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July 17, 2018

OPEC hits spare capacity limits, US budget deficit growth accelerates

OPEC hits spare capacity limits, US budget deficit growth accelerates


According to an estimate of the EIA released last week Saudi Arabia will have to use all of its spare production capacity to make up for the drop in oil exports from sanctioned Iran and financially troubled Venezuela. The data shows that OPEC spare capacity equals to the Saudi Arabia’s meaning it’s the only member in the cartel which can substantially raise production.

However prices started the week with a severe drop, pricing in the news that US may deploy its strategic reserves to correct market prices if OPEC won’t take action on request from the US. 

IEA released a report this week which stated that, the Kingdom could expand production additionally up to 2 million barrels in May. In June, it fell to 1.58 million, and in July it was already up to only 1 million barrels.


Saudi Arabia spare output capacity

Saudi Arabia spare capacity heads to the lower bound. Source IEA, Bloomberg


What this data says is that Saudi Arabia hiked its oil output by about 500 thousand b/d in May. Over the summer months, the output of the kingdom rose by 0.9-1 million barrels.

According to the US Department of Energy, in June, OPEC’s ability to raise oil production fell to 1.54 million barrels per day, which corresponds to capacity reserves of Saudi Arabia. That is, the only country capable of materially increasing production is the Middle Eastern kingdom.

At the same time, in 2016, when the world oil market was hit by extreme oversupply, OPEC spare capacity averaged 1 million barrels. It is possible that production of the cartel will be difficult to fall below this level.


OPEC spare capacity

OPEC spare capacity is equal of the Saudi Arabia’s


Spare capacity is used like a safety cushion as it allows to absorb supply shocks and maintain production at safe level to meet it with demand. Flurry outages from Iran, Libya, Venezuela and Canada create dangerous situation where the oil shortages may not pass unnoticed and cause sharp price spikes as reserve capacity of OPEC and Russia is reaching lower existing bound. 

Taking into account historical data, won’t likely to add more than 500K barrels additionally to its production but the market glut may loom on the horizon, because US producers don’t sleep as well and keep output at record peaks. Recall that according to OPEC estimates, global demand will reach 99.4 only million barrels per day in the third quarter of 2018, while projected total world supply – 99.2 million barrels. In other words oil market will probably need to find additional supply to return to equilibrium.

So even with increase of output by 1M barrels in June to 11M barrels, Saudi Arabia probably failed to cover the deficit of crude oil and the fears of oversupply could be overstated.


No worries about the debt…yet


Since the beginning of the fiscal year, the US budget deficit has risen to $607 billion.

In the first nine months of 2018 (fiscal year in the US started in October 2017), the budget deficit exceeded $607 billion, which is 16% more than in the same period of last year.

In 2017, expenses exceeded revenues by $665.8 billion, $ 58.7 billion higher than the current amount for only 9 months from 12.


Budget deficit US by year

US budget deficit by year. Source:

For the first nine months of this year, the budget received 2.5 trillion dollars, and spent 3.1 trillion dollars. Against this background, the US national debt reached 21.2 trillion dollars.

By the way, the growth of public debt is far from the fastest in the last ten years. For example, in 2009, due to the economic crisis, the budget deficit exceeded $1.4 trillion. And for four consecutive years it was more than 1 trillion.

Despite the fact that the US debt is already more than 21 trillion dollars, at the current interest rates, the United States creditworthiness is not particularly at risk. It is enough for the United States that the world economy grow at a moderate pace what ensures low interest rates and the dollar remains major reserve currency. That also ensures stable demand from the world to US debt securities which credit risk remains at 0 level. 

Each year the United States sells Treasuries worth $600-700 billion through auctions, and for the entire global economy this is not pretty much. The US will be in danger when the cost of debt servicing will surge. Today it is about 400-450 billion dollars a year.

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