LONDON (Reuters) – The cost of keeping spare oil output capacity ready to plug any gaps in global supply is costing Saudi Arabia more than $1 billion a year.
After reducing output in line with an OPEC agreement to trim supplies last week, Saudi Arabia’s spare oil capacity will reach around 2.5 million barrels per day in November.
The world’s largest exporter has pledged to bring that supply on line within 90 days if international supplies are threatened by a large unexpected supply outage.
The operating costs of keeping all that oil ready to go at such short notice is around $1 a barrel a day, analysts said.
“To maintain about 2.5 million bpd of spare capacity would easily cost Saudi Aramco over a billion dollars,” Saudi oil analyst Nawaf Obaid said.
“That is the both direct and indirect cost of having people there managing the fields, surveying them, replacing equipment and other general oil service costs.”
The cost is a lot higher if the investment to build the capacity is taken into account, said Sadad Husseini, a former top executive at Saudi Arabian oil firm Saudi Aramco.
“You have to make that capital investment first to get spare capacity,” he said. “In the Arabian Gulf, capacity can typically cost $5,000-$8,000 a barrel.”
That would imply current spare capacity has cost Saudi Arabia up to $20 billion to build.
The kingdom has spent billions more as it aims to maintain spare capacity by bringing on new projects in coming years.
If output stays at current levels, the Saudi cushion alone should rise to 3 million barrels in the first quarter of next year, Obaid said.
If all OPEC members cut back from November as much as they agreed last week, then the group’s total spare capacity would rise to 3.8 million bpd from the 2.6 million bpd estimated by the International Energy Agency last month.
Holding spare capacity also incurs the much higher opportunity cost of potential revenue for selling the oil.
With oil at nearly $60 a barrel, the Saudi government alone is in theory losing around $150 million in revenue per day for its 2.5 million bpd of spare capacity.
In practice, revenue would be a lot less because the additional supply would push prices into a tailspin.
The rise in OPEC’s output cushion after the cut has eased investor concern that the global supply system would struggle to deal with a major outage, pushing down the price.
US crude CLc1 traded below $60 a barrel on Tuesday.
Worries that Iran’s nuclear dispute with the West might lead Tehran to cut its 2.4 million bpd of exports contributed to oil’s rally to a record high of $78.40 a barrel in July.
“Spare capacity will jump. It means OPEC would be able to cope with an oil embargo from Iran,” said Frederic Lasserre of SG CIB Commodities.
“Since the lack of spare capacity fuelled the rally in the first half of the year, increasing spare capacity should have the opposite effect.”
Saudi Arabia’s operating costs were among the cheapest in the world, so its cost per barrel for spare capacity was also among the cheapest, Husseini said.
Still, with inflation pushing up costs across the oil service industry globally, operating costs have been rising and in some Saudi fields were at $2 to $3 a barrel per day, he added.
Other Middle East producers have higher operating costs and so cutting back would be more expensive. In Nigeria, with a higher proportion of expensive offshore production, costs would be higher still, analysts said.
Nigerian operating costs vary from $5 to $15 a barrel. It would face resistance to trimming output from joint production ventures with international companies looking to recover investment costs as quickly as possible.
Spare capacity costs pale in comparison to the huge revenue flow into producers’ coffers from record oil prices. Saudi oil revenues this year were forecast to come in at over $200 billion.
“It is a cost that the Saudi leadership is willing to assume,” said Obaid. “It wants to bring assurances to global markets that there is spare capacity.”