Dwindling OPEC+ spare capacity sets oil up for sizzling summer

As they strain to restore oil production, OPEC and its allies are being left with a diminishing buffer of spare supplies – potentially setting up crude prices for a sizzling summer.

With depressed investment and internal unrest hobbling coalition members from Nigeria to Russia, the task of satisfying the vigorous recovery in world fuel consumption is down to just a few Middle Eastern producers. As they raise production, the buffer of untapped supplies held back to cover any emergency disruptions will grow ever-more precarious.

“The oil market appears to be heading for a period with little margin of safety,” said Martijn Rats, oil strategist at Morgan Stanley. “Prices will need to rise to levels where some demand erosion takes place.”

By the time the holiday driving season propels global fuel use above 100 million barrels a day in July, the world’s reserve capacity will be almost entirely held in Saudi Arabia, the United Arab Emirates and Iraq, and could amount to just 2.3 million a day — the lowest since 2018.

While the relationship isn’t absolute, periods of low spare capacity often correlate with rising prices – and vice versa – as traders either grow confident or anxious over how much supply would be available in the event of a crisis. Crude’s spike to an all-time high of almost $150 a barrel in 2008 came as reserves became perilously low.

This makes the travails of the Organization of Petroleum Exporting Countries and its partners a worrisome prospect for oil-consuming nations. International crude prices are already at a seven-year high above $85 a barrel as global fuel demand withstands the omicron variant of Covid-19.

That’s feeding into the inflationary pressure that imperils the global recovery by inflicting a cost-of-living crisis on millions of people. The White House is keeping a close eye on the situation, and is working working with oil-producing countries including members of OPEC+ to ensure supply rises to meet demand, National Security Council spokeswoman Emily Horne said in a statement on Tuesday.

The danger could recede if IEA forecasts prove correct that the US, Brazil and Canada will return to pump at record levels later this year. The pressure might also be relieved if Iran secures a new nuclear agreement with the US, removing American sanctions on its oil exports. The Islamic Republic could restart about 1.3 million barrels a day of off-line output if customers can resume purchases, according to data compiled by Bloomberg, but progress in the negotiations has been slow and difficult.

Missing targets
Formally, OPEC+ is gradually restoring the vast swathe of production halted during the pandemic in gradual monthly installments of 400,000 barrels a day. But in practice, the volumes added have been significantly smaller as nations like Angola and Nigeria struggle with diminished spending and operational disruptions.

“It’s not easy because there’s a problem of capacity,” Oman’s Oil Minister Mohammed Rumhi said in an interview in Riyadh on January 12. “The last five years the investments have been limited in the industry and we’re paying the price for it now.”

Last month the 10 OPEC nations in the accord managed only 60 per cent of their stipulated 250,000 barrel-a-day increase. The crisis extends across the OPEC+ coalition, with even Russia – the second-largest producer in the group – failing to increase output in December. The country is expected to deliver only half its permitted hikes going forward.

“Russia can’t even hit their OPEC+ target right now because of a lack of investment,” Jeff Currie, head of commodities research at Goldman Sachs Group, said in a Bloomberg television interview. “There are only two countries that can produce more today than they could in January 2020. Who are those? Saudi Arabia, the UAE.”

The downturn extends beyond OPEC+. Investment in new supplies tumbled by 30 per cent in 2020 as oil prices slumped, according to the Paris-based International Energy Agency. US shale producers continue to limit spending on drilling while they return capital to shareholders after years of burning through cash.

As the burden intensifies on the Middle East heavyweights, the spare capacity they hold back as a kind of shock absorber in case of a supply disruption becomes depleted. That could leave global markets dangerously exposed to outages, which remain a constant threat, as recent unrest in Libya and Kazakhstan have shown.

By July, when US motorists take to the road for vacations and Gulf exporters burn more fuel at home for air conditioning, spare production capacity held by OPEC+ may have diminished to just 2.3 million barrels a day, according to Bloomberg calculations. Capacity was last near such levels in the fourth quarter of 2018, according to the International Energy Agency.

If OPEC+ continues on its current trajectory, the cushion will become even smaller in the second half as the group revives the remainder of its offline supplies.

“It’s going to be a tight 2022 as demand recovers,” Francisco Blanch, global head of commodities and derivatives research at Bank of America, said in a Bloomberg TV interview.