OF POWER SHIFTS AND SPARE CAPACITY
August 2, 2013 § 1 Comment
A recent article by Bordoff (Columbia University) and Levi (Brookings Institution) makes some interesting observations with regard to a possible shift in the balance of oil power from the Middle East to the Western Hemisphere. Of particular note is their discussion of the concept of spare capacity. For a net exporting nation this would be defined as the ability to shut in or produce more at will. They report that the Saudis have spare capacity of 3.5 million barrels per day (MMbpd) against total exports of 8.7 MMbpd.
This immense spare capacity allows the Saudis to be the moderating influence on oil prices. If prices rise steeply, with the risk of causing demand destruction, the Saudis can open the spigots. They could also respond to pressure from influential importing nations. No small wonder, therefore, that the US continues to have a comfortable relationship with the Kingdom despite major differences of opinion on issues such as women’s rights and the war on terrorism.
For net importing nations the concept of spare capacity scarcely applies. For the US, increased domestic production, which is proceeding in leaps and bounds, merely means decreased reliance on foreign oil. But here is the kicker. Our new found oil is all from tight formations and virtually all of it is sweet, light oil. It commands a higher price than the heavy oil from Canada, Mexico and Venezuela. Many of our refineries have invested heavily in coking equipment to deal with the heavy stuff. Their margins are less for the light crude. So, the displaced crude will be the light oil from Nigeria and some from the Middle East, which is increasingly turning heavier, despite the benchmark name Arabian Light.
All of this complication underlines a truism: oil is not just oil and refineries are very picky about what crude suits them. The smartest move may be for us to export the light crude at high prices and continue to import the heavy crude at low prices (that differential can be as much as $30 per barrel). That requires Presidential approval, I do believe. For reasons best known to someone other than I, refined products can be exported at will but the raw oil or gas export requires approval, except to NAFTA countries. Permitting oil exports at high prices has no downside to it especially if the resulting import is from friendlies such as Canada. The question of Canadian oil being dirty can be debated elsewhere. Suffice to say there are solutions if folks are prepared to be a wee bit innovative. Unconstrained export of LNG will have a significantly net negative impact on the economy. When you go to this link, go further to the report linked therein.
The authors of the cited article opine that the Saudis will continue to be the controlling factor on oil prices even if our dependence drops dramatically. This seems right because even if the US drops to zero oil from the Middle East, it will have an interest in keeping oil price moderated. In part this would be to keep our own imported oil price in check, and in part it could be to protect our allies. But this probably means that the dreams of a few of us, of ceasing the policing of the Strait of Hormuz, may well need to be relegated to the wishful thinking pile.
One important point missed by the authors is the potential impact of gas and gas derivatives reducing domestic demand for oil. They recognize the oil/gas price spread and the arbitrage opportunity it brings in the chemicals industry. But they don’t sufficiently recognize the significant movement in displacing diesel with compressed natural gas (CNG), liquefied natural gas (LNG), gas derived synthetic diesel and dimethyl ether (DME). Technology is increasingly enabling this direction and it could have a material impact upon the demand for oil. When added to the oil derived chemicals, such as nitrogen fertilizer, ethylene and propylene, as already noted by them, significant demand destruction of oil can be anticipated in the US. This was noted recently be a Saudi prince (pictured above) in a warning to the Saudis to diversify.
One final argument relates to the previous point regarding the role of abundant and cheap natural gas in the US. To the extent that this affects demand destruction of oil, natural gas could be the spare capacity nobody is thinking about. It can be turned on in under a month when needed. Shutting in natural gas is more feasible than shutting in oil. In an odd twist the oil substitute natural gas could be our spare oil capacity.