Spare Capacity Theory

There are many things that people know about oil markets. This is especially true of those who know little, about oil. They know that oil prices, for example, are controlled by ExxonMobil. Or, at the very least, by nefarious speculators in the futures market. They also know that global oil producers don’t use much of their own oil. And, in particular, they know that OPEC has lots of spare capacity. Oil production capacity that can be turned on tomorrow, for example, should world events disrupt supply. Which brings us to today’s events in Libya.

I note with interest that David Fyfe of IEA Paris earlier today attempted to calm world oil markets, by reminding that in the OECD there are over 1.6 billion barrels of oil in inventory. By marshaling these western supplies of already-pumped, above-ground oil, the world could gain a new source of oil for up to one year, at a rate of 4 mbpd (million barrels per day). There are a few sticky issues surrounding such a claim. Not least of which is that oil markets regard drawdowns of above-ground inventories as a reason to send prices even higher. But that point aside, let’s consider what Fyfe did not claim: the head of IEA’s oil markets division did not claim that Non-OPEC oil producers, which account for nearly 60% of world oil supply, could lift supply to make up for the Libyan disruption. That’s no surprise. Non-OPEC oil production has already peaked, and couldn’t increase supply either tomorrow or next year.

In the graphic to the left we see the latest publicly available charts for OECD inventories, from the 18 January Oil Market Report from IEA. Note that in the bottom chart what’s being accounted for is not only the 1.6 billion barrels of crude that Fyfe refers to, but another 1 billion barrels of oil products. That said, the scale of these large numbers can be a tad misleading. They represent in part just the normal flows of the global oil market and are a snapshot of oil as it flows from production, to refining, and to distribution. For a different measure, these same levels of inventory represent 57.5 days of supply. Which the IEA itself says are the lowest in the past two years.

In truth, the spare capacity that the world cares about—that the oil futures market cares about—is not the inventory level. But rather, actual production capacity that can be brought on immediately. You can see the problem, from a price standpoint. If the world loses Libya’s 1.5 mbpd production for 90-120 days, and starts drawing down above-ground inventories, this only makes the inventory cushion that much thinner for any new supply disruptions. The question on the mind of the oil market therefore is not Mr. Fyfe’s 1.6 billion barrels of crude, but whether countries like Kuwait, the U.A.E. and especially Saudi Arabia or even Russia can lift supply. Immediately.

Of course, “everyone knows” that OPEC is sitting on lots of oil. However, as has been discussed here, at The Oil Drum, and elsewhere it remains decidedly unclear whether Saudi Arabia can indeed turn on extra taps at will. But the problems for world supply of oil do not merely end with production capacity. Even if OPEC is indeed sitting on 1-3 mbpd of spare capacity, it’s not clear for how long they can both increase production, and export that production to the world. Not only has Saudi Arabia’s production not increased in the past five years, but, Saudi is increasingly using its own oil for its own population. The result? Flat, to declining exports of oil from Saudi Arabia.

Spare Capacity Theory, therefore, looks alot like an unproven consensus reality. I’d like to define it as follows:

Spare Capacity Theory: the assumption among western bankers, policy makers, economists, and stock markets that OPEC producers can lift oil production at will, and, export all of that spare production to world consumers.

We shall see how much the oil markets themselves believe in this theory. Today’s five dollar upward price advance—from already high price levels—suggests the market is justifiably concerned about events in Libya, and the risk of more unrest to come in oil producing regions. Given the potential magnitude of this situation, I actually think its good that we can still rely on price as a means to ration supply.

-Gregor

Further Reading:

Brown and Foucher: Egypt, a classic case of rapid net-export decline and a look at global net exports

Gregor.us: The Ascent of Middle East Food and Energy Demand

  • Anonymous

    Your usual excellent, lucid writing. God Bless us all …

  • Anonymous

    Here’s what I think. First, Gregor you are always spot on, and no, I’m an American. :)
    Just a joke – I’m a citizen of the world, and have many friends / relatives around the world.

    As a Peak Oil follower, and also a follower of many, especially Jim Kunstler. The world is being lied too, as to how much oil is left. Peak Oil is here now. And despite the financial corruption, debt etc., Peak Oil is now, in IMO and the root cause of this. There’s no way to escape it. I’m not a 2012 person, but the sh*t is now breaking the fan.

    To be honest, who would have thought everything would be happening at once, at such a pace. I’m not surprised. And I would say this is just the early stages of the 4th turning.

    Thanks for another great article. I first learned about you via Max Keiser.

  • Dan

    Consider the magnitude of the oil price drop when economic sanctions against Libya were lifted and Libya could freely export oil again. Shouldn’t that drop be roughly comparable to the price rise consequent to the current supposed interruption of Libyan supply?

  • http://pollutico.com stephan Tychon

    Reserve futures?
    PeakOil is cheapOil’s consequence,
    the rootcause of global distortion:

    http://complexxon.org
    http://twitter.com/cheapOil

  • B-buni

    Of course it isn’t possible to know for sure how much reserve capacity saudis have. But when confronted with the choice of believing in Aramco, Sadad Al-Husseini and other prominent sources of information OR choosing to belive in nuts like Ken Deffeyes, Colin Campbell, Matt Simmons or other peak oil nuts – the choice ought to be pretty simple unless you have an emotional agenda.

    You only need to look at the track record of the ridiculous predictions…

    And you know, reasonable people follow the “all liquids” graphs and think looking at only c&c is rather ridiculous (regarding non-opec and also generally).

  • gregor.us

    Dan I think that would be a little too symmetric, don’t you? As time rolls on, for example, the cost structure of the net, marginal barrel of oil marches relentlessly higher. Sudden loss of oil production now means something very different than it did in 2002. MEND of the Niger Delta discovered the power of small changes at the supply margin way back in 2005, for example.

    G

  • gregor.us

    I’ve written extensively about the advantages to secrecy among OPEC producers, especially Saudi Arabia. For Saudi Arabia, it has been crucial to their role within OPEC and the world that oil markets believe in their capacity to dial down, and dial up production at will, and with ease. So, for me, it’s less about lying–although one could certainly use that word–and more about patterns of energy diplomacy. If there is lying it comes more from the agencies like IEA who know full well the situation with reserves and flows, but who spin the information hoping things will change. And of course, things have neither changes nor improved on the oil supply front.

    G

  • gregor.us

    Cheers.

  • timl2k10

    Good job of completely missing the point. Did you even read the article? It’s not about “reserve capacity”, it’s about spare production capacity. Thus the rest of your rant is completely off-topic.

  • gregor.us

    I appreciate the sarcasm, if it is indeed sarcasm. Though since you have paired up Sadad Al-Husseini *with* Aramco on the same side–it’s hard to know. :-)

    G

  • gregor.us

    Sorry, I don’t host free ads here. -G

  • B-buni

    Nope, no sarcasm there. Maybe you should find out what mr husseini says, i have seen him misrepresented in the peak oil media. But you wouldn’t know, since that’s all you read.

  • B-buni

    It’s a different word for the same thing…jeez

  • timl2k10

    No it isn’t. And saying it is doesn’t make it true. You’re entire post is about reserves and statements made about reserves.
    Gregor is talking about spare production capacity. Read the article. If you still don’t understand the difference, why are you even posting?
    I think I smell a troll.

  • B-buni

    I was talking about spare production capacity. Get it now? Or do you need further explaining :)?

  • gregor.us

    I’m not familiar with “the peak oil media.” I am, however, familiar with those who believe there’s no difference between crude oil and biofuels and natural gas liquids (included in All Liquids measures). Without fail, they cannot explain those differences. Would you like to address those differences?

    G

  • B-buni

    http://www.businessdictionary.com/definition/reserve-capacity.html

    And yea, i guess it can be misleading in oil-related debates, but it’s not like it’s rocket science :)

  • timl2k10

    That’s a generic term generally applied to electronics, but OK.

  • timl2k10

    Ok then, maybe you should re-write your original reply so it has anything to do with what Gregor wrote. Thanks.

  • B-buni

    Perhaps it is you who should address why you believe total liquids is a bad number to follow instead of me going on a wild goose-chase with your tricky argumenting.

  • timl2k10

    Btw, what’s with the phrase “peak oil nuts”? Peak oil is a fact, look it up on Wikipedia. Do you rant about “blue sky nuts” and “green grass nuts”?

  • B-buni
  • B-buni
  • B-buni

    Peak oil is a fact? No, it’s actually a phrase. But if you mean it’s a fact that we’ve REACHED peak oil – I’d say that a) it depends on if you’re looking at just c&c or all liquids and b) even if you’re looking at c&c it’s way early to blow the whistle. If you look at oil production history you can see that we have had that big dip of 10-15 years (can’t remember the exact length). And what i’m mostly referring to with the “nuttiness” is the early calls of peak oil but even more so the way they view that diminishing production is going to affect society.

  • timl2k10

    So, you know of no individual oil fields that have peaked? No countries whose production has peaked (U.S. perhaps?). You think world production peaking will be inconsequential? You have your head firmly buried in the sand then. You are part of a global problem. You are among those who will not face the facts. (I’m assuming here you can at least grasp them).

  • B-buni

    Jeez, can you read? I never said I don’t expect it to happend. I probably expect it to happend sooner than most. But later than some. Those some being peak oil nuts.

  • B-buni

    And in addition to that, I don’t believe peak oil will be the end of the world (as many nuts do), since I can easily see us doing OK with a lot less oil. World economy grew a lot during the big dip in historical oil production as well. World didn’t end even if oil production decreased for 15 years. It just became a lot more efficient.

  • timl2k10

    You expect it to happen sooner than most, so I guess to many that makes *you* a nut! oops! :)

  • gregor.us

    I think you’ve taken up more than your fair share of space now, with a number of posts that add little value. However, I will give you a chance to back up your assertions that making the distinction between C+C and All Liquids is ridiculous.

    In the interest of other readers, and this thread, please back this assertion up with data, and facts. Use numbers. Otherwise, any further posts from you here will be blocked.

    Best, Regards

  • B-buni

    Most being the general uninformed public…why would that make me a nut? Nuts are the ones calling peak oil now or in 5 years. Even energy agencies like the IEA are predicting it should be around 2030.

  • timl2k10

    Yes, that most trustworthy unpoliticized organization! Undiscovered unconventional to the rescue!

    Step 1) Estimate demand
    Step 2) assume we will discover and recover the supply needed, and, viola, there’s plenty of oil.

    Piece of cake!

  • B-buni

    I haven’t argued that making the distinction would be ridiculous. You just like putting words in peoples’ mouths with your semi-directed strawmen. I just noted that you probably are looking at c&c since you’re saying non-opec production can’t go up which I think is quite silly.

    According to EIA STEO non-opec is going to increase this year (albeit not by much and this is total liquids)

    So as total liquids is a number represented as mbd of oil equivalent, why don’t you use that number? I consider that a fair question, as this is what agencies like the EIA consider appropriate.

  • Moe Gamble

    It’s a bad number because it double counts the energy that goes into biofuels and it fails to adjust for the lower BTUs in liquids other than oil.

    Further it’s a bad number because it fails to address the lower energy return on energy invested.

    I agree that we can get along on less oil than we currently use, but the loss of cheap energy to higher-utility users like China is going to cause a contraction in the U.S. economy anyway. Every rural Wal-Mart worker who can no longer afford to drive his used gas guzzler 50 miles to the store is another worker out of the economy. He or she might be better off staying home and sewing clothes and growing vegetables for the family, but the parasites who’ve been living on that worker’s back (stock owners, the government, etc.) are now cut off from their cut of his labor.

  • B-buni

    As it should be a mbd of oil equivalent measure, I don’t think the BTU part is true. The EROEI question may be valid to some extent, but I believe it is quite overstated in peak oil -circles. If you look at the near future NGL is the fastest growing nonconventional and especially regarding NGL I believe the EROEI is quite excellent. Biofuels, CTL and the likes are probably somewhat a different story, but I haven’t really seen any convincing research on this either.

  • gregor.us

    “I haven’t argued that making the distinction would be ridiculous.”

    And…

    “And you know, reasonable people follow the “all liquids” graphs and think looking at only c&c is rather ridiculous (regarding non-opec and also generally). ”

    Thank you. As I said, in the interest of other readers I gave you a chance to come back to the discussion in a responsible way. You did not provide any data to back up your troll-ish claims, and that is no surprise. You are now blocked. Good-bye.

    -G

  • Wetairshower

    Here is some basics then, If you cannot lift ‘supply’ then cut ‘demand’ with a world wide credit crisis. Is that too hard to understand??

  • Wetairshower

    Peak oil can only become a reality is if the banks start lending again. The supply increases when the demand fot oil is reduced due to the world wide credit crisis. The flow of money controls the flow/demand for oil. And the flow of money, she aint happenin.
    Ecomomix 101.

  • Bannedguy

    Oh I believe I did reply to your argument. It is no surprise it went to deaf ears though, because you don’t appear to want to engage in meaningful argumentation. But that’s regular behaviour for peak oil nuts :)

  • Bannedguy

    I mean, “making the distinction” and “only looking at” are two quite different things so I’m really puzzled if you think you have stated something there :)

  • Steve

    I do believe he said what he meant. You did nothing but wave your hands. Why do you think it IS important to make that distinction?

  • Bannedfornothing

    Oh I believe I did reply to your argument. It is no surprise it went to deaf ears though, because you don’t appear to want to engage in meaningful argumentation. But that’s regular behaviour for peak oil nuts :)

    I mean, “making the distinction” and “only looking at” are two quite different things so I’m really puzzled if you think you have stated something there :)

  • Bannedbycoward

    Oh I believe I did reply to your argument. It is no surprise it went to deaf ears though, because you don’t appear to want to engage in meaningful argumentation. But that’s regular behaviour for peak oil nuts :)

    I mean, “making the distinction” and “only looking at” are two quite different things so I’m really puzzled if you think you have stated something there :)

  • steve

    Classic post.

  • Wou

    Oh I believe I did reply to your argument. It is no surprise it went to deaf ears though, because you don’t appear to want to engage in meaningful argumentation. But that’s regular behaviour for peak oil nuts :)

    I mean, “making the distinction” and “only looking at” are two quite different things so I’m really puzzled if you think you have stated something there :)

  • Tedakai

    One point that (I think) has gone unaddressed is the quality of oil which constitutes any spare capacity which may exist. When OPEC “cuts” (and let’s assume they actually do from time to time), the crude types held back tend to be the heavy/sour (read low revenue) types. This was evident (at least to me) when OPEC cut back during the 2008 financial crisis in the LLS/Mars spread on the US Gulf Coast. Normally about $6/bbl (LLS over), it rallied in to an extremely tight $3/bbl during early 2009. Today it’s back out to over $5/bbl ($5.86/bbl Argus March month average to date) reflecting the return of heavier/sourer crudes as OPEC “cheated”.
    This would lead one to believe that those volumes constituting “spare capacity” (current production, not reserves to be proven/drilled) is generally heavy sour and not necessarily the best fit for incremental refining capacity which tends to be topping/reforming.
    Old, old memories also suggests to me that Libyan production is generally low sulfur/sweet, the loss of which is not easily replaced by Arab Gulf crudes.

  • gregor.us

    Indeed. If we refine our definition of spare capacity–away from the gray, hazy, generally accepted view of “extra” that is just sitting idly by waiting for the call–to include both the strain on older oil fields, the duration of extra production and its sustainability, and then to your point, oil grade quality, I think people could understand better why Libya’s 1.5-1.7 mbpd production cannot be replaced easily. In fact, I don’t even think half of Libya’s production can be replaced easily. And it matters, quite alot, because Libya exports over 80% of what it produces.

    G

  • gregor.us

    I really look forward to seeing how much actual production flows, if any, from increased OPEC actions and especially how much is exported. I suspect that OPEC could possibly cobble together 400 thousand barrels from all members, net, to export over the next 6 months. Slowly of course.

  • http://www.facebook.com/Joss82 Sylvain Jo

    Last link on the post is broken, missing h of http.
    You’re welcome ;)
    Great article, BTW.