Iran sanctions put Saudi oil output capacity to the test While all eyes in the oil market are on Iran, Ras Tanura, a sandy peninsula on the Saudi coast, is under almost as much scrutiny. The oil export terminal, the world's largest, has witnessed an uptick in activity over the past two weeks, suggesting Riyadh is ramping up oil production as looming sanctions by the European Union and US disrupt Iran's crude exports. The increase in output by Saudi Arabia, which is expected to continue over the next few months, will test the country's production capacity at levels not seen since the late 1970s. Riyadh is regarded as the big "swing producer" of the oil market, adjusting its production to balance the global supply and demand equation. While almost all oil producers always pump at full capacity, the kingdom attempts to preserve at least 1.5m barrels a day of spare capacity, a cushion that allows it to boost output if needed. With inventories of crude held by industrialised nations at their lowest in four years, and the lowest in 15 years in Europe, Saudi Arabia's spare capacity is one of the last remaining buffers in the market. Another is the strategic reserve held by members of the International Energy Agency, the group of oil-consuming countries. "The crisis is going to increase demand for Gulf countries" oil," says Paul Tossetti at PFC Energy in Washington. Kuwait and the United Arab Emirates are already close to their maximum production level, so it will all be up to Saudi Arabia. While an increase in Saudi production could push down prices, some traders and investors believe it could have the opposite effect. As Saudi spare capacity decreases, they argue, the oil market will build in a greater risk premium as traders fear there will be no buffer should there be further disruption. Riyadh has used its spare capacity several times during the past decade, including when it lifted output during a Venezuelan oil strike in late 2002 and the US-led invasion of Iraq in early 2003. Last year it increased production to offset the collapse of Libyan oil output. But the challenge for Saudi Arabia is greater this time. The kingdom is already pumping at its highest level in 30 years, producing 9.9m b/d in January, according to the IEA, amid disruptions to production in South Sudan, Syria and Yemen, and strong demand for crude from Asia. Amrita Sen, oil analyst at Barclays Capital in London, says the starting point is not "nearly as comfortable" as it was last year when Riyadh reacted to lost Libyan supply. Also, the depletion of oilfields means Saudi Arabia's maximum pumping capacity has dropped to 11.9m b/d, the IEA believes. As such, the supply cushion has fallen to 2m b/d, roughly 40 per cent lower than immediately before the Libyan civil war. Oil traders and analysts believe that, to counter the impact of sanctions on Iran and other supply shortages, Riyadh will need to boost production by at least 500,000 b/d. The replacement barrels will go to European countries, Japan, India, South Korea and China. The timing adds to the pressure on spare capacity. Domestic Saudi demand increases in the summer, when higher air conditioning use compels Riyadh to burn crude for power generation. The IEA estimates that between July and September the kingdom will consume 3.2m b/d, up from 2.6m b/d in the current quarter. The combination of strong domestic demand and a shortfall in Iranian exports could push Saudi production above 11m b/d, reducing its cushion of spare capacity to just 1m b/d, the lowest since early 2006 in the wake of hurricane Katrina, according to IEA estimates. Robert McNally, head of consultancy Rapidan Group and a former White House oil adviser, says that if Saudi Arabia increased production to more than 11m b/d on a sustained basis, "it would signal that short-term spare capacity is nearly exhausted and that Riyadh may be preparing for an emergency in the Gulf by positioning crude near its consumers." Some question whether Saudi Arabia's capacity is as high as the IEA estimates. In an interview in January, Ali Naimi, Riyadh's oil minister, said that the amount of oil that could be pumped "almost immediately" was 11.4m to 11.8m b/d. "There are many in the market who are sceptical of the Saudi numbers, for the simple reason that they've never produced that much before," says Mike Wittner, head of oil research at Société Générale in New York. Maybe they can do it, maybe they can't. I guess we're going to find out.