Release of strategic oil reserves: New form of economic stimulus

IHS CERA Chairman Daniel Yergin and IHS CERA Managing Director Jim Burkhard offered the following analysis regarding the June 23 decision by members of the International Energy Agency (IEA) to release 60 million barrels of oil from strategic oil reserves.

On June 23 International Energy Agency (IEA) members announced the release of 60 million barrels of strategic oil reserves over a month—the equivalent of 2 million barrels per day (bpd) for 30 days. Half of this amount—30 million barrels—will come from the US Strategic Petroleum Reserve (SPR), which currently holds 726.5 million barrels of crude. The release of 60 million barrels over 30 days will temporarily increase world oil supply by about 2.3 percent.

Since the March disruption of 1.2 million bpd of Libyan oil exports, the use of strategic (government-controlled) oil reserves has been under discussion by some members of the IEA. Before the civil war, Libya exported 1.2 million bpd of oil, which makes this disruption comparable to the amount of crude oil lost from the US Gulf of Mexico following Hurricanes Katrina and Rita in 2005, when the IEA also released supplies, although at that time there was very little spare production capacity.

Although oil prices have come down since Brent reached $126 per barrel in April, worries about the potential for another economic slowdown have grown. The outcome of the June 8 OPEC meeting added to fears that oil prices could increase again and intensify economic headwinds. Meeting for the first time in six months, OPEC’s ministers were unable to reconcile their strongly held positions about the need to raise a restrictive output ceiling set at a meeting in Algeria in December 2008. The OPEC meeting broke up without a consensus. Saudi Arabia’s oil minister Ali Al-Naimi described it as "one of the worst meetings we have ever had."

At the beginning of the year growth expectations for the global economy were rising—and this supported oil prices. Uprisings in North Africa and the actual disruption to Libyan production propelled prices even higher from February to April. Prices were in the "danger zone"—a range that hurts economic growth and consumer confidence. More recently, economic data and developments in the United States and Europe have indicated weaker economic growth. This confluence—the ongoing Libyan disruption and economic worries—were the key drivers behind the unprecedented use of strategic reserves as an economic stimulus.

The IEA has released oil twice before. The first time was in 1991 at the onset of the first Gulf War. The second time was in 2005 in response to the disruption caused by Hurricanes Katrina and Rita. What makes this time different is the lag between the actual disruption and the release—more than three months—combined with the role of economic headwinds in shaping the decision.
The June 8 OPEC meeting exposed a clear divide in the organization. On one side are Saudi Arabia and its allies—the holders of essentially all of the 3 to 4 mbd of OPEC spare production capacity—and on the other are Iran and its allies, which have little to no spare production capacity. The IEA release was coordinated with major producers, which makes it consistent with efforts led by Saudi Arabia and supported by Kuwait, the United Arab Emirates, and Qatar to assure that expected gains in world oil demand are met by more supply.

Additional supply relative to a given level of demand is a source of downward pressure on prices—at least during the one month window of the release. The market’s initial reaction was a sharp downward move. West Texas Intermediate fell $4.21 per barrel on June 23, to close at $91.20. Brent dropped $6.67 per barrel, to $107.44. Even before the IEA announcement, oil prices had been trending downward over the past week as economic worries grew.

The oil release signals that IEA members are taking into account the broader macroeconomic environment to decide on using strategic reserves. Making 60 million barrels of oil available does not mean, however, that they will be purchased. Sales from the US SPR need to be in line with market prices—the oil cannot be sold at a discount. How much of the 60 million barrels is eventually taken up by the market will provide an indication of how tight the balance is between world oil demand and supply.
Before the release, IHS CERA’s supply and demand outlooks indicated no physical shortfall of oil and a still significant volume of spare crude oil capacity of between 3 and 4 million bpd. But the IEA release is not just about the fundamentals or offsetting a supply disruption. Market psychology is important as well—and this decision is a signal that, at least for now, IEA members are willing to use strategic reserves to soften economic headwinds and attempt to relieve some of the Libyan disruption, even if well past the actual event. If the use of strategic reserves is limited to 60 million barrels and if their uptake by the market is tepid, then their impact on prices is likely to be short-lived. However, if they catch a downward trend in oil prices, then the timing will be regarded as successful. The key factor that will shape oil prices is the global economic recovery and the overall supply to the market. 

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