Saudi Arabia’s unique role in the oil market as Opec’s swing producer, the de facto central bank of oil, owes as much to its spare capacity as it does to its colossal reserves, the world’s lowest drilling cost and the sheer scale of its oil exports.
However, the kingdom has also historically not hesitated to cut planned increases in spare capacity, when the Saudi government decided that its national interest lies in keeping global oil prices “higher for longer”.
For instance, an oil price spiral after the Iranian revolution in 1979 led to a decision to raise Saudi Arabia’s spare capacity to 14 million barrels per day (mbd) when production in 1980 averaged 10.8mbd.
But the collapse of oil prices six years later because of the Volcker Fed’s stratospheric interest rate regime and the onset of global recession amid a Latin American sovereign debt crisis forced Saudi Arabia to scrap this epic planned increase to end an oil price meltdown in 1986.
Thus Saudi Aramco’s decision to cancel its planned increase in spare capacity from 12mbd to 13mbd comes as no surprise, even though this target had been in place since 2020 and billions of dollars had been invested in increasing output in oilfields such as Marjan and Zuluf.
The Saudi government obviously believes that the current oil market will remain over-supplied, thanks to a 1.5mbd surge in new output from the US, Canada, Brazil and Guyana.
In essence, Saudi Arabia has borne a disproportionate share of Opec+’s successive output cuts since the autumn of 2022, and its production has fallen to 9mbd, significantly below the US’s 13.3mbd current output.
Saudi Arabia’s current spare capacity is thus 3mbd without the planned increase.
This is more than sufficient to meet the needs of its downstream clients in Europe and Asia in case current geopolitical tensions in the Red Sea, Lebanon and Gaza escalate into a direct military confrontation between Israel and Iran.
In any case, the muted geopolitical risk premium in oil prices, despite the disruption and rerouting of tanker traffic in the Red Sea, reinforces the view in Riyadh that rising supply from the Americas will keep the global oil market over-supplied at a time when Chinese demand will increase by only 600,000 barrels a day in 2024.
After all, Saudi Arabia’s current 3mbd is 60 percent of global spare capacity and dwarfs that of any other oil producer on earth, enabling Riyadh to continue playing its traditional role as Opec’s power broker.
Saudi Arabia’s closest ally in Opec is the UAE, and Abu Dhabi has also seen its spare capacity rise as a result of recent Opec+ output cuts.
The UAE’s spare capacity has risen to an all-time high of 1 mbd and, coupled with Kuwait’s 300,000 barrels, constitutes a secondary buffer of idle output that can be activated in times of crisis.
So it was entirely rational for the Saudi government to save $25 billion to $40 billion in future Saudi Aramco capex by ordering its state oil and gas colossus to scrap its 2020 target to increase spare capacity.
Opec+ has reduced output by 6mbd to prevent oil prices from falling below $70 a barrel on a sustained basis.
Saudi Arabia has been the linchpin of this strategy, as its vast Vision 2030 economic development blueprint and $85 Brent budget break-even price makes it imperative that it keeps oil prices “higher for longer”.
Iran is a wild card in the global oil market, since the Biden White House has ignored sanctions and allowed it to increase its output to 3.2mbd.
This could well change dramatically if Donald Trump wins the November 2024 presidential election and resumes “maximum pressure” sanctions on Iran that had choked its output to below 1mbd on the eve of the pandemic
Trump will be the Republican nominee for the 2024 election. If he engineers a U-turn in Biden’s Iran policy, oil prices could well move to the higher end of the recent Brent $75-$95 range.
For now, ample spare capacity in Opec and a surge in supply from the Americas, notably the US, Brazil and Guyana will ensure that black gold remains within its trading range.
Also published on Medium.
