-- John Kemp is a Reuters market analyst. The views
expressed are his own --
(Adds context, refiles to raise first reference to U.S. code
into paragraph 14)
By John Kemp
LONDON, June 23 The International Energy
Agency's (IEA) decision to release 60 million barrels of crude
oil from strategic reserves is intended to drive speculators out
of the market and resist the formation of a bubble by breaking
expectations about near-term supply shortages, rather than
While the intervention will be intensely controversial,
especially in the industry and among hedge funds and others
running long positions in crude futures and options, it can be
presented as a relatively limited move in response to fears
about a shortage of specific grades of crude over a short time
window, smoothing the process of adjustment.
It is specifically designed to counter fears about a
short-term supply-demand imbalance for light sweet crude oils
over the peak refining period. These worries have kept Brent
futures <0#LCO:> in a steep backwardation and policymakers fear
they may be contributing to the emergence of a bubble that
imperils recovering economies across North America and Europe.
While the IEA's decision is limited and sensible, it does
signal the agency, prodded by the Obama administration, will
take a more active approach to managing the market than before,
and introduces a new dynamic and source of uncertainty into oil
This is only the third time in its history the agency has
called on member countries to make a coordinated release.
The IEA has traditionally opposed using stocks to blunt
price rises. "To use the reserves for price management is
dangerous and would fail ... a policy of releasing oil to
counteract high prices would add an additional source for
speculation," IEA Director for Energy Markets and Security
Didier Houssin told the U.S. Senate in May 2009.
If the IEA had ordered the release of stocks in response to
soaring prices in 2004 "the market [might have] worried that the
stock draw was reducing our strategic reserves and providing a
negative incentive to invest in new supplies or improve
efficiency, making the fundamental supply/demand situation even
worse," according to Houssin
IEA and industry objections to using the SPR to mitigate
purely economic disruptions or manage price rises seem to break
down into several categories:
(a) Strategic stocks will be quickly exhausted if they are
released to meet a fundamental supply-demand imbalance (such as
excess demand growth) rather than a temporary disruption (a
hurricane-related shortfall or closure of the Strait of Hormuz).
(b) Releasing stocks blunts price signals and delays
adjustments needed to bring supply and demand back into balance.
(c) Deploying stocks in response to rising prices would
politicise the reserves as governments and interest groups
lobbied for releases to mitigate the impact on voters,
businesses and consumers.
The U.S. government position has been no clearer. The Energy
Department has described the SPR as the "first line of defence
against disruption in critical petroleum supplies", a deterrent
to hostile cut off of oil imports and providing economic
security. But the department has been cool to the idea of
releases in response to purely economic concerns or acting as a
In fact, there has always been confusion around the purpose
of the reserves. The 1975 Energy Policy and Conservation Act
(EPCA) which established the U.S. Strategic Petroleum Reserve
(SPR) sets out various conditions for releasing crude that are a
complicated mix of military, strategic and physical on the one
hand and economic on the other [ID:nLDE726163].
Crude may only be released and sold following a presidential
finding that "drawdown and sale are required by a severe energy
supply interruption or by the obligations of the United States
under the international energy program" [IEA mandated stock
releases] (42 USC 77 Section 6241 (d)(1)).
The presidential determination must include three findings:
"(A) an emergency situation exists and there is a significant
reduction in supply which is of significant scope and duration;
(B) a severe increase in the price of petroleum products has
resulted from such emergency situation; and (C) such price
increase is likely to cause a major adverse impact on the
national economy" (Section 6241 (d)(2)).
Smaller releases up to a maximum of 30 million barrels in
total spread over no more than 60 days can be authorised to meet
the adverse impact of smaller-scale disruptions including
domestic shortages (Section 6241 (h)).
EPCA states the SPR is intended to "reduce the impact of
severe energy supply interruptions" (Section 6201) but
that can be interpreted to cover a range of situations.
At one end of the spectrum are severe physical disruptions
(owing to war, revolution, embargo, or natural disaster) which
leave sufficient oil supplies unavailable at any price, and harm
the ability to project military force or lead to severe domestic
rationing and widespread disruption to the economy. Release in
such circumstances is uncontroversial.
At the other end are minor physical disruptions or
imbalances between supply, demand and inventories that do not
threaten physical availability, but push up prices substantially
and threaten significant economic harm. Release in such
circumstances is fiercely contested. Opponents argue
intervention is a mistake and the government should rely on
price increases to ration demand and incentivise more supply.
The chaos in Libya and the resulting shortage of light sweet
crudes sits somewhere in the middle of the spectrum between
physical shortages and a pure price spike. Some production has
been lost. There is no risk of the United States running out of
oil but the loss of Libyan output satisfies the first release
condition. There clearly has been a severe increase in prices
(satisfying condition 2). Higher prices could pose a danger to
the recovering economy (condition 3).
So the situation in Libyan and prospective shortfalls in
crude oil availability over the summer months are squarely
within the sort of situations in which the IEA and the U.S.
government should consider releasing crude. But that still does
not explain why the IEA, under pressure from the United States,
has chosen to act this time when it was so reluctant previously.
The suspicion is that the decision to order the release
reflects a change of personnel and philosophy -- particularly at
the White House. President George W Bush and his energy advisers
took a strongly pro-market orientation and were content to allow
price rises to force demand rationing and rebalance the market.
President Barack Obama appears much more inclined to intervene.
The president has already made clear he believes speculators
are to blame for exacerbating the recent price rise.
Policymakers have noted the record long positions in crude
futures and options built up by hedge funds and other
speculators, according to data published by the U.S. Commodity
Futures Trading Commission.
Gyrations in oil prices (such as the sudden drop on May 5
and equally rapid recovery) have not helped the cause of those
who insist prices are driven by fundamentals.
Across the federal government, and in other capitals, there
has been a marked loss of faith in the ability of markets to
price assets correctly in the aftermath of the 2008 financial
crisis, and a new willingness to intervene - for example the
Federal Reserve's quantitative easing programme. Intervention
that was once unthinkable now has more supporters.
The IEA was careful to welcome the decision by Saudi Arabia
and its allies to increase production. This is intended to
complement that output increase, bridging any near term
shortfall by releasing stocks until the extra Saudi oil reaches
The decision to release light sweet crudes is meant to
alleviate shortages in that very specific part of the market,
which have been made worse by the gradually declining liquidity
in the Brent benchmark and the forthcoming summer maintenance
season, and resulted in untypical tightness in the Brent market,
reflected by a steep and persistent backwardation.
It is meant to get the market over the high-demand summer
period, avoiding a further draw in commercial inventories that
would otherwise risk triggering a fresh round of speculation
about shortages and renewed upward pressure on prices.
(Editing by Anthony Barker)