Oil traders know output gains trim a market cushion

Bob Tippee

A production increase coordinated by the Organization of Petroleum Exporting Countries isn't always what it appears to be.

Much of the price response depends on how much oil the group's heavy hitters can produce but don't before the output change.

By definition, when OPEC raises production, idle capacity falls. The latter effect can spook the market enough to offset price moderation sought by the former.

The market needs its cushions against supply disruptions. When those cushions are thin, traders get nervous.

For now, one of the market's two cushions, inventory, looks stout. The other cushion, spare capacity, looks—well, interesting.

In August, according to the International Energy Agency, spare capacity of the 10 OPEC members other than Algeria and Iraq, which don't have quotas and produce as much as they can, totaled 3.3 million b/d. A year earlier it was 2.27 million b/d.

Against the production numbers that yielded the recent figure, the 500,000 b/d production increase OPEC announced Sept. 11, effective Nov. 1, would lower spare capacity to 2.8 million b/d.

That's still up from last year—and the 3 prior years—but is it enough?

The answer depends on how much oil traders think the market might need in a hurry. In 2002-03, the market lost supply in sequential, sudden increments of 2-2.5 million b/d from Venezuela, Nigeria, and Iraq.

Spare capacity at the current level could cover such losses. But then there's Iran, another place where anything can happen. In August the Islamic Republic produced, by IEA's reckoning, 3.87 million b/d. Loss of Iranian oil would make all that oil in storage very important while it lasted.

While welcome, the past year's growth in spare production capacity offers little comfort. It happened because OPEC cut production. Total sustainable capacity of quota-bound OPEC members actually fell August-to-August by 170,000 b/d.

If there's warming news in any of this, it's that capacity losers include the three producers that worry the market most. So potential losses from disruptions in Venezuela, Nigeria, and Iran are less, however slightly, than they were before.

But that's stretching. Demand's still rising. The market remains under strain.

(Online Oct. 5, 2007; author's e-mail:

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