Reserve capacity is becoming the biggest risk factor for oil

With about 2.5 million barrels per day (Mb / d) of Iranian supply targeted by the Trump administration, how will the oil market cope with the losses? Is the supply capacity sufficient to fill the gap?

There is much debate about the true extent of the world's unused capacity. Or, more specifically, there is a range of conjectures about the amount of surplus that is found in Saudi Arabia, the only country that really has the capacity to increase large volumes of supply on short notice.

Saudi Arabia claims that it could produce 12.5 MB / d if it was really needed. However, this allegation has not been put to the test. The highest level of production ever recorded in Saudi Arabia was just over 10.7 Mb / d in 2016, just before it contributes to the reduction in production. OPEC +.

Adding about 2 mb / d of additional supply – as President Trump demands – is a daunting challenge. "Recent history shows that Saudi Arabia has never produced more than 10.6 million b / d average over a single month and even in the recent period we have observed a strong lower Saudi oil stocks, "writes Bank of America Merrill Lynch. a note, arguing that there are many reasons to question the idea that Saudi Arabia has about 2 Mb / d of unused capacity. "So, it seems that the oil market has little confidence that Iranian volumes can be easily replaced."

The International Energy Agency estimates that there is about 1.1 Mb / d of total capacity available globally which can really be increased rapidly. A more flexible definition of unused capacity that encompasses the possibility of adding supply over several months gives a figure of about 3.4 Mb / d, of which 60 percent is located in Saudi Arabia . More modest additions come from the UAE, Kuwait, Iraq and Russia.

The problem is that Saudi Arabia is already increasing production to replace barrels lost elsewhere. Saudi Arabia added 500,000 bpd in June compared with a month earlier, bringing production to 10.5 Mb / d. But this increase only offset losses in Libya, Angola and Venezuela. In other words, Saudi Arabia had 2.5 mb / d of unused capacity in early June, burned 0.5 mb / d, but because of losses elsewhere, the oil market is Has seen no net increase in supply.

News reports suggest that production increases will continue in July, possibly up to 11 Mb / d. This leaves about 1.5 Mb / d of remaining capacity remaining. But again, the losses in Libya and Venezuela could catch up with the additions.

This means that Saudi Arabia could use two-fifths of the spare capacity it had without the market really feeling the additional supply. And that is before we come to the potential failures in Iran. If all 2.5 million tonnes / month of Iranian exports are closed, this would theoretically add $ 50 to the price of oil, according to Bank of America Merrill Lynch.

In an extremely problematic scenario, it may be that Saudi Arabia does not have the extra 2 Mb / d of supply it claims to make. Or, maybe this ability is not immediately available. Some analysts have argued that it would take additional drilling to push production up to 12.5 Mb / d, and that this could only take place for several months. In the end, it would mean that Saudi Arabia would be unable to fill the hole left by Iran, and oil prices would likely skyrocket.

However, not everyone is so pessimistic. Barclays argues that the global reserve capacity could actually be about 1 to 1.5 Mb / d higher than it is commonly thought. The investment bank has acknowledged that the worsening situation in Libya, combined with potential catastrophic losses in Iran, is putting the oil market at a dead end. "However, these contingencies are not totally certain Meanwhile, we believe that the market is less focused on some of the weakening demand indicators and stronger supplies that signal a weaker market balance, so we maintain our short term bearish view term, "the investment bank wrote in a note. Barclays estimates the average price of Brent at only 73 dollars a barrel in the second half of 2018 and 71 dollars in 2019.

The crucial difference between many bullish forecasts and that envisaged by Barclays is that Barclays thinks that the oil market will remain in a net surplus. The bank conceded that serious blackouts in Iran would blow this scenario, but argued that "the US government will quickly find politically unpalatable in an election year to quickly reduce Iran's exports to India and China to zero" .

Moreover, according to the bank, after taking into account 0.5 mb / d of the disused neutral zone of the Saudi-Kuwaiti border, which could restart next year, in addition to other capacities surplus in the United Arab Emirates, Russia and Saudi Arabia, the total available capacity worldwide could be 1.5 Mb / d higher than what EIA has suggested.

To top it off, government stocks could be reduced. Barclays says that, in theory, governments could add 5 million days / day of supply to the market for a period of 180 days, which would only represent about half of the global stocks on which they are sitting. Obviously, it's an unlikely scenario, but the investment bank says it's illustrating the amount of oil that could be called in a pinch.

Barclays is a bit of an aberration in its limited price forecast. Needless to say, there is quite a bit of disagreement about the true extent of the unused Saudi capabilities. But we can finally get a glimpse of Saudi Arabia's maximum capabilities if Iran really begins to shut down its supplies.