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Nick Cunningham

Nick Cunningham

Nick Cunningham is a freelance writer on oil and gas, renewable energy, climate change, energy policy and geopolitics. He is based in Pittsburgh, PA.

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The Saudis Won’t Prevent The Next Oil Shock

Saudi Arabia is starting to panic, and is growing concerned that the growing number of supply disruptions around the world could cause oil prices to spike. Saudi Arabia is moving quickly to head off a supply crunch, aiming to dramatically ramp up production to a record high 11 million barrels per day in July, according to Reuters.

The increase, if it can be pulled off, would be an incredibly rapid ramp up in output, up more than 1 million barrels per day (mb/d) from May levels.

How this plan fits into the latest OPEC+ deal remains to be seen. It was only a few days ago that Saudi Arabia and its coalition partners said that they would add 1 mb/d of supply back onto the market, with many of them acknowledging that, in reality, the figures would be closer to 600,000 bpd because of the inability of so many producers to ratchet up output.

As such, the addition of 1 mb/d from Saudi Arabia alone would lead to the OPEC+ group exceeding the production levels they just committed to, after factoring in additions from Russia and other Gulf States.

However, the surge in output does not need to exported, at least not right away. Saudi Arabia could divert extra barrels into storage. Moreover, higher output is needed during summer months anyway because the country burns oil for electricity, which spikes amid hot summer temperatures. So some of the extra production will be consumed domestically. Related: Hefty Inventory Draw Boosts Oil Prices

Still, an industry source told Reuters that the increase in output “will go to the market,” although the details are unclear. Bloomberg reports that shipments from Saudi Arabia to Aramco’s overseas storage facility in Egypt have already been on the rise this month.

“We already mobilized the Aramco machinery, before coming to Vienna,” Saudi oil minister Khalid al-Falih said over the weekend.

The dramatic ramp up in production suggests that Riyadh wants to prevent prices from rising too much. Producing at 11 mb/d will help offset the outages in Libya, Venezuela, Nigeria, Canada and Iran, but it might not be enough. The U.S. State Department said on Tuesday that Washington would take a hardline towards countries importing Iranian oil. The Trump administration expects countries to zero out Iranian oil imports by November 4, and the State Department said it would be unlikely that anyone would be granted a waiver.

That raises the odds of a much more serious outage from Iran than previously expected. Some analysts put the potential outage at 1 mb/d or more. If the U.S. is successful at convincing most countries to stop buying oil from Iran, the outages could rise to as high as 2 mb/d, although that remains speculation. Related: Gasoline Price Set To Soar Despite OPEC+ Deal

In another sign of how unpredictable the oil market has become, Kazakhstan lost 240,000 bpd this week, due to an unknown cause.

In this context, Saudi Arabia producing at 11 mb/d is probably needed, and it still might not be enough.

Worse, ramping up to 11 mb/d significantly cuts into available spare capacity. Estimates vary, but Saudi Arabia may have the ability to produce as much as 12.5 mb/d, although perhaps less. That means producing at 11 mb/d leaves only up to 1.5 mb/d of spare capacity. Add in smaller contributions from elsewhere and global spare capacity might only amount to 2 mb/d of supply as of July, or only about 2 percent of total global production. That would be down from about 3.0 to 3.5 mb/d up until recently.

“It basically leaves us with no spare capacity, at a time when Iran isn’t the only issue,” Amrita Sen, chief oil analyst at consultant Energy Aspects Ltd., said in a Bloomberg television interview. “Venezuelan production’s falling, Angola, Libya, Nigeria --there are lots and lots of issues everywhere in the world.”

Unless demand falls back, or some of these outages dissipate, oil prices could be heading much higher.

By Nick Cunningham of Oilprice.com

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  • Don on June 27 2018 said:
    KSA hasn't produced 11mbpd for decades. Even when oil reached $100, $120 and $140 a barrel during the past ten years KSA still did not chose to raise production to 11mbpd. Why now? I believe KSA can get to 11mbpd but how long can the maintain it?? According to the IEA definition of spare capacity KSA must maintain the 11mbpd for at least three months.
  • Kr55 on June 27 2018 said:
    Very unlikely that there will be that big of real production ramp up. They will try to fill the gap by selling more stored oil, which technically is not against the agreement.
  • John Brown on June 27 2018 said:
    Think of it? Production is dropping like a rock in Canada just like in Venezuela! Why? Both are Governed by incompetent socialist ideologues. Of course it doesn’t make much difference except both countries a losing out on tens of billions on revenue, taxes, & hundreds of thousands of high paying jobs. Trudeau & Fellow Socialist Maduro don’t care. They both live very well. Working folks aren’t important to either of them.
  • Mamdouh G Salameh on June 28 2018 said:
    Saudi Arabia is starting to panic not because it can’t prevent the next oil shock but because the growing number of supply disruptions around the world leading to a steep hike in oil prices will give the lie to its claims that it has a production capacity of 12.5 million barrels a day (mbd), a spare capacity of 2 mbd and the ability to raise production immediately to 11 mbd.

    Saudi Arabia's claim that it can produce at least 12.5 mbd if needed doesn’t stand scrutiny. Saudi Arabia’s production never exceeded 10.4 mbd before almost a million of which came not from actual production but from stored crude oil on tankers and on land. Saudi Arabia is only able to raise its oil production by 400,000 b/d being the amount it cut under the OPEC/non-OPEC production agreement.

    Moreover, Saudi Arabia’s claim that it has a spare production capacity of 2 mbd is very questionable.

    Saudi oil production peaked in 2005 at 9.6 mbd and has been declining since with depletion rates in its major oilfields including the giant Ghawar estimated at 5%-7%. Ghawar accounts for more than 50% of current Saudi production. A depletion rate of that magnitude means that Saudi Arabia has to add annually some 500,000-700,000 barrels a day to maintain current oil production. This has not been happening to all intents and purposes.

    Many analysts are assuming falsely that US sanctions could lead to a loss of up to 1 mbd of oil from Iran’s oil exports. This is not going to happen.

    The news that the United States is pushing allies to cut imports from Iran to zero by November 4 signifies that the Trump administration is not sure that the sanctions against Iran will work this time.

    Iran’s single biggest oil customer, China, has no reason to comply with US sanctions in the current tense atmosphere between them. And with the U.S.-China trade spat and the Chinese threat to impose a 25-percent tariff on U.S. crude oil imports, China’s Iranian oil imports could only go up.

    Russia has every reason to ignore US sanctions against Iran and to continue to implement the oil-for-goods barter trade agreement with Iran having been subjected to US sanctions against it since 2014. As for the European Union (EU), it already made its position clear that it will continue to buy Iranian crude.

    Sooner or later the global oil market will realize that the threat of US sanctions on Iran’s oil exports is more of a hype. It appears now that President Trump’s request to Saudi Arabia to ramp up its oil production has a lot to do with the U.S. midterm elections in November. He is afraid that rising oil prices could undo the economic boost from Trump's tax cuts. There you have it.

    Iran’s trump card is the petro-yuan which has virtually nullified the effectiveness of US sanctions. That is why I have been saying that Iranian oil exports will not lose a single barrel of oil as a result of the US sanctions.

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

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