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Highlights

OPEC has some 3.16 million b/d of spare production capacity

IEA says global stocks sufficient to counter geopolitical risks

Spare capacity is a more reliable cushion than SPRs

OPEC is slowly tightening the oil market and increasing its spare capacity, but the risks of policy miscalculation as well as significantly disruptive events are rising in the Middle East.

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As OPEC kingpin Saudi Arabia maintains its production discipline to chase higher prices, some analysts say it's only a matter of time before OPEC's output quotas leave the market overly exposed to geopolitical upheaval.

While the bloc's output cuts have helped boost the amount of spare production capacity it holds to potentially protect against a supply squeeze, the buffer is smaller than it has been in times of previous market turmoil, such as in 1979 and 1990, noted Paul Sheldon, S&P Global Platts Analytics' chief geopolitical adviser, highlighting the oil shocks associated with the Iranian Revolution and the Gulf War.

Sheldon adds that "global spare capacity is currently well below the levels of those periods, even with OPEC+ production cuts in place, so in that respect markets are relatively susceptible to an outsized, disruptive, geopolitical event."

OPEC's rebounding spare capacity

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, it is a recovery from just 1.91 million b/d in the final quarter of last year and Iran has 1.43 million b/d available on top should sanctions end, according to IEA calculations.

The kingdom's national oil company, Saudi Aramco, has said it could potentially pump 12 million b/d on a sustained basis. That compares with current production of less than 10 million b/d, a level it has stayed below since March, according to the S&P Global Platts OPEC survey.

For now, OPEC has been content to cite the glut in oil stocks as the justification for persisting with its production cuts, in the face of heightened maritime tensions in the Persian Gulf and the chokepoint Strait of Hormuz, through which more than one-fifth of the world's oil supply transits.

OPEC and 10 non-OPEC partners led by Russia agreed earlier this month to extend their 1.2 million b/d in supply curbs through the first quarter of 2020.

The IEA has also maintained that global oil stocks are sufficient to ward off any current geopolitical risks, and many other market watchers agree. The IEA estimates that, as of May, oil held in storage by OECD countries totaled more than 2.9 billion barrels - some 6.7 million barrels higher than the five-year average.

This explains in part why the oil price has barely budged despite the recent attacks on oil ships in the Persian Gulf as well as Iran's attempted seizure of a BP-owned tanker.

The market has also shrugged off potential risks to supply from war-torn Libya, as well as restive Nigeria and sanctions-hit Iran and Venezuela, with many investors focused more on the demanddampening trade dispute between the US and China, along with the meteoric rise in US shale production.

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"We have enough oil in storage, SPRs [strategic petroleum reserves] and spare capacity to counter any shortages that result from political instability in the Middle East or anywhere," said Anas al-Hajji, an independent oil consultant based in Dallas.

RESPONDING TO OUTAGES

The US holds close to 650 million barrels of crude in its Strategic Petroleum Reserve. India and China, key consumers of heavier, sourer Middle Eastern crudes, have also looked to bolster oil stocks.

But while stored barrels can provide temporary relief to supply disruptions, spare capacity is a more reliable and sustainable cushion, if used properly.

"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," said Bassam Fattouh, director of the Oxford Institute of Energy Studies.

The key question for the market, then, is whether Saudi Arabia and its OPEC cohorts will be responsive enough in triggering their spare capacity when called upon. Saudi officials say they remain flexible in their plans, but they have also not been shy about their intent to tighten the market.

Should security of supply concerns threaten a repeat of 2018, when oil prices rose to near four-year highs on concern over the US' sanctions on Iran, Saudi Arabia may stick to promised production cuts, this time emboldened by global oil buffers beyond spare capacity and determined not to make the same mistakes. It's a high stakes strategy.

-- Paul Hickin, paul.hickin@spglobal.com

-- Edited by James Leech, james.leech@spglobal.com