03-01-2017

OPEC’s Spare Capacity Will Calm Oil Markets in 2017

Opec

The disparity between OPEC members complying with the deal and ignoring it altogether is a big one, thereby casting doubts on the possibilities of the organisation’s promise to cut production to 1.2 million barrels per day.

But while large cuts from OPEC are generally very bullish for oil prices, there is a side effect on the oil market from those reductions that could mute the price impact. Taking such a large volume of oil off the market does not make that production capacity go away. Indeed, moving 1.2 mb/d of capacity from active production into idled capacity will provide a substantial buffer to any unforeseen supply disruption.

That has always been the logic behind OPEC’s use of “spare capacity.” Saudi Arabia is pretty much the only country that has a large volume of oil capacity sitting on the sidelines, output that can be ramped up within a few weeks or months. The EIA defines spare capacity as output that can be turned on within 30 days and sustained for at least 90 days. Periods of low oil prices and low price volatility tend to correspond with periods of time in which Saudi Arabia has a large cushion of spare capacity. If the global oil market suffers from a surprise outage – say from a natural disaster like Hurricane Katrina or a man-made disaster like the war in Iraq – then there is capacity that can be called upon to plug any supply deficit.

Saudi Arabia has done this in the past, and because the oil markets are aware that such a capacity exists, volatility tends to be lower than it otherwise would be.

Source: TVC NEWS

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