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Oil market buffers should offer comfort amid geopolitical risks

Oil market buffers should offer comfort amid geopolitical risks
Paul Hickin, director, EMEA oil news & analysis at Platts explains the importance of buffers and spare storage capacity in global oil markets amid geopolitical uncertainty

Concerns over oil demand growth, stubborn stock levels and strong US supply have emboldened OPEC and its allies to keep cutting output. But the risk of miscalculation and significant disruption in the Middle East, sanctions on Venezuela and geopolitical uncertainties in countries such as Libya and Nigeria have raised the stakes for security of supply. OPEC's growing spare capacity in particular, along with strategic stocks, should provide an extra layer of comfort.

When a market is experiencing a dramatic surplus of inventories, political risks to supply tend to be less relevant to or supportive of oil prices. This was the case during the oil price collapse from 2014-2016, when political risks to supply appeared to have had a relatively muted impact on oil prices, with fundamentals trumping politics as prices fell to below $30 a barrel from over $100/b amid a market flooded with OPEC crude. This helps to explain why the market has moved little on a spate of incidents this year around the Strait of Hormuz, a key shipping and oil artery.

But with US supply growth having stalled, albeit at around 12 million b/d and OPEC and Russia and its alliance determined to bring down stocks via its 1.2 million b/d agreement through to the end of the first quarter of 2020, the oil market could become more exposed to geopolitical upheaval.

A prolonged supply disruption amid depleted commercial oil stocks would see the market hone in on spare capacity - the ability to bring regular barrels to the market for a sustained period of time - for reassurance. Spare capacity is the most effective and dependable area from which markets can bring sustainable production volumes online to replace supply disruptions elsewhere. Spare capacity played a significant role in stabilising oil markets during previous periods of major supply outages, such as 1979 and 1990, with the Iranian Revolution and Gulf War respectively.

The question is whether there is sufficient 'swing' production. The International Energy Agency estimates OPEC had some 3.16 million b/d of spare production capacity available in the second quarter (stripping out Iran), with more than 2 million b/d of that held by Saudi Arabia. That equates to just over 3% of global demand. While spare capacity is low in the broader scheme of things and leaves the oil market relatively susceptible to an outsized, disruptive, geopolitical event, it has recovered from just 1.91 million b/d in the final quarter of last year. Moreover, Iran has 1.43 million b/d available on top should sanctions end, according to IEA calculations.

Saudi Arabia is well aware of its importance. Its national oil company, Saudi Aramco, said in July it could potentially bring 12 million b/d to the market on a sustained basis having made plans to expand the Marjan and Berri fields, adding 550,000 b/d of Arabian Crude to its capacity. That compares with production of less than 10 million b/d, for many months this year.

The swing producer's mettle was tested late last year, ramping up output to more than 11 million b/d to counter any supply shortfall from Iran sanctions as Brent touched $86/b before waivers granted to eight key consumers of Iran crude led to prices to nosedive to $50/b before the year was out. Some analysts doubt whether Saudi Arabia can go much above 11 million b/d for a lengthy period of time.

There are also strategic and emergency oil stocks – those held in storage by countries for a rainy day – that also act a little like spare capacity but with important differences. Under IEA and EU rules, member countries must maintain emergency stocks of crude oil and/or oil products equal to at least 90 days of net imports or 61 days of consumption, whichever is higher. They were very effective in insulating customers from the 1 million b/d Druzhba pipeline fiasco earlier this year after contaminated crude from Russia meant European buyers had to tap reserves.

The US holds close to 650 million barrels of crude in its emergency fuel storage, known as the Strategic Petroleum Reserve, which can meet the nation's demand for over a month. Two-thirds of this crude is considered to be of a sour viscous grade, ideal for the majority of US refineries and processing plants. Although presidents have the right to tap into the stockpile in cases of 'severe energy supply interruption', its use is tightly regulated.

Key consumers of heavier sourer Middle Eastern crudes India and China have also looked to bolster oil stocks. Indian government officials have said there is an urgent need to seal more deals to lease SPR storage facilities as well as build more strategic reserves capacity. Meanwhile, China has continued to increase its oil buffers and its moves to destock this year has also played a role in keeping a lid on oil prices, analysts have said.

But while emergency oil stocks can provide a temporary buffer to supply disruptions, spare capacity is a more reliable and sustainable cushion. Analysts have noted that storage and stocks do play a role in smoothing the cycle, but there are differences such as the size of spare capacity, how quickly it could become available, and that it can be used as a policy instrument to smooth the impact of disruptions.

The IEA reacted to the latest developments in the Strait of Hormuz over the summer – which transports a fifth of all global petroleum liquids consumption through its waterway – by noting emergency oil stocks can cover supply disruptions for an 'extended period', adding that global oil supply had exceeded demand by 900,000 b/d in the first half of the year and commercial stocks in the OECD countries totalled more than 2.9 billion barrels — higher than the five-year average.

But while the IEA talks up the oil market's buffers - including the emergency stocks, additional supply growth from US shale, Canada, Brazil and elsewhere and growing spare capacity – the market will still react to any supply shock. For example, when the US and IEA acted in coordination to replace disrupted Libyan supply in 2011, the duration of the resulting price relief appeared limited.

The oil market's buffers may well provide the security of supply and the opportunity for OPEC to rebalance the market, but they are not a cure-all for geopolitical risk.

Hickin will be talking more about global supply and demand balances as well as current market structures during the first day of the Tank Storage Asia conference in Singapore on September 25. For more information visit www.tankstorageasia.com.



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