You can be sure that OPEC ministers will not ask the big question when they meet in Vienna later this week. They will mull over crude stock levels, growth in Chinese demand, flagging European demand and U.S. shale oil output, but they won't consider the nagging question that weighs on the minds of oil-consuming nations: How much longer can we rely on the cartel to balance the market? In particular, does Saudi Arabia have the spare capacity to meet extraordinary shortfalls in oil supply?
It's an article of faith within OPEC that the organization provides the final consumer barrel. Far from being an oligopolistic price-fixer, OPEC reckons that its quota system balances the market and stabilizes prices by raising output when demand is strong and reducing supply when it is weak. Yet, OPEC is failing in its self-appointed role. Despite signals from the International Energy Agency (IEA) of a recovery in oil demand, the cartel's output has been falling this year, not because of a cynical attempt to boost prices but because OPEC members are failing to deliver.
Libya promised to restore its full capacity of 1.6 million barrels a day (b/d), but according to a Platts survey last month, the North African state's oil industry is still suffering from the recent civil war; Libyan oil production in April was only 210,000 b/d. Iran is still labouring under sanctions, despite boasts that its output would increase. Iraq's promised surge to four million daily barrels is stuck in the sand at 3.2 million, and Nigeria's output is still under par, held back by civil disturbance, oil theft and corruption.
If the IEA is right about the return of energy demand growth this year, there is a gap in the market of about 800,000 b/d that needs to be filled. In other words, the IEA reckons the amount of oil that OPEC must produce this year needs to rise by about a million b/d from 29.7 million b/d if we are to avoid price surges. OPEC's spare capacity, according to the estimates of the U.S. Energy Information Administration (EIA), is just over two million barrels a day, almost all of that in Saudi Arabia, which is currently producing 9.7 million b/d.
You might then wonder who has been filling the tank over the past year while the OPEC pumps have been out of action and the answer is, of course, the United States, Canada and Russia. The Brent crude price over the past year has been strong but remarkably stable, roughly fluctuating in a narrow band between $100 (U.S.) and $110 per barrel. Despite clear signs of rising demand and ample evidence of weakness in OPEC, the market seems to have absorbed the geopolitical turmoil of civil war in Syria, North African turmoil, and sanctions with equanimity. The hidden assumption has been that North America and Russia would step into the breach. Happily, they did, and non-OPEC oil output increased by 1.3 million b/d in 2013, mainly due to U.S. shale oil, with contributions from Canadian oil sands and Russia. The EIA forecasts that North American output will increase by 1.4 million b/d this year.
The oil world is turning upside down; instead of filling the final barrel, OPEC is struggling to meet demand while North America and Russia are keeping the market balanced.
It was perceived wisdom that Saudi Arabia, being the largest OPEC exporter and dovish in geopolitical terms, would act as the ultimate swing producer. That has been the case in previous shortages but we are now in a world where OPEC's margin for supply manoeuvre is severely weakened and there must be questions about the capacity of Saudi Arabia to quickly respond to a series of disruptions to oil supply, such as war, accidental damage and embargo. With the absence of spare capacity anywhere in the OPEC system other than Saudi Aramco, the question is whether it is reasonable to expect the Kingdom to cope, not least when its own internal oil demand is expanding at a double-digit percentage rate.
The U.S. oil industry, being entirely private, is unlikely to step into the breach formally as a swing producer, although the government can for a short emergency period use its strategic petroleum reserves to balance its own internal supply and demand. However, it raises the interesting question whether Washington could use its prohibition on crude exports as a market lever, by switching it on and off temporarily. The more likely candidate for selective market intervention is Russia, which has the capacity in terms of reserves and the industrial concentration in state-owned companies, such as Rosneft and Gazprom Neft. Russia has not built up a buffer of spare capacity but, with sufficient investment, it could do so.