It was about four years ago that crude prices turned down. At the time, expectations were for something closer to a traditional energy cycle, so there’s been plenty of false starts—and disappointments—since then. The absence of adequate Permian Basin takeaway is one such obstacle, but pending bottlenecks have also prompted observers to refocus their attention on events overseas.

With Permian growth sidelined for the next 12 to 15 months, questions of net production growth in other areas of the world are being re-assessed. And with steepening decline rates in a number of countries—not just Venezuela—conversations have swiftly switched from concerns about OPEC cheating to talk of testing the limits of OPEC’s spare capacity in the near to medium term.

Of course, geopolitics is up front and center now that the Trump administration has not only withdrawn the U.S. from the Iran nuclear deal, but also indicated that Nov. 4 marks an end—not start—of a drawdown period to cease Iranian oil imports. Estimates of how much Iranian exports could decline have ratcheted up from several hundred thousand barrels per day (bbl/d) to almost 1 million.

This and other dislocations mean that the fundamental backdrop for oil “is shaping up to be the most constructive in years,” according to a late-June report by RBC Capital Markets. What final investment decisions have been made by the industry are now “extremely transparent to the market,” it noted. “There are fewer and fewer pockets of global supply that can surprise to the bearish side for prices.”

The RBC report foresees a multiyear period marked by growing concerns over spare capacity due to industry-wide underinvestment. “We believe that concerns regarding perpetual tightness and dwindling spare capacity will be the overarching narrative for at least the next 18 months,” it said. For 2019, RBC forecasts Brent and West Texas Intermediate prices averaging $85.50 and $76.00/bbl, respectively.

“The forward curve has been too low for far too long,” it stated, projecting that strength in the term portion of the commodity curve would raise crude prices to “investable levels for global projects.” While term pricing has begun to move higher, it observed, “notional value and stability are equally important in order to attract more costly, long lead-time, low decline global projects.”

Historically, the margin of spare capacity has served as an important indicator of future crude prices. A late June report by Jefferies said global spare capacity stood at roughly 2% of demand, the “lowest level since at least 1984.” With a number of analysts forecasting global demand to reach 100 MMbbl/d by the end of this year, this would translate to a spare capacity cushion of just 2 MMbbl/d.

Although spare capacity is held by various OPEC members, including Saudi Arabia, the United Arab Emirates and Kuwait, plus OPEC ally Russia, the market is focused on Saudi Arabia. According to Morgan Stanley, Saudi’s spare capacity was estimated at 1.3 to 2.1 MMbbl/d when its production was running at about 10 MMbbl/d. As of early July, production was said to have already risen to 10.7 to 10.8 MMbbl/d.

Morgan Stanley predicted that Saudi production would move up further to 11 MMbbl/d in 2019, noting that “if production increases as we now forecast, a large share of this (spare capacity) would be eroded, leaving the global oil market with a ‘limited margin of safety.’”

If Saudi Arabia is on its way to 11 MMbbl/d of production, how feasible is a next move to 12 MMbbl/d, the upper end of its presumed capacity?

“From our understanding, they’ve tested 11 MMbbl/d for a month, they’ve sustained it, so I think they can absolutely deliver on that,” said Amrita Sen, chief oil analyst at Energy Aspects, in an interview with Bloomberg. “And the Neutral Zone [production between Saudi Arabia and Kuwait] is likely to start up later this year or early next,” she added.

“But beyond that, this is absolutely uncharted territory,” said Sen. “Our understanding is it’s going to take 9 to 12 months, with more rigs, more capex. ... Let’s say they commit to increasing capex and rigs and get to 12 MMbbl/d—we’ve never been in this situation where the oil market has no spare capacity.”

Even if other Gulf countries and Russia bring on their remaining spare capacity, that will likely go to offset losses in Iranian supplies, continued Sen. “Then, if you throw in Venezuela, Libya and Nigeria, the market just doesn’t have any shock absorbers.”

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