, the UAE wants to attain a total production capacity of 3.5 mbpd, however, it emphasizes that it is in no rush to move away from the comfortable level of 3 mbpd that it currently produces. With the Umm Lulu and SARB fields hitting the markets as soon as they could, adding almost 100 kbpd to the UAE’s output levels this year alone, the unused spare capacity will be quite slim in the 2018-2019, however, it should reach 200-300 kbpd by 2022-2023.

Moreover, we might live to see the day that Saudi Arabia is no longer the world leader in spare production capacity. The fact that Iraq never really managed to compete with the Saudis was more a consequence of bad political choices and internal frailty than its resource endowment. Even now, a few swift political fixes might assuage a lot of fears – for instance, were Baghdad and the Kurdistan Regional Government to find a sustainable long-term solution that would be mutually acceptable, some 300 kbpd of oil could come back to markets in an instant. Iraq’s southern provinces still have the potential to unearth supergiant oil fields. By mid-2020s, just two LUKOIL-operated fields, West Qurna-2 and Eridu, will add almost 1 mbpd of production to Iraq’s tally.

Iraq’s ambition is not a new phenomenon, in early 2010s Baghdad put forward a 12 mbpd production target for 2017. Then it was revised down to 9 mbpd, now, after all the destruction left behind by the Islamic State, the long-term output aim is 7 mbpd (production currently hovers around 4.5 mbpd). To reach this, sectarian violence ought to end, the government should attract as much foreign investment in infrastructure as possible. In such a case, should OPEC quotas still be around by the time all this is reached, Iraq would build up a sizable spare capacity, one to rival Saudi Arabia. Yet spare capacity building must not be as straightforward, sometimes all it takes is a clever trick.

Actually, Saudi Arabia is a fitting example that increasing a country’s export capacity does not necessarily stem from reservoir engineers and geophysicists strenuously examining reservoirs and oilmen drilling indefatigably, sometimes a policy trick might do just as well. According to World Bank numbers, some 25 percent of Saudi Arabia’s power generation comes from burning crude oil – by replacing crude with something else, one gets a sizable boost to oil export volumes. Riyadh seems to be moving towards fuel oil and natural gas – the former because after IMO 2020 kicks in, HSFO will be largely unneeded on global markets but could still do good in domestic electricity production, the latter due to an impressive resource base (estimated at 290 TCf in total) that they no longer want to flare. If Saudi Arabia adds a nuclear reactor or two (as it aspires), voilà more than 1 mbpd of additional crude export capacity.