OPEC: What Spare Capacity?

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OPEC: What Spare Capacity?

Anwar Altaqi – Esam Aziz

Accusations directed at OPEC by politicians and the international media have reached a new, absurd level. OPEC did increase its output to compensate for Iranian exports. As senior Saudi officials have repeatedly said, OPEC did its job and increased production. But some politicians in Western capitals want to make OPEC a guarantor for moderate crude prices. This is nonsense. Prices are determined by the supply-demand balance — that is to say, by market forces. OPEC has a ceiling for its output, just as buyers have a ceiling for their consumption. Above all, sellers have the interest of their countries before their eyes.

Finger pointing at OPEC went as low as accusing the organization of hiding a part of its spare capacity. Even the U.S. State Department claimed that OPEC has hidden more than 1.4 million barrels per day of its spare production capacity. The statement referred to statistics published by the Energy Information Administration (EIA), which is part of the U.S. Department of Energy.. But how exactly did the EIA reach this conclusion? And how did the State Department repeat the claims without verification?

The U.S. media is littered with reports, published months ago, stating that global markets should be aware of the “limited spare capacity” in oil producing countries, particularly OPEC. The State Department spokesperson also said that Russia and Saudi Arabia were withholding production, while the United States was ramping up its own output, with the national total seen to rise by 1 million barrels per day (bpd) within 12 months. This contradicts the data of the International Energy Agency (IEA), based in Europe, which says that the producers added “at least” 1.250 million barrels per day compared to the same time last year. Sanctions on Iran did not prevent one million barrels a day of Iranian crude from reaching the market. Those sanctions are not even imposed yet.

Just when Saudi Arabia reached another understanding to increase its production, the wave of accusations against OPEC substantially increased. 

Then again, what do those Western officials want exactly? To push the available spare capacity to zero? Whenever global spare capacity has reached zero in the past, prices skyrocketed. Newcomers to the oil market know that having a zero spare capacity is synonymous with inviting a major oil shock. Sometimes reckless regimes, like the one in Tehran, create mayhem just to trigger market panic. Unused spare capacity is a cushion for the very oil market stability that OPEC critics talk about. 

Even if OPEC were to pump to its maximum capacity volume, as U.S. President Donald Trump has urged, it would not be able to respond to any future disruptions, raising the risk of an even more dramatic surge in prices. There is always a need to have some spare capacity somewhere to reassure markets that there is a safety net in the case of any significant geopolitical crisis. Those who blame the producers because they “hide” spare capacity do not know what they are talking about. They are loudly inviting chaos. Do they know the impact of zero spare capacity in economic and political terms? Can they guarantee that zero capacity will not encourage the Iranians to cause a small crisis with huge echoes?  

Then, there is the U.S. Strategic Reserve. Why doesn’t Washington seriously consider releasing part of this reserve, which is still being built up every day, even when President Trump pressures OPEC to use all its spare capacity, and the State Department accuses the organization of hiding part of its unused capacity? 

When the State Department said that it is engaging OPEC countries “to encourage them to utilize their spare capacity to ensure world oil supply meets the demand,” analysts asked, “What?” It was an amazing statement. Maxing out global spare capacity would surely heat up prices, not cool them off, as a single supply disruption anywhere in the world could trigger a price spike. Then OPEC would be accused again of causing what the U.S. government has caused.

 

Moreover, there is a need for calmer heads to first define what spare capacity is. The EIA defines spare capacity as “the volume of production that can be brought on within 30 days and sustained for at least 90 days.” But the IEA, based in Europe and less biased, only considers production that may not be brought on for as long as 90 days. U.S. Energy Secretary Rick Perry went as far as considering potential Neutral Zone (between Saudi Arabia and Kuwait) output as spare capacity. But the neutral zone is only neutral because its production is shared between Saudi Arabia and Kuwait. But it is not “neutral” in production. It does produce crude every hour of every day.

Trump’s criticism of OPEC and his demands of Saudi Arabia are unprecedented in the history of U.S.-Saudi relations. The war of words is also troubling, since U.S-Saudi ties have not been this close in roughly 70 years. Saudi Arabia’s Crown Prince Mohammed bin Salman said in an interview that the kingdom is fulfilling promises to make up for Iranian crude supplies lost to American sanctions. “The request that America made to Saudi Arabia and other OPEC countries is to be sure that if there is any loss of supply from Iran, we will supply that,” he said in the interview. “And that happened.” 

We now notice that there is an exaggerated estimation of the amount of crude exports that Iran will lose. The number circulating is 1.5 million barrels per day. This unrealistically high amount may be a way to pressure OPEC to produce more than what Iran will fail to sell after the sanctions. As we previously wrote, our estimation puts the number anywhere between 500,000 and 1 million barrels per day. 

It is time to restore normal communication between OPEC and the United States — that is to say, away from the media. This specter of criticizing OPEC publicly is not helpful to the stability of oil markets.