Spare Capacity Theory

"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 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."

"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."

http://gregor.us/oil/spare-capacity-theory/