By John Kemp
LONDON (Reuters) - A 30 percent rise in spot oil prices since late June has been enough to renew fears that spiraling fuel costs could push the U.S. and European economies into a recession by year-end.
G7 ministers are now attempting to head off an even bigger rise by hinting at their readiness to release oil from emergency stockpiles.
“Mindful of the substantial risks posed by elevated oil prices, we are monitoring the situation in oil markets closely,” the finance ministers warned in a highly unusual statement late on Tuesday. “We encourage oil-producing countries to increase their output to meet demand.”
It is rare for the G7 to comment on oil prices in so much detail, and unprecedented for them to do so outside a regular ministerial meeting.
The statement comes after strong indications from the White House, as well as its allies in Britain and France, that emergency reserves could be released in response to recent price increases and signs of tightness in the market.
It concluded with a warning: “We stand ready to call upon the International Energy Agency to take appropriate action to ensure that the market is fully and timely supplied.”
Supply disruptions, including at a crucial field in the North Sea, as well as sanctions on Iran have pushed prices sharply higher since June. Hopes for a resolution of the crisis in the euro zone and for more monetary stimulus in the United States, Western Europe and China have all fuelled the rally.
Previous price increases in 2010, 2011 and earlier this year were all followed by abrupt economic slowdowns. In recent months, growth has already showed signs of slackening, even before the latest surge in oil prices. Policymakers fear the rising cost of petroleum, if not checked, could again push the leading economies into recession by the end of the year.
Oil availability has emerged as the main constraint on growth, and oil prices have emerged as an important speed-limiter in the global economy.
But there are several reasons to think the underlying supply-demand situation is improving as a decade of high prices and heavy investment finally begins to pay off in terms of significant increases in production and more efficient fuel use.
Supply interruptions continue to produce price spikes, but each successive peak has been lower. In 2008, Brent prices peaked at more than $140 per barrel. In 2011 and again earlier this year, prices peaked at more than $125 per barrel. The current price spike reached just over $117 before prices eased back to around $112.
In contrast to the decade between 1998 and 2008, prices no longer appear to be on a secular upward trend but instead to have hit more of a plateau a little above $100 per barrel.
There are still shortages of specific crude grades, particularly light sweet oil from the North Sea, which is putting upward pressure on benchmarks. Near-term shortages from production problems at the UK’s Buzzard oilfield pushed Brent crude for immediate delivery to a premium of around $2 per barrel over the next month. It was trading at a discount of more than 50 cents in June.
In 2011, similar production problems resulted in large premiums for nearby delivery and triggered a release of emergency oil stocks by the IEA. Even then the market continued to tighten through August, September and October. By contrast, in 2012, premiums for nearby contracts have started to ease even without a stock release.
Global inventories appear to be relatively healthy. Stocks have drawn down rapidly during the third quarter but from an unusually high level at the end of June. In the United States, for example, commercial crude stockpiles have fallen by more than 26.5 million barrels in the last nine weeks (almost 7 percent) but remain above the previous five-year peak (Chart 1). Product stocks remain comfortably in line with average levels (Chart 2).
Unlike previous price spikes in 2011 and earlier this year, the recent rise in oil prices has not been associated with a big accumulation of net long positions in WTI and Brent futures and options by hedge funds and other money managers.
Speculators have remained on the sidelines, perhaps chastened after the two previous rallies abruptly collapsed, inflicting widespread losses.
Money managers boosted their net long position in WTI-linked futures and options by 36 percent between June 26 and August 21, from 142 million barrels to 192 million, according to an analysis of data released by the U.S. Commodity Futures Trading Commission (CFTC).
But the increase has come from a very low level, and the net long position is still far below recent peaks in February 2012 (304 million barrels) and May 2011 (363 million).
There are also far more hedge funds and other money managers on the other side of the market, betting against a further rise in prices. On August 21, money managers held short positions equivalent to around 67 million barrels of oil, compared with just 28 million in February and 38 million in May 2011.
As a result, the derivatives market remains much more balanced than during previous price escalations. The ratio of hedge funds’ long positions to short ones has risen to 3.88:1, from a recent low of 2.71:1 in June but is still far below the peak levels of almost 12:1 in February and 10.5:1 in May 2011 (Chart 3).
So far, crude prices have risen mostly in thin markets over the traditionally quiet July and August months. The rally does not appear to have drawn in a substantial number of hedge funds.
But policymakers are probably right to conclude the rally could draw in more speculators if they do nothing to push back against it, which could exaggerate the price increase and risk a further slowdown in growth during the last part of the year.
Hedge funds are attracted to anything that looks like a one-way bet with the capacity to draw in increasing amounts of new money in a self-reinforcing momentum strategy, as the legendary hedge fund manager George Soros has explained (“The Alchemy of Finance” 1987).
By playing up the threat of a sudden and large release of crude and products from emergency stocks, policymakers maximize uncertainty for speculators, ensuring that a further rise in prices does not turn into a one-way bet.
Free-market purists will object to the threat of intervention. Industry analysts, including many at the IEA itself, doubt the appropriateness and effectiveness of a release.
But for policymakers anxious to avert another sharp rise in prices, followed by an equally sharp drop once the damage to the economy becomes apparent, maximizing strategic ambiguity is probably the most sensible course.
editing by Jane Baird