(John Kemp is a Reuters market analyst. The views expressed are his own. Repeat fixes link to related column)
By John Kemp
LONDON, Feb 22 (Reuters) - The loss of oil supplies from South Sudan, Syria, Yemen and Iran satisfies all the conditions for member countries of the International Energy Agency (IEA) to release crude and products from government-controlled stockpiles.
For the time being, the agency seems content to wait, relying on offers of extra crude from Saudi Arabia and its Gulf allies to make up shortfalls left by Iran and other countries. The spring maintenance season, when refineries’ crude consumption is traditionally weakest, buys the agency time to see if Saudi Arabia can fill the gap.
But if extra Saudi supplies prove inadequate and unable to stem the continued drawdown in inventories, the agency may be compelled to order a release to avert the risk of a damaging price spike. The most likely timing would coincide with the summer driving season in the United States, or the emergence of a serious slowdown in the U.S. and European economies.
The release of crude and product stocks in July 2011 has created a compelling precedent, and the timing of any new stock release in response to Iran would most likely be similar.
Stock releases are always controversial. The IEA has authorised them only three times since the agency was established in 1974.
In the run up to the first Gulf War in 1990-1991, the agency implemented a contingency plan covering around 2.5 million barrels per day, mostly through a draw down in government stockpiles and reduced stock holding requirements for refineries and other private sector organisations with inventory obligations.
In 2005, responding to the damage caused to oil installations and refineries along the U.S. Gulf Coast following hurricanes Katrina and Rita, IEA members agreed to make available 60 million barrels of crude and refined products.
In June 2011, following the loss of 1.3 million barrels of day of oil exports as a result of the Libyan civil war, IEA members authorised the release of 60 million barrels of crude and products from government and industry stocks.
The decision to release stocks in 2011 proved particularly controversial, dividing the agency’s members and whipping up a firestorm of criticism from senior oil analysts and traders.
According to IEA Deputy Executive Director Richard Jones, its purpose was “to prevent a potentially abrupt drawdown in OECD inventories during the second half of 2011 if other OPEC supplies did not increase to help offset the loss from Libya” (testimony to the U.S. Senate Committee on Energy and Natural Resources, Jan 31, 2012).
The IEA was strongly criticised by many market participants who felt the agency was trying to manipulate prices in response to political pressure from the Obama administration, and wasted emergency stocks in a futile gesture that failed to have more than a passing impact on either spot oil prices or timespreads.
However, Jones told senators the agency feels “vindicated” after a review of the results conducted late last year.
“The release of stocks, particularly from the US Strategic Petroleum Reserve, provided short term liquidity in light-sweet crude, and allowed the re-routing of export cargoes otherwise headed to North America, back towards European refiners who most keenly felt the loss of Libyan feedstocks.”
“We think the coordinated action by IEA members played at least a partial role in helping avoid a damaging price spike during summer 2011”.
The IEA and member countries have been circumspect about whether they will order another release in response to problems in South Sudan and Iran.
“We are monitoring the situation carefully as we usually do,” IEA Director of Energy Markets and Security Didier Houssin said in a Feb. 20 interview with Reuters. “We are ready to react if needed,” he said, implying the agency was treating the situation like any other supply situation.
Like military action against Iran, U.S. and European policymakers have made clear all options are on the table. But the assumption has been that the IEA would only order stock releases in the event military action by one of the belligerents actually disrupts shipping through the Strait of Hormuz. That may, however, underestimate the likelihood and timing of a stock release.
Justifying last year’s stock released, the IEA cited “the ongoing disruption of oil supplies from Libya. This supply disruption has been underway for some time and its effect has become more pronounced as it has continued...Greater tightness in the oil market threatens to undermine the fragile global economic recovery.”
The logic for releasing supplies now is the same. Losses from Iran, South Sudan, Yemen and Syria are a serious supply disruption which has the capacity to cause a damaging spike in prices that risks derailing a fragile economic recovery.
On most measures, current outages and the problems besetting Iran’s exports are having a similar impact to Libya’s civil war and production problems in the North Sea last year. Total export losses are slightly smaller. But front-month Brent prices have jumped $20 per barrel (18 percent) since mid-December to the highest level since before the flash crash in May 2011.
Front-month Brent futures now command a premium of more than $1 over the next-nearest contract LCO-1=R, a sign of tightness in the physical market similar to the levels recorded in Q1 and Q2 2011. IEA policymakers cited inter-month spreads as evidence of extreme tightness in the cash market justifying the 2011 stock release.
In euro and sterling terms, oil prices are now at record highs. Throughout North America and Western Europe prices are at levels the IEA previously identified as the “danger zone” for oil-importing countries.
For all these reasons, the 2011 stock release appears to set a compelling precedent for releasing stocks again in 2012.
Calls for a release will mount as the U.S. driving season and presidential election approaches, and the delayed economic damage done by rising prices becomes more apparent. U.S. and European politicians will come under intense pressure to show they are doing all they can to shield the economy from the side-effects of sanctions.
There is one key difference between the situation in H1 2011 and H1 2012. Unlike the immediate aftermath of the Libyan interruption, when Saudi Arabia and OPEC initially rejected calls from the IEA for more oil exports, this year the Saudis have been quietly promising to make up any losses as a result of sanctions on Iran and other supply problems.
IEA Deputy Executive Director Jones made the link between enhanced OPEC/Saudi supplies and IEA stock releases explicit in his Senate testimony. The IEA called for the release of 60 million barrels “to act as a bridge to higher supplies from other OPEC producers ... and to try to prevent a potentially abrupt drawdown in OECD inventories ... if other OPEC supplies did not increase.”
“While other OPEC members, notably Saudi Arabia, did step in during the summer to raise production, so far their efforts and the IEA stock release combined have only managed to fill around 75 percent of the gap left by reduced Libyan volumes,” he said.
In contrast, relations between the IEA and Saudi Arabia are now closer than they have been for years, as both sides unite to put pressure on Iran to give up its uranium enrichment programme and suspected quest for nuclear weapons.
Saudi officials have worked in tandem with their western counterparts to ensure sanctions do not reduce oil supplies and cause prices to spike. Saudi Arabia has promised to boost exports to countries struggling with the loss of Iranian crude.
For the time being, the IEA may prefer to rely on extra Saudi barrels, to avoid risking the controversy and uncertain effectiveness of a stock release. But so far rising Saudi exports have not prevented the market from tightening further. If Saudi Arabia cannot stabilise prices on its own, the pressure for a stock release is likely to become fierce. (Editing by Anthony Barker)