According to prices in the market, and numerous market observers, the world is not producing enough oil to keep up with near-term demand. Are we facing the start of a major supply crunch in the upstream world of oil like for natural gas?
As global demand recovers from the pandemic, could we be near exhaustion of short-term production capacity, which means that the drop in revenues during the pandemic has caused capex (upstream investments) to fall below the balancing point of sustaining production capacity? Moreover, is the spare capacity we are accustomed to think is there, in the core-OPEC Middle Eastern countries, lower than we have thought as the pandemic caused capex reductions also in the National Oil Company-dominated suppliers of Saudi Arabia, the UAE and Kuwait? And what about Iraq?
It is estimated that global liquids production declined by a record 6.5 million bpd y/y in 2020, only to recover by a meagre 1.4 million bpd y/y last year, with growth mostly owing to the recovery in Libya and increased production from sanction-constrained Iran. Countries in the OPEC+ deal reduced supply in 2021 versus 2020, while US shale and other non-OPEC+ E&P companies added only a combined 300,000 bpd y/y in 2021, capped by balance sheet repair and limited spending resulting in record-high free cash flow generation in a recovering oil and gas market.
To match the expected global demand for liquids, supply would need to increase by a record-high 5.8 million bpd y/y in 2022. And where is the supply going to come from? Well, in our current base case, non-OPEC+ countries look set to bring nearly 2.0 million bpd of additions to the market, mostly from US shale.
That leaves around 3.8 million bpd of call on growth from OPEC+, which includes deal-exempt countries Libya, Venezuela and Iran. Based on our current research, we believe this is achievable through a combination of expected brownfield production, field start-ups and utilization of spare capacity in Saudi Arabia, the UAE, Kuwait, Iraq and partially Russia. Whether Iran strikes a nuclear deal, paving the way for a return of around 1 million bpd of sour crude production to the market, remains an open question, but the world’s supply capabilities is there with or without an Iran comeback.
The spare capacity cushion in the OPEC Middle Eastern countries will anyway be tested in the coming months, as the world continues to remain very dependent on supply from the region to keep up with the demand growth. The supply pinch is here, but so far it looks like the world can avoid a full-blown gas-like supply crunch in 2022, if OPEC+ delivers the supply growth to keep the market balanced.
Bjørnar Tonhaugen, Head of Oil Markets, Rystad Energy
Also published on Medium.