The Truth Behind Saudi Arabia's "Spare Capacity"
Crude oil topped $103 this morning.
The last time oil was this high was Sept. 26, 2008 – the last trading day before the US House rejected the first bank bailout bill. Wall Street then threw a snit and slashed 777 points off the Dow in one day.
There doesn’t appear to be any overt reason why the price popped today. But beneath the surface, we see a series of ominous developments from Saudi Arabia, the world’s No. 1 oil exporter. Events that could make $103 oil seem as quaint as an 8-track tape left in an abandoned car for the last 40 years.
First, a little background. World energy demands – and, by extension, traders in the market – rely on something called “spare capacity” or producers’ ability to jump-start new oil production within 30 days and keep it up for at least 90 days.
If you listen, you’ll hear it on the tip of the “official” tongue. Yesterday, for example, Treasury Secretary Tim Geithner assured Congress: “It’s important to note that there is considerable spare oil production capacity globally.”
“Spare capacity” in the oil market is directly analogous to the bag of tricks Ben Bernanke alluded he’d dip into when the time comes to unwind the Fed’s balance sheet.
For better or worse, most of the “spare capacity” burden falls on Saudi Arabia. Saudi princes claim to be able to goose production from 9 million barrels a day to 12 at the drop of a hat.
Never mind that they’ve never done anything like that before, even when oil ran up from $25 to $147 a barrel between 2003-08. The official line – and, therefore, the oil market – still believes it’s true.
But for how long? This chart from Morgan Stanley, analyzing worldwide demand estimates, suggests “spare capacity” will be tapped out in two short years.
Even by conservative demand assumptions, “spare capacity” disappears by 2013…
As fighting was getting under way in Libya a week ago, Saudi Arabian oil officials got on the phone to the International Energy Agency (IEA). They’d just boosted their daily oil production from 8.6 million barrels a day to 9 million. They wanted the world to know they could step in with the “spare capacity” to replace Libyan production.
Oil prices dropped in the final half-hour of trading.
Amazing, isn’t it? Saudi Arabia’s stated reserves are 259 billion barrels. Which is what they were last year…and every year going back to 1980.
In his book Twilight in the Desert, the late Matt Simmons, a gentleman with whom we shared an editor at John Wiley & Sons, found ample reason to cast doubt on official Saudi figures during the previous decade. WikiLeaks made public last month that a senior official from the state-owned oil company believes Saudi reserves are overstated by 40%.
And yet the market responded to what was effectively a PR campaign by the Saudi princes.
“There is in fact good reason to think that the Saudis are producing 9 million barrels a day,” says author Steve LeVine, writing at Foreign Policy, “but reasonable doubt that they went up to that level just last week in response to Libya.”
More likely, they boosted production some time ago to help meet domestic demand.
“If they were producing that much then,” LeVine says, “it does not necessarily prove that they can raise their production now, neither for the many months before full Libyan production returns to the market.”
The Saudis have also made public plans to start injecting carbon dioxide into the world’s largest oil field, Ghawar, no later than 2013. CO2 injection is what you do when an oil field starts yielding progressively less oil. It gooses the output…for a little while.
The plans come as no surprise from the Saudis, given Ghawar was discovered in 1948.
Even if the Saudi princes are telling the truth about their spare capacity, it all goes bye-bye in two more years. The fact that they’re resorting to complex and costly new tactics to keep the world’s largest oil field creaking along doesn’t exactly inspire confidence.
Bottom line: “Saudi Arabia can’t make the shortfall from Libyan supplies,” says commodities investing legend and Vancouver veteran Jim Rogers. “They’ve said in the past that they can increase production, but they can’t.”