By John Kemp
LONDON, March 30 (Reuters) - Unless oil prices drop for other reasons, the United States and other governments appear set to release crude and product stocks from their strategic reserves before or during the summer in a bid to slow the rise in prices, avert an economic slowdown and sustain support for their strategy of sanctions on Iran.
The probability of a release is now more than 50 percent. The only remaining questions concern the timing and scale of releases; how many countries take part; whether they will receive support from other reserve holders such as China; and whether swing-producer Saudi Arabia will help the effort by maintaining higher than normal exports even as commercial inventories rise.
Members of the International Energy Agency (IEA) are split about whether the conditions for a release have been met. U.S. policymakers have been canvassing the idea of a stock release for some weeks. Britain and France appear receptive to a request for a coordinated stock release. Germany and a number of other European countries remain opposed.
As a result, the agency has struggled to articulate a clear view about whether a release is warranted. Executive Director Maria van der Hoeven told journalists last month there were “no discussions” about a reserve release and she had not been in touch with the United States about it, though countries were free to employ their own reserves after consultation with the IEA.
The agency’s most recent market survey reiterated previous warnings about falling inventories and a tightening supply-demand balance. “(The) post-recession OECD industrial stock overhang has been gradually whittled away. Inventories...look very tight in absolute terms,” the agency wrote in its March “Oil Market Report”.
“There may be no actual physical supply disruption at present deriving from the Iranian ‘issue’. But there are ongoing non-OPEC outages totalling around 750,000 barrels per day, as a slew of technical and political factors continue to hobble non-OPEC supply.”
Outside observers have detected a marked reluctance by the IEA and the European Commission to support a stock release. But the IEA’s opposition appears to be softening as a result of sustained pressure from Washington and some other capitals.
Following a regular meeting on March 28-29, Van der Hoeven acknowledged that “The oil market has been tightening in recent months; crude oil prices are very high again, and petrol prices have reached a record high level in some member countries. The International Energy Agency, like many others, is concerned by the impact of these high prices while the global economic recovery remains fragile.”.
It was not quite an admission that the legal conditions for a coordinated release had been met, but it came very close, noting tight supplies and the economic fallout.
Van der Hoeven promised “The IEA is closely monitoring market developments and will remain in close contact with member countries to exchange views about the oil-market situation. As we have mentioned many times, the IEA was created to respond to serious physical supply disruptions, and we remain ready to act if market conditions so warrant.”
Reading between the lines, Washington and its allies have made clear they reserve the right to go ahead with a release unilaterally, and the agency has been told to get out of the way.
The legal trigger for a stock release is ambiguous. The IEA’s information documents suggest the trigger is an “actual or potentially severe oil supply disruption” or a “major world oil supply disruption” (“IEA Response System for Oil Supply Emergencies,” 2011).
The original 1974 Agreement on an International Energy Program (IEP), which established the system of collective response, demand restraint, and emergency stocks, appears to refer to interruptions amounting to 7 percent or more of a participating country’s daily supplies (Articles 8, 13-15).
But this requirement has been waived in the three stock releases the IEA has approved so far (the Gulf War in 1991, Hurricane Katrina 2005 and the Libyan civil war in 2011).
Crucially, the agreement makes clear that collective action can be triggered not just by existing but by expected problems: “Whenever the group as a whole or any participating country sustains or can reasonably be expected to sustain a reduction in its oil supplies, the emergency measures...shall be activated.”
In the United States, the conditions for releasing crude oil from the Strategic Petroleum Reserve (SPR) are broadly similar.
Stocks may be released only if “the president has found drawdown and sale are required by a severe energy supply interruption or by the obligations of the United States under the international energy program” (42 USC 77 6241(d)(1)).
U.S. law defines a severe energy supply interruption as a shortage which “(A) is or is likely to be of significant scope and duration, and of an emergency nature; (B) may cause major adverse impact on national safety or the national economy; and (C) results or is likely to result from an interruption in the supply or imported petroleum products, an interruption in the supply of domestic petroleum products, or sabotage or an act of God” (42 USC 77 6202(8)).
The president must certify that “(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” (42 USC 77 6241(d)(2)).
Notice both U.S. law and the IEP agreement contain forward-looking elements. Stocks may be released not just in response to a current shortfall but an expected one. Note also U.S. law envisages stock releases both in response to physical shortfalls and also the economic damage caused by a sudden rise in prices.
The question for the agency and its member governments is whether the current shortfalls (from South Sudan, Yemen, Syria and Iran) and expected future ones (if Iran’s exports fall further) are sufficient to warrant a release.
The problem for the agency, and governments which oppose a stock drawdown, is that last year’s release in response to the Libyan civil war has set an unwelcome precedent.
IEA Deputy Executive Director Richard Jones has said last year’s release should be considered a success. But officials have struggled to explain why it was appropriate to release stocks as a result of the Libyan export disruption in 2011 but would not be appropriate in response to a host of smaller disruptions in 2012, which amount to a similar loss of oil.
Most of the conditions (rising prices, falling inventories, tightening supply-demand balances and timespreads) seem very similar.
Meanwhile, even if sanctions have not yet interrupted Iran’s exports, which is open to debate, it is reasonably foreseeable they will cut export volumes by summer, which could supply the forward-looking justification for a stock release envisaged by the IEP and U.S. law.
Ultimately, stock releases are a political act. In this case, energy policy on stock releases will be subordinated to the wider diplomatic policy of containing Iran (and restraining Israel) through the use of oil sanctions.
Throughout this dispute, foreign policy has trumped energy policy. From an energy consumer’s perspective, it may not have been terribly sensible to impose an embargo on Iran’s crude exports, but foreign ministers overruled their energy counterparts. Having started down this route, foreign policy experts must see it through.
“The view is that higher oil prices are a price worth paying to prevent or push back a war against Iran and higher oil prices can be alleviated by using emergency stocks,” an industry source told Reuters this week.
Political leaders in the United States, the United Kingdom, and certain other countries will subordinate everything to that aim, which is what makes a stock release highly likely, unless prices start to come down of their own accord.