Capacity Crunch
Where has all the spare production capacity gone. After the failed Doha initiative, where it appeared all the adults had left the room and new Saudi oil strongman Deputy Crown Prince Mohammed bin Salman left other summit members fuming, the market now is concerned that it might not matter after all. An ongoing oil worker strike in Kuwait is cutting their output from 2.8 million barrels of oil a day to 1.5 million barrels of oil per day and it is unclear whether there are any producers that have ready spare capacity to make up that difference. While the Kuwaiti oil company has upped output, it is unclear whether that can get production to pre-strike levels that could start to speed up the balance in the global oil market.
On top of that the Kuwaiti crude quality is not easily replaced by competitors. While they boast about rising production ambitions in the future, in the short term this strike is going to take its toll. Besides if things are so great in Kuwait why did they have to cut oil workers' salaries that started this strike in the first place.
The strike comes against a backdrop of production issues around the globe. With U.S. oil production falling below 9 million barrels a day and reports of a crash in U.S. shale production, it is clear that in the short term shale oil can’t come to the rescue. The Financial Times says 1.5 million barrels a day is close to the equivalent of the U.S. Permian region’s shale oil output. We also have outages in Nigeria, in Kurdistan and plunging output in Venezuela, Brazil and throughout Latin America. We are seeing production fall in Kazakhstan.
All of a sudden the global market that was over producing demand by 1.5 to 2.0 million barrels a day may arguably be under producing demand in short order assuming the Kuwaiti strike lingers.
We are also getting support from the floods in Texas which may have caused at least one refinery outage and could impact others in coming days. The Wall Street Journal reported that no significant impact was reported for oil fields and the belt of refineries around Galveston Bay. And that gasoline producing unit was taken out of production at Royal Dutch Shell Plc's (LON:RDSa) joint-venture Deer Park refinery. It was unclear if weather was a factor in the unit's shutdown according to Energy Aspects.
From the big picture this bodes well for the bull side of the equation. The idea that the Doha failure and that OPEC and non-Opec would keep raising production and demand would be weak may not be panning out. Stability in global markets and record oil imports from China have set aside fears that global demand for oil would collapse. What is more the historic power shift away from Saudi oil minister Ali al-Naimi to Saudi Arabia’s 30-year-old deputy crown prince Mohammed bin Salman, is increasing the odds of conflict with Iran in the future which may put a new geo-political risk premium into the price of oil.
From a long term perspective, we are again seeing changes that happen at the end of a historic bust cycle. Falling oil output from oil producing nations that are cashed strapped. A crash in exploration spending. Huge capital spending cuts and major bankruptcies. A tightening in credit in an industry that has lost the confidence of banks. This is all laying the ground work for a new super spike in the price of crude oil in the future. We continue to recommend to look at the long term big picture for this market. Long dated options and back month futures and long futures protected with options. Even if Saudi Arabia were to lift its production from 10.2 million barrels a day currently to above 11 million barrels a day, it is likely that is all they could do. The Globe reports that Saudi Arabia is running through $10bn of foreign exchange reserves a month to plug its fiscal deficit. The fixed riyal peg makes it much harder to roll with the budgetary punches as Russia is able to do with the floating ruble and Russia will have a hard time raising output as well as they still have problems of their own. Iran is probably already priced into the market. So who is left. Bottom line we should be looking at the big picture and learn the lessons of price crashes of the past.