World, We Have a Problem
Posted August 4, 2022
The OPEC+ announcement that the cartel will boost crude oil production by just 100,000 barrels per day (b/d) in September – far less than the 650,000 bpd increases agreed upon for July and August – certainly wasn’t the news President Biden hoped for after his recent visit to Saudi Arabia. (See the White House press secretary’s response to the first question from reporters during Wednesday’s briefing.)
As Bloomberg reported, the increase will give an already tight global market extra supplies at a slower pace than in recent months despite months of requests from the White House for even more. Indeed, the response to the president’s trip and concerted diplomacy was one of the smallest increases in OPEC+ history.
Consequently, while the small increase could be political comeuppance for weak U.S. – Saudi relations, it also renews questions about the Saudis’ and OPEC’s spare production capacity and how much more they could potentially add to global oil supply.
As defined by the U.S. Energy Information Administration (EIA), spare capacity is production that could be brought online in 30 days or less. OPEC’s announcement may signal its members need more time to increase production even further, and/or it could indicate its members are not united on production levels, which has frequently happened in recent years.
With those points in mind, let’s explore the spare capacity of the Saudis and OPEC+ – their actual ability to further open the crude oil taps.
This week’s OPEC production announcement is consistent with the context that the Saudi energy minister, Prince Abdulaziz bin Salman, offered in May that “the world is running out of energy capacity at all levels.” Some analysts argue that Saudi Arabia has already reached its capacity and is no longer a global swing producer.
These estimates are not officially agreed to by the Biden administration, EIA or the International Energy Agency (IEA), which say that OPEC held about 3.0 million barrels per day (mb/d) of spare production capacity as of July 2022.
If one takes Saudi Arabia’s statements at face value, however, the world could have a problem so long as the global economy and oil demand continue to grow.
The crux is that a myriad of limitations – including but not limited to, historical crude oil capacity and production, natural declines of production and scarce capital investments since 2020, as well as apparent considerations for the quality and logistics supporting OPEC crude oil spare production capacity -- reinforce what Prince Abdulaziz said, that the world is running out of energy capacity.
In other words … world, we have an energy problem. Let’s look closer.
Apparent capacity limit
First, OPEC informed the European Union in April that it is not possible to replace potential Russian oil supply losses, contemplated to be as high as 7.0 mb/d. So far, the effective loss of Russian production as of July 2022 has been around 1.4 mb/d per day, per EIA, and as much as 3.0 mb/d by May, per IEA.
Historically, the most total petroleum supply that OPEC produced was 37.0 mb/d in 2016, and members were estimated to hold 1.4 mb/d of spare capacity at that time, per EIA.
IEA spare capacity and production target by OPEC+ nations, as depicted by Reuters, showed Russia as having another 1.0 mb/d of spare production capacity in May 2022. EIA’s estimates were similar but show that OPEC deployed another 0.5 mb/d of its capacity as of July 2022.
By comparison, for 2022 as a whole, EIA projects that OPEC could average 34.2 mb/d of production in 2022 while holding an estimated 2.8 mb/d of spare production capacity. Since OPEC’s production increases so far this year have tracked more than 1.0 mb/d less than EIA’s assumption, their estimates of production and spare capacity could differ accordingly.
Natural declines and historically low capital investments
The pace of natural production declines and investments are a way to connect the 2016 and 2022 EIA estimates. If the natural decline of production were around 3% per annum, the lower bound that IEA has historically assumed, OPEC production could naturally decline by over 1.0 mb/d per year, offset by investments to sustain existing production or develop new producing wells.
However, as Bloomberg reported before Russia’s war in Ukraine escalated, three-quarters of OPEC members pumped a total of 1.0 mb/d below their targets, apparently due to a lack of capital investments in the aftermath of the pandemic and subsequent oil market downturn.
Putting these pieces together, with natural declines and relatively less capital investment since 2019, the main takeaway here is that it’s no stretch to say there are limits to how much additional production OPEC could bring at this time.
Saudi Arabia historical fixed capacity target and lowered investments
Specifically for Saudi Arabia, which EIA estimates to have the most spare production capacity of all OPEC members, a brief from the Oxford Institute for Energy Studies explains why, prior to the pandemic in 2020, Saudi Arabia’s National Transformation program established a flat target for production capacity of 12.5 mb/d: “In this environment when demand prospects are highly uncertain, Saudi Arabia has no plans to increase its productive capacity above 12.5 mb/d.”
Since 2019, Saudi Arabia’s national oil company, Saudi Aramco, cut its capital expenditures by $5.9 billion (18.1% year on year, year on year) in 2020 and then sustained their spending at about 90% of its 2019 level in both 2021 and 2022 so far, per Bloomberg. Lower capital expenditures would generally not result in production capacity increases over time.
In 2023, Saudi Arabian capital expenditures are projected to increase by $11.6 billion over the 2019 level per Bloomberg, potentially increasing their production capacity as high as 13.4 mb/d by 2026-2027, per S&P Global. But this would not be available to address the world’s needs this year or the next.
Again, the gist of all these numbers is that the amount of OPEC spare production capacity is uncertain and likely limited. Now, let’s consider some qualitative factors.
Lower crude oil quality requiring workovers
Crude oil quality could be lower and require workovers within existing spare capacity. Some of Saudi Arabia’s spare production capacity resides in the neutral zone with Kuwait or fields with Bahrain that could require work to be operational. Historically, the quality of crude oil generally in Saudi Arabia’s spare capacity has also been relatively heavy or sour – and therefore is generally not as tradeable or fungible as light sweet crude oil that can easily be refined via crude oil distillation almost anywhere in the world.
Capacity to process and transport crude
Historically, the ability to process and move crude oil from place to place has been a big factor. Moreover, the September 2019 attack on Abqaiq, Saudi Arabia, highlighted the importance of midstream processing and pipeline infrastructure to Saudi Arabia’s capacity to deliver. When the official target has been maximum production of 12.5 mb/d, it must be asked whether that could occur via a surge, or if it is a sustainable output rate.
Weak OPEC incentives to add or deploy its spare capacity
The world only recently eclipsed oil price levels that Saudi Arabia has historically considered to be equitable (more than $95 per barrel in today’s dollars). Other OPEC members, including Iran and Venezuela, have said in the past that equity requires even higher prices. And major business consultancies have for years advocated that this is OPEC’s last and best hope to monetize their oil resources and diversify their economies, before the energy transition eventually dominates. For example, see reports by Accenture, Bain, BCG, Deloitte and McKinsey, among others.
Little to no reason for OPEC to lend the Biden administration a helping hand
Abstracting from any reports of strained international relations between the U.S. and Saudi Arabia, the lack of consistency from one U.S. presidential administration to the next could undermine the incentive to help. Said differently, why expend limited resources and spare capacity now if the institutional memory and relationship with the U.S. could swing like a pendulum in months and years to come?
Ultimately, the global economy matters
Much of this discussion about spare capacity could be moot if oil demand falls. At least for now, however, the diminished economic growth expectations so far this year are still for U.S. and global GDP growth to fall to levels that are historically above their 20-year averages. Unless unanticipated economic risks develop, this means the world likely needs more oil and natural gas this year and in coming years.
The industry’s investment and drilling as of June 2022, however, were more than 25% below their levels at the same point in 2019 and therefore insufficient to yield the same production as the world had in 2019.
What about the United States?
Beyond OPEC+, the United States is one of few places in the world that could bring additional production within a relatively short period. As API President and CEO Mike Sommers has aptly summarized, President Biden should tap U.S. oil production, rather than traversing the globe and committing billions in foreign aid and other concessions.
Virtually everyone understands the administration’s goal of increasing renewable energy, rather than fossil fuels. But the path to decarbonization likely cannot occur unless consumers also have affordable energy.
Whether we take Saudi Arabia’s statements at face value or delve into the detailed quantitative and qualitative factors that could affect uncertain spare production capacity estimates and ultimately production, the truth is that a more assured path to helping American families and businesses and strengthening U.S. energy security is at hand, here in America.
About The Author
Dr. R. Dean Foreman is API’s chief economist and an expert in the economics and markets for oil, natural gas and power with more than two decades of industry experience including ExxonMobil, Talisman Energy, Sasol, and Saudi Aramco in forecasting & market analysis, corporate strategic planning, and finance/risk management. He is known for knowledge of energy markets, applying advanced analytics to assess risk in these markets, and clearly and effectively communicating with management, policy makers and the media.