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There are several key points that together suggest to us that, while the increase in US supply is important for non-OPEC supply and for the US trade balance, the relative position of US supply compared with Saudi Arab..

30 Nov 2012

Commodity Online
Amid market debates of who would produce more of crude oil; US or Saudi Arabia, Barclays has come out with a killing proposition: spare capacity, not actual production, is the measure of overall importance in the oil market; making all the debates worthless in a waving of hand. 

There are several key points that together suggest to us that, while the increase in US supply is important for non-OPEC supply and for the US trade balance, the relative position of US supply compared with Saudi Arabia is something of a red herring.

In other words, while it matters that the US will produce more in absolute terms, it is almost irrelevant as to which country produces the most. First, the alignment is only temporary. On the IEA projections the gap is just 0.1 mb/d by 2025 and Saudi Arabia produces 3.1 mb/d than the US by the end of the survey period.

Second, at no point in the IEA projections does US production exceed Saudi capacity.

Saudi Arabia could always produce more than the US should it want to do so for any reason, and the temporary dip below the US output level is a function of the maintenance of spare capacity in Saudi Arabia.

Third, power within the oil market is not, and has never been, a function of which country produces the most oil; it is a function of the control over spare capacity. In that sense, what makes Saudi Arabia powerful is that it has oil capacity that it does not produce, not the volume that it does produce.

The final key point is that the result is entirely dependent on Saudi Arabian output falling from current levels, losing 0.9 mb/d by 2015 and then falling a further 0.3 mb/d by 2020. In turn, that result is entirely dependent on a scenario in which Iraqi output ramps up sharply and Saudi Arabia gives way in a market that becomes demand-constrained. In short, a lot of shoes have to fall all at once to get a very narrow and temporary lead for US production.

Iraq has to achieve output increases, demand has to stay muted, Saudi Arabia has to decide not to depress US output by opting for a periodof lower prices, the US output increase has to come through, the rest of non-OPEC has to perform far better than it has been doing, and Saudi Arabia has to wave Iraqi increases ontothe market without any tactical or price response.

In Barclays' view, this does not seem like a central scenario, this seems like a lot of things happening together that are unlikely to all come through, indeed in our view only a minority of them are likely to be correct.

Had the projected lead of the US in 2020 been huge, then the result might be more robust. However, that gap is just 0.5 mb/d, with all the forecast errors associated with being eight years down the curve.

“In our view, it seems somewhat disingenuous for so much coverage to have been given to a narrow output gap that might not be a robust result, is temporary and in reality does not matter in terms of market influence.”the Bank said.


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