The OPEC+ group continues to return modest volumes of supply to the market, cautious not to tank oil prices as demand weakens after the summer. Production increases are estimated to be smaller than headline figures suggest: some producers lack the capacity to increase production further, while others are compensating for previous overproduction.
While lower-than-expected production increases support oil prices, they also reduce spare capacity for OPEC+ producers. Not that many of them have significant excess production capacity. With the exception of Saudi Arabia, the United Arab Emirates (UAE) and Iraq, the other members of the OPEC+ alliance are likely at maximum, leaving the market in a precarious position when the next supply shock hits. This could come with another flare-up in the Middle East or more sanctions against Russia or Iran.
Thinning of the supply cushion
Over the past three years, OPEC+ cuts, which at one point withheld supply equivalent to about 5% of global consumption, have supported oil prices. But the excess capacity left by the cuts has also eased fears of shortages during all confrontations between Israel and Iran since 2023, for example.
However, as OPEC+ proceeds to reverse these cuts, now taking advantage of its latest layer of reductions of 1.65 million barrels per day (bpd), the spare capacity of those producers that do have it is being reduced. So is the market’s ability to absorb the next supply shock.
In the current fragmented and volatile geopolitical situation, this shock could occur any day and expose the limitations of the OPEC+ alliance in managing a “stable” oil market, as it likes to say.
Insufficient spare capacity will not be able to offset a major supply shock. Analysts have also warned that the market is overestimating the size of that excess capacity.
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Standard Chartered Research said this summer that a recent international OPEC seminar showed a mismatch between what energy producers and market analysts think about excess production capacity. Unlike Wall Street analysts, who frequently talk about excess capacity of 5 to 6 million bpd, speakers from various industry sectors noted that excess capacity is limited and highly concentrated geographically.
StanChart believes this erroneous assumption about excess capacity has been a major drag on oil prices, and the implications for the entire future oil price curve could potentially be profound once traders realize that roughly two-thirds of the capacity they thought was available based on demand doesn’t actually exist.
Spare capacity, as defined by the International Energy Agency (IEA), is “capacity levels that can be achieved within 90 days and maintained over an extended period.”
Spare capacity may be overrated
The IEA, in its latest monthly report, estimates total OPEC+ spare capacity at 4.05 million bpd, including 2.43 million bpd in Saudi Arabia, 850,000 bpd in the United Arab Emirates and 320,000 bpd in Iraq. All other OPEC+ producers are at maximum.
But after several years of reduced production levels, it is unclear how much even Saudi Arabia could contribute in three months if a supply shock occurred in the market.
In November, Saudi Arabia’s production quota will be 10.06 million bpd.
Saudi Arabia says its total sustainable production capacity is 12 million bpd. However, it pumped 12 million bpd only once in its history, for a month in early 2020, during the price war with Russia, before COVID sank consumption and forced major production cuts by the OPEC+ group. The Saudis have pumped 11 million bpd or more only for brief periods in 2018 and 2023.
Based on precedent, Saudi Arabia’s current excess production capacity is likely only between 600,000 bpd and 1 million bpd, which can be increased quickly and sustained over a period of time, according to estimates by Reuters energy columnist Ron Bousso.
At this time, apart from Saudi Arabia and the United Arab Emirates, the other OPEC+ producers have no excess production capacity, limiting their production increases in the coming months, even though the group has extended the rollback of cuts to October and November.
OPEC+ delegates told Bloomberg last month that they expect about half of the major output increases to happen in the future, due to offsets for overproduction and a lack of spare capacity.
“It’s very much like Warren Buffett’s saying that when the tide goes out, you find out who’s swimming naked,” Jeff Currie, director of energy pathways strategy at Carlyle, told Bloomberg Television last month.
“In this case, swimming naked is having no spare production capacity,” Currie said in the Bloomberg interview in early September, when OPEC+ announced it was beginning to reverse the 1.65 million bpd cuts announced in April 2023.
The market is currently focused on the supply glut looming later this year and early 2026. But dwindling excess capacity, predominantly in two large Middle East producers, will not be able to offset a major supply shock, leaving oil prices exposed to potential spikes when the next crisis hits.
By Tsvetana Paraskova for Oilprice.com
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