The US must cooperate with others and stop pressuring OPEC
The statement issued by the US State Department last week was unprecedented in the history of the relationship between OPEC and the US administrations.
Political pressure from consuming countries was always there on OPEC whenever prices have reached unfavorable levels. This time, however, the pressure is not being communicated in a coherent and constructive way that would help OPEC meet its objectives in stabilizing the market.
The key phrase in all messages from the US is “spare capacity.” This is the amount of idle production capacity that OPEC countries put aside to meet sudden disruptions in global supplies.
The International Energy Agency (IEA) describes effective spare capacity as the amount of oil that can be brought online within 30 days and kept running for 90 days.
In theory, OPEC is endowed with massive oil resources, but in reality not all of this oil can be tapped and produced swiftly.
Strangely, it seems that US policymakers lack a deep understanding of what spare capacity is, and what it is used for.
Looking at the various messages coming from Washington, DC and their timings, it can be concluded that US politicians want OPEC’s spare capacity to be a tool to bring down prices. Although it plays a great role in shoring down prices, that’s not what spare capacity is all about.
Its main purpose is to limit the fear in the market in case of a supply disruption so there is a baseline amount of oil that must be kept untouched at all times. The use of idle barrels should be limited to extreme cases when there is no longer any producer who can pump oil.
Riyadh has always maintained a policy of keeping at least 1.5 million barrels per day (bpd) of oil idle at all times. And as Saudi fields shared with Kuwait in the Neutral Zone are shut down, Riyadh must be prudent about how much of its spare capacity it can use, and when.
Leaving the market with a thin spare capacity at a time when more disruptions are expected just to respond to short-term price fluctuations is a very risky endeavor. The purpose of spare capacity is to address temporary and short-term supply disruptions. Using spare capacity over the medium or the long-term is the wrong approach.
The situation is similar to taking a bleeding patient to the emergency room. After the bleeding stops, the patient must be transferred to a specialized doctor who can offer care over a long period of treatment if needed. But asking the ER doctors to treat the patient over a very long period contradicts the main purpose of ER, which is to handle “emergencies.”
The statement that the State Department put out seemed at face value to capture the concept of spare capacity, but reading more deeply into it and understanding the context in which it was said, it seems that it aims to encourage OPEC to lower prices.
The US State Department said in its statement that the US “continues to engage with OPEC countries and we encourage them to utilize their spare capacity to ensure world oil supply meets the demand.”
And if the US wants OPEC to replace Iranian crude, Iran’s customers must come first to suppliers and ask for that.
Oil demand doesn’t generate in a vacuum, and it is based on nominations from customers. In the case of OPEC, countries such as Saudi Arabia, Kuwait and the UAE are honoring their contractual commitments. They supply their customers with every barrel they ask for, and this known in the market through allocations that news agencies such as Bloomberg report.
OPEC can’t “pump and dump” crude into the market. And if the US wants OPEC to replace Iranian crude, Iran’s customers must come first to suppliers and ask for that. So far many refiners in India and China have continued buying crude until further notice.
The US statement doesn’t do any good when it says OPEC and its allies led by Russia “continue to withhold oil production.” In fact, the alliance known as OPEC+ raised output by more than a million bpd since June. The statement only gives credit to the US, saying it is “doing its part” to add oil supply to the market.
Russia is already taking steps to address imbalance in the market but it is also nearing its full output potential. According to recent media reports, it was pumping crude last month at record levels of more than 11.3 million bpd, a significant increase since June.
Despite the many claims, it was clear after the Algeria meeting that spare oil production capacity in OPEC countries was thin. The only country with any substantial capacity is Saudi Arabia, but even that is getting thinner and it now stands at 1.5 million bpd, Saudi Energy Minister Khalid Al-Falih told reporters in Algeria.
The non-availability of enough spare capacity is one of the reasons why OPEC+ has not been able to bring compliance rate to 100 percent till now.
In conclusion, the market is becoming tight owing to factors the US played a role in. And pressuring OPEC to pump more will make the spare capacity thin and raise prices further.
It’s time for the US government to cooperate with others and coordinate policies with them. It’s not the time for blaming others and asking them to take steps that may backfire. When it comes to managing the global market, OPEC and now OPEC+ have a better track record than the US, so the alliance knows what it is doing more than the US.
Better then to let OPEC+ do its work with less pressure and more cooperation in a “laissez-faire, laissez-passer” environment.
• Wael Mahdi is an energy reporter specializing on OPEC and a co-author of “OPEC in a Shale Oil World: Where to Next?” He can be reached on Twitter @waelmahdi