OPEC supply boost could stretch spare oil capacity to the limit, IEA warns

The Organisation of Petroleum Exporting Countries’ (OPEC’s) rejuvenated bid to tame crude prices could soon exhaust the world’s spare capacity cushion, according to the latest monthly report from the International Energy Agency (IEA).

The IEA’s closely watched report comes shortly after crude had its biggest one-day drop in two years, amid heightened U.S.-China trade tensions and persistent global crude supply problems.

The Paris-based agency said that while there were signs the rally in oil prices may start to weigh on demand growth, for the moment the key risk is supply capacity, with moves by producers to raise output cutting into the thin buffer of reserve production.

“Rising production from Middle East Gulf countries and Russia, welcome though it is, comes at the expense of the world’s spare capacity cushion, which might be stretched to the limit,” the IEA said in its monthly report.

“This vulnerability currently underpins oil prices and seems likely to continue doing so. We see no sign of higher production from elsewhere that might ease fears of market tightness,” it said.

The IEA’s comments come as a host of outages, from Venezuela to Libya, have tightened markets and boosted oil prices to as high as $80 a barrel in recent weeks. That has led Saudi Arabia and other countries to lift output to make up the shortfall, partly under pressure from the US and other big oil consumers.

While in the short-run that should stop markets tightening too quickly, it has left traders nervous about whether producers will be able to respond if a further supply outage hits.

Oil prices tumbled Wednesday, posting the biggest one-day fall in two years, with Libya’s export situation improving and fears of a trade war between the US and China growing. But traders maintain they still see significant risks of a supply gap materialising.

Brent crude stabilised Thursday, rising 1.5 percent to near $75 a barrel.

“Based on current fundamentals (falling stocks, lack of capacity) and Iranian sanctions on the horizon, we see a bit of upside for Brent,” said Jack Allardyce at Cantor Fitzgerald Europe.

The IEA said it saw only 2.1 million barrels a day of quickly available spare capacity in three Opec members: Saudi Arabia, Kuwait and the United Arab Emirates.

If Saudi Arabia increases output towards record levels of near 11m b/d this summer, as it has indicated, it would cut the kingdom’s spare capacity to “unprecedented” levels, the IEA said.

Saudi Arabia is lifting output, in part, because of the reimposition of sanctions on Iran’s 2m b/d of oil exports that take effect from November. Estimates vary widely for how much Iranian oil the US will succeed in cutting, but the state department has said the aim is to drive them to “zero”.

“[In the fourth quarter] US sanctions on Iran are expected to hit hard and Venezuelan capacity may spiral lower,” the IEA said. “To help compensate for the further unplanned declines and limit stock draws, Saudi Arabia could ramp up even more which would cut its spare capacity to an unprecedented level below 1m barrels per day.”

With global demand for oil seen topping 100m b/d this year that would leave the world with spare capacity equal to barely 1 per cent of consumption.

Some traders are cautioning, however, that trade tensions between the US and China may blunt Washington’s attempts to curb Iranian barrels, potentially giving the market some breathing space. China is one of the biggest buyers of Iranian crude and some expect it will be more likely to try and circumvent US restrictions if a trade war escalates.

Refineries in China have already started cutting imports of crude from the US, which Beijing has threatened with retaliatory tariffs, meaning they may need alternative sources of oil to fill the gap.