June 27, 2011
The Strategic Petroleum Reserve drawdown
The International Energy Agency announced on Thursday that its 28 member countries had agreed to release 60 million barrels from their combined strategic stockpiles. The U.S. plans to contribute half of this total, all in the form of sweet crude. Thirty million barrels represents about 10% of the U.S. strategic petroleum reserve of 293 million barrels of sweet crude oil, and about 4% of the entire 727 million barrels stockpiled in the U.S. SPR.
To think through the effects such a move might have, suppose that there were no changes in production or private inventories. The two million barrels per day released from the IEA program would represent 2.3% of the 87 million barrels per day currently being produced globally. If for illustration we assume a short-run price elasticity for oil demand of 0.1, the result would be a 23% decrease in the price for the month of July, after which the price would return to its previous value.
That of course is not what's going to happen, because it would make no sense for anyone to sell oil for 23% less in July than you could get for it in August. If oil is cheaper in July than August, you'd want to buy more of that cheap oil in July, store it, and sell it back at a profit in August. If it were completely costless to store oil and if there were no urgency to sell it now rather than later at the same price, the outcome would be that the release from the public SPR would be matched by an equivalent increase in private inventories with no effect at all on the price.
But that's not what's going to happen either, because it's not costless to store oil and because with constant prices and positive interest rates it's always better to sell now rather than later. The actual effect we'd expect from a one-time release from the SPR would be a more modest effect on the price spread out over a longer period of time, with much of the initial release going into private inventory and eventually being sold back out of private inventories. For example, suppose the 60-million-barrel release results in an extra 10 million barrels ultimately being consumed over each of the next six months. The resulting flow (333,000 b/d) would represent about 0.38% of daily supply, which again using the 0.1 elasticity would be predicted to keep the price about 3.8% lower than it otherwise would have been for a period of about 6 months or so. That price decrease would be front-loaded, with the biggest impact in the first month, and the price gradually rising back to its original level after six months.
When the SPR release was announced on Thursday, the price of Brent fell 6.1% and West Texas Intermediate was down 4.6%.
Some traders may anticipate that there will be further SPR releases. The Libyan conflict has been estimated to have taken about 1.5 mb/d of light, sweet crude off the market. The IEA described the SPR release as intended to "help bridge the gap until sufficient additional oil" is produced by oil-producing countries. If the gap still needs bridging a few months down the line, perhaps potential oil buyers anticipate that Thursday's announcement is just the beginning.
Jim Brown sees the IEA move as a miscalculation, arguing that most of that lost Libyan production is not going to be restored even if Libyan leader Muamar Gaddafi were immediately removed, that much of the advertised increase in Saudi production may go to their own consumption, and that Chinese consumption has continued to increase despite the disruptions in North Africa. Speaking of which, the Chinese might see a temporary drop in prices as an opportunity to add to their own SPR. To the extent that happens, we're getting back to the no-effect scenario.
Another possibility is that prices were heading lower anyway, and all the IEA move did was to help them jump to an appropriate level more quickly. This is how I would interpret the claim that speculation was a factor keeping oil prices higher than they otherwise would have been, and seems a more plausible rationale for the move than the temporary bridge story.
In any case, the deed is now done, and the IEA has run an interesting experiment for us in how oil markets function. But I would recommend against further SPR sales, regardless of the final outcome of the current effort. The reason is that I see the long-run challenge of meeting the growing demand from the emerging economies as very daunting, and in my mind is the number one reason we're talking about an oil price above $100/barrel in the first place.
A one-time release from the SPR, or even a series of releases until the SPR runs dry, does nothing whatever to address those basic challenges.
Posted by James Hamilton at June 27, 2011 09:16 AMdigg this | reddit
The release of 30M bbl is equivalent to 37-38 hours of US oil consumption and 2-3 days' worth of US oil imports.
From a technical trading standpoint, however, the decision to release oil from the reserve occurred, coincidentally or not, at a critical technical West Texas price level at or around the 200 DMA, setting up a possible price target area of $75-$80 in the weeks ahead (and perhaps eventually as low as the $50s-$60s in '12-'13).
Of course, the price of oil was going to fall as demand slows and the global economy slows or contracts going into year end and early '12, not because of the release of oil from the SPR; however, the politicians will take credit for the price decline for selection-year purposes, no doubt.
Posted by: Bruce at June 27, 2011 09:51 AM
I have already heard two news stories that have attributed the decline in gasoline prices to the release of oil from the SPR. That is the dumbest thing and yet I am sure there are people who will give the politicians who close the door after the horses are gone all the credit for saving the world.
Posted by: Ricardo at June 27, 2011 12:24 PM
If, as you suggest (and I agree), the long-term trend is up, then any downward price impact from this could only be considered temporary. Given that the speculators are largely dealing in the "paper market" as opposed to the "physical market", why wouldn't they simply treat this as an opportunity to buy the dip and sell 6 months from now when the effects have been reversed? I imagine that there would be some short-term selling to cover positions exposed by the unexpected IEA release. Once that's done, I would think that their actions would still be putting upward pressure on the market, tending to offset any price breaks provided by the IEA release. Overall, I'm not sure I see how this substantively changes the basic speculative equation.
What am I missing?
Also, it seems that there are at least two other realistic possible complications. First, what if the KSA is unable or unwilling to produce more oil? After all, this is reducing the price and they weren't willing/able to produce more when the price was higher.
Second, what if the other OPEC producers decide to make production cuts that offset the release by the IEA? The higher price would generate the same revenue as greater sales at a lower price, while keeping more oil in the ground for even higher prices in the future (or for domestic use). I saw where the IEA made an implied warning against that sort of thing, but, really, the IEA is in no position for an extended battle with people who can actually produce (or not produce) oil, when all the IEA can do is release oil previously bought and stored. Also, since these reserves are theoretically "strategic", and since populations in most of the reserve areas are increasing, won't it be necessary to replenish the reserves at some point (or even increase them beyond their current extents)? With long-term prices rising, doesn't this become a matter of selling low and then buying high? What, exactly, is the long-term strategic benefit of that plan?
Posted by: Brian M at June 27, 2011 12:24 PM
Some updated net exports numbers, and Chindia net import numbers follow.
Following are what we show for global net oil exports (GNE) for 2002 to 2010 (oil exporters with net oil exports of 100,000 bpd or more in 2005, which account for 99% plus of global net oil exports).
Note that GNE increased at about 5%/year from 2002 to 2005, and then we had flat to declining GNE. I suspect that this inflection point was quite a shock to oil importing countries, especially developed oil importing countries. At the 2002 to 2005 rate of increase in GNE, we would have been at about 59 mbpd (million barrels per day) of GNE in 2010.
Also shown are Chindia's combined net oil imports. The difference between GNE and Chindia’s imports is what I define as Available Net Oil Exports (ANE), i.e., GNE not consumed by Chindia. As you can see, ANE fell from 40.4 mbpd in 2005 to 35.1 mbpd in 2010.
Global Net Oil Exports Less Chindia’s Combined Net Oil Imports
2002: 39.1 - 3.5* = 35.6 (ANE)
2003: 41.6 - 4.0 = 37.6
2004: 44.8 - 5.1 = 39.7
2005: 45.5 - 5.1 = 40.4
2006: 45.5 - 5.5 = 40.0
2007: 44.6 - 6.1 = 38.5
2008: 44.5 - 6.4 = 38.1
2009: 42.3 - 6.9 = 35.4
2010: 42.6 – 7.5 = 35.1
*Chindia's combined net oil imports (BP + Minor EIA data, mbpd, total petroleum liquids)
Note that ANE in 2010, 35.1 mbpd, were below ANE in 2002, 35.6 mbpd. In other words, the supply of global net oil exports that were available to oil importers other than China & India in 2010 was below the supply of net oil exports available to oil importers other than China & India in 2002--and of course it was well below what was available in 2005.
A plausible estimate is that ANE will be down to between 27 to 30 mbpd by 2015.
Obviously, this analysis does not support the popular misconception that generally rising oil price are solely due to “Speculation.” It also goes along way toward explaining the IEA’s decision to release emergency oil supplies.
While US crude inventories are fine, the WSJ reported that European commercial crude oil inventories are at five year lows, and I think that the IEA was quite concerned about supply versus demand problems in the fourth quarter (at current oil prices).
The problem that the developed countries are facing of course is that given a continued decline in ANE, after the release of emergency crude oil supplies, then what? Do they keep depleting emergency crude supplies?
Posted by: Jeffrey J. Brown at June 27, 2011 12:35 PM
JDH What struck me was the significant and rather abrupt drop in the spread between WTI and Brent. A few days ago the spread was $18.80, today it's down around $14.44. If the release of the SPR did not contribute to the smaller spread, then this would suggest that the spread was going to close on its own without the SPR release. I find that a little hard to believe. Is there an economic reason why releasing from the SPR would have an asymmetric effect such that it drops the price of Brent more than the price of WTI?
Posted by: 2slugbaits at June 27, 2011 02:48 PM
Jeffrey, that prospective 25-34% decline in ANE into '15-'20 will be a ~33-45% compounded decline in global per capita terms, all else equal.
With peak global oil production, falling ANE, and GDP parity and oil consumption at virtual parity between the three major trading blocs, the imperial US military is now at risk of outright shortages of liquid fossil fuels in the years ahead, facing a zero-sum liquid fossil fuel supply constraint owing to growth of Chindia and Peak Oil.
Who gets the declining marginal crude oil export supplies hereafter? The imperial US military or Chindia?
If Chindia gets the marginal supplies, the US is in a situation in which the imperial US military is effectively spending treasure protecting the oil supplies and shipping lanes to allow US supranational firms to continue investing and producing in Chindia.
And we now have US motorists, truckers, airlines, and other domestic and foreign businesses competing with our own imperial military for dwindling marginal ANE of crude oil.
Clearly, the situation is unsustainable, including Chindia's ability to increase growth of their share of ANE without a negative zero-sum effect on the US, EU, Japan, and rest of the world.
The US and EU cannot allow Chindia to continue to grow GDP and oil consumption at 8-10%/yr. with Peak Oil and falling ANE and net energy, as well as a heavily oil-dependent military; however, without cheap Asian labor, oil, and imported goods, the US cannot grow.
Something has to give . . .
Posted by: Bruce at June 27, 2011 02:52 PM
2slugbaits: The Brent over WTI spread is replicated by the Gulf-of-Mexico over Cushing spread. Sales of U.S. SPR for delivery at the Gulf of Mexico refineries should depress the Brent price rather than WTI, and of course the 30 mb sold outside the U.S. matters only for Brent. I haven't studied the details of the U.S. SPR delivery locations, but I'm assuming from the facts you mention that these will mainly be Gulf locations.
Posted by: JDH at June 27, 2011 03:01 PM
All very interesting, but totally missing the point: Obama released oil from the strategic reserves [which must be replenished] while Obaminions in the EPA increase the difficulty associated with bring new oil on line.
Left Hand; Right Hand... talk to each other. Well, why bother? It was only a political stunt anyway.
Posted by: Bruce Hall at June 27, 2011 03:17 PM
"...the IEA has run an interesting experiment for us in how oil markets function."
I think it is a good idea to do this experiment (IF that's what it is). It should give them enough data to know the extent that speculators influence the market, where the big money flows are coming and going to, what the reaction of other suppliers and consumers would be, etc. The world economy is still very fragile. In some ways, I think that letting Lehman go bankrupt was a calculated experiment as well. Where are all the mines buried? How are we being gamed? ...and possibly just an experiment in appearances as well-we've got to let *somebody* go bankrupt, right?
Posted by: Doc at the Radar Station at June 27, 2011 05:16 PM
Another excellent post--interesting to think through how the market might respond.
I am heartened that the link between the various SPR's and global economy is being made, and that some tentative steps are being made to enable coordinated action. I think this effort also represents a first step in developing some sort of market thesis of the oil price response to SPR withdrawals.
In addition, if one believes in speculation (I'm in the skeptic camp), then this sort of intervention should really dampen speculative fervor, as investors will now know the government may move against them at any time. That could be useful.
So these are all positive. I am personally of the view that the SPR should be actively traded (within limits) to create an on-going institutional capability, rather than just ad hoc as with the current initiative. Our understanding of market responses are really pretty primitive--we need more data over time, and a more permanent trading capability would be useful in that regard.
I might also have taken a different approach tactically. I would have announced the intent to intervene (why sell oil if you can talk the markets down?) and strictly withheld information regarding quantities. That would prevent traders from taking any reductions in price too lightly--a risk which Jim intimates above. Because quantities are known, there is a non-zero probability that traders will do the math, and within a week or so figure that the initiative doesn't amount to much, and bid prices back up to near earlier levels. This would discredit the whole SPR initiative, I fear.
In any event, I agree with Jim. The release from the SPR can help, but if the Saudis don't step up big time with increased oil production, then the effect will be fleeting at best.
Posted by: Steven Kopits at June 28, 2011 06:01 AM
As regards Jim Brown's comments, I think they are a bit uncharitable wrt the IEA.
The IEA is trying something new, which involves coordinating many political bodies. This is necessarily a messy exercise, and a theoretical optimum regarding approach and timing is probably unachievable. I personally applaud the IEA for working to bring focus and action to bear on the oil price issue.
Posted by: Steven Kopits at June 28, 2011 06:07 AM
My first impression was that the release of emergency supplies was basically a vote of no confidence in Saudi Arabia's ability to materially increase their net oil exports, especially their light/sweet net exports, and that may still be the case.
However, the release of emergency supplies, perhaps combined with slowing demand, would also serve as an excellent fig leaf for Saudi Arabia, by allowing them to assert that there was no need for additional Saudi oil exports.
Note that Saudi net oil exports have been below their 2005 annual rate of 9.1 mbpd (total petroleum liquids, BP) for five straight years, with four of the five years showing year over year declines in net oil exports.
I am surprised that the BP data base showed a year over year decline in Saudi net oil exports last year, from 7.3 mbpd in 2009 to 7.2 mbpd in 2010. In just five years, from 2005 to 2010, the ratio of Saudi oil consumption to production has gone from 18% to 28%. If we extrapolate this rate of increase, they would approach 100%, and thus zero net oil exports (consumption = production), in only 14 years, around 2024.
Posted by: Jeffrey J. Brown at June 28, 2011 07:01 AM
My first thought was "Oh, they are selling off assets to keep the government running."
…which given the weird timing and limited effect, I think makes more sense than anything.
I think that Treasury underestimated the amount of maneuvering that entities dependent on government money would do in the run up to August 2nd, and now they now are, or soon will be, scrambling to keep the lights on. If people know when a crisis will happen, then they line up early to get their money out –Financial Crisis 101.
Posted by: The Econometrix at June 28, 2011 08:03 AM
My market bet depends on the USA mismanaging energy, now and into the future. The release of strategic reserves is bullish for longer-term oil prices. The USA is now involved on 5 military fronts in Muslim countries. In this blog post and elsewhere there is zero discussion of ramping up excise taxes on gasoline, diesel and similar.
Bearish for US hegemony; bullish for oil prices and upstream companies.
Sometimes I wonder if Michael Moore's Roger and Me hyperbole-film is the primary driving force behind US economic and energy policy. Rather than face structural problems head on, all out efforts are made to employ unemployable low-productivity American workers, and keep any short-term adjustment pain to a strict minimum.
Posted by: westslope at June 28, 2011 09:40 AM
Is this a hidden stimulus ?
I'm no economist, but it seems this would be a way to stimulate the economy, right ? could this be a politically viable way to do more stimulus ? after all, congress didn't need to approve this. Are other countries having similar political issues ?
Posted by: orlando at June 28, 2011 10:37 AM
Jeffrey - If the Saudis consume their entire oil output then they have no exports and no income. To do that, they need to make the country self-sufficient in some other manner. The Saudis will see pressure to economize with internal oil consumption soon enough.
Econometrix - 30 million barrels = about 1 day's budget deficit
Orlando - Yes, I too interpret the release as a stimulus program. Monetary and fiscal policy are tapped out, and if you look for culprits in the current economic softness, oil is the leading suspect. So lowering oil prices would be the plain vanilla prescription.
Posted by: Steven Kopits at June 28, 2011 11:19 AM
As noted up the thread, I usually take care to say "Approaching zero net oil exports." In any case, note that many oil exporters that are showing declining net oil exports, e.g., Mexico & Saudi Arabia, are currently experiencing stable to rising nominal cash flows from oil export sales--because of generally rising oil prices.
As also noted up the thread, the real problem for OECD countries is that Chindia is--so far at least--consuming an increasing share of a declining volume of global net oil exports.
The five year rate of decline in ANE (Global net exports less Chindia's net imports) is about 3%/year, and net export decline rates tend to accelerate with time. The next five year (2010 to 2015) decline rate in ANE could easily be in excess of 5%/year.
Posted by: Jeffrey J. Brown at June 28, 2011 11:35 AM
Sorry, but I don't see the hype. Lets note after the breakout of the conflict, there was going to be a release from the SPR.
Overblown, uninteresting. How about posting something that matters.
Oh yeah Westslope, when your "short term" adjustment turns into a generational adjustment, you will truly understand why pseudo-nationalism of the bourgeois is fought against with fists flying.
Posted by: The Rage at June 28, 2011 11:59 AM
Of course, I take your general point.
But I think it's sometimes helpful to sense check numbers to see if they add up otherwise. Saudi has a population around 25 million, versus, say 300 million for the US. US oil consumption is, say, 19 mbpd; Saudi crude oil production, about half that. If Saudi consumes all its oil output, per capita oil consumption would be 6x that of the US, with no export revenues.
It is export revenues which permit high Saudi oil consumption. Oil exports are their Golden Goose: they won't kill it.
Posted by: Steven Kopits at June 28, 2011 01:49 PM
Steve Kopits Oil exports are their Golden Goose: they won't kill it.
True, but the real question is whether that greasy golden goose will kill the Saudis. Rent-based mineral extraction economies don't have a happy history, going all the way back to 16th century Spain. I think there's a reason why oil exporting countries have never been able to consistently capture Hotelling rents despite the fact that all our economic theory tells us oil markets are the ideal candidates. The goose never quite dies at the optimal rate.
Posted by: 2slugbaits at June 28, 2011 02:31 PM
As you know, their total petroleum liquids production has been below their 2005 annual rate for five straight years. Here are the five year, 2005 to 2010, rate of change numbers for Saudi production, consumption and net exports (BP, Total Petroleum Liquids):
Net Exports: -5%/year
What the data show is that the Saudis are consuming an increasing share of declining (relative to 2005) production. This caused their consumption to production ratio to go from 18% in 2005 to 28% in 2010.
In a somewhat similar fashion, Chindia is consuming an increasing share of declining Global Net Exports (GNE).
As previously noted, this leaves the OECD countries basically taking what's left over. Our view is that the US, starting in 2006, is now well along the path to "freedom" from our reliance on foreign sources of oil.
Posted by: Jeffrey J. Brown at June 28, 2011 06:38 PM
Right now, the difference between the US versus Canada and Australia is that the latter two are big commodity exporters. Both their economies are doing much better than ours. In Canada, today Newfoundland and Alberta make transfer payments to the "poor" provinces of Ontario and Quebec.
Oil is a major reason that North Dakota and Texas have added such a large portion of jobs in the recovery.
Without oil, Saudi Arabia would look more like Yemen.
Norway's 9% budget surplus is made possible by its oil revenues.
So, if a country has bad governance without oil, it will likely have bad governance with oil. But to call oil an unmitigated curse is to ignore much of the good it has done around the globe.
Posted by: Steven Kopits at June 29, 2011 03:35 AM
I think I have told this story before here, but this is clearly an appropriate time to repeat.
So, when Clinton withdrew oil from the SPR, he had a discussion about it with Chief of Staff Leon Panetta and CEA Chair Joe Stiglitz. Stiglitz opposed it saying "It will have no effect and the price will come down anyway," to which Panetta said "Great! We can withdraw the oil, cause no harm and claim credit when the prices come down," which they did.
Posted by: Barkley Rosser at June 29, 2011 12:50 PM
Steve Kopits Oil is a major reason that North Dakota and Texas have added such a large portion of jobs in the recovery.
You need to differentiate between the returns to different input factors. The return to oil in the ground is rent. The return to the capital investment to pull the oil up from the ground is profit. The return to labor to help that capital pull up the oil from the ground is the wage. Employing capital and labor is a blessing. A country that sits on a lot of oil but does not have an indigenous capacity to extract that oil and only receives the rent is country with a bleak future. Short-term rents can provide a country with a very nice lifestyle, but the gravy train only lasts so long. The curse of oil wealth is that the oil itself is a wasting asset. Worse yet, it discourages the development of labor skills. That's what I meant by the lesson of 16th century Spain. Spain did very well at first, but over the long run, not so much.
So, if a country has bad governance without oil, it will likely have bad governance with oil.
True, but a badly governed country that relies on labor and capital inputs for its GDP has a better chance over the long run than a badly governend country that relies on rent claims. Egypt's prospects look much brighter than Saudi Arabia's.
Posted by: 2slugbaits at June 29, 2011 02:41 PM
I wonder about the goal being a secondary effect: randomizing the market itself. The market is clearly being supported by money chasing oil futures. The people playing that game are making a lot of money, and the effect on the overall economy is very negative. Remember, the last time gasoline was $4.00/gallon, the price of crude was $150. Now it's near $100, so somebody is making much more margin.
Releasing oil at random from the reserve make the entire market less predictable and less attractive. Do it a few times, at random, over the next six months, and people will simply. prudently, take smaller positions. So there may be a significant multiplier in messing with this market, for the good of people who actually live and work in our society.
Posted by: Dollared at June 29, 2011 04:22 PM
Steve Koptis wrote: "Norway's 9% budget surplus is made possible by its oil revenues."
Is it really? I would guess that Norway would run similar surpluses on smaller budgets "without oil".
Pre-oil one could eat off the floors of state-owned homes in Norway. I cannot for the life of me imagine a similar situation in North America.
Posted by: westslope at June 30, 2011 08:50 AM