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An SPR bazooka and the central bank of oil

Public Policy

In a perfect world of crude pricing, there would exist a mechanism to soak up excess length when prices were low, and add length into the market when prices were high.

In the world of money, this is called a central bank, with a dual mandate of keeping inflation low and employment as full as possible. There is no central bank for crude oil. But if there were, its dual mandate would be a price floor for producers and a price ceiling for consumers.

And let’s be clear here: this would be a price floor for US shale oil producers, say high enough to insure they keep producing, and a price ceiling for US gasoline consumers, say low enough that they don’t stop driving.

(Oh who knows, say a minimum of $70/b for producers and a maximum of $4.50/gal for gasoline.)

The only entity out there with enough liquidity to actually enforce this kind of a mandate is the US Strategic Petroleum Reserve. As of the week ended March 14, US Energy Information Administration data showed there was almost 700 million barrels of oil sitting idle in strategic storage, just waiting for a purpose.

At present the market has two principal forces on constant watch: Saudi Arabia and China.

Saudi Arabia, as a “swing producer”, can almost be relied upon to adjust its production in order to target a certain price band. One can argue that the Saudi’s have been very effective at this, and here we are sitting right around $100/b. Sure that works for them, but what about New Jersey drivers?

More recently, the swing consumer clearly has become China. While everyone watches Chinese supply and demand very closely, much of the data remains opaque and hard to forecast.

The bottom line is neither of these market dynamics can be counted on to ease volatility, let alone backstop the dual mandate of a central bank of oil.

And while a futures contract has really always been the free market’s best attempt at serving this “mandate,” it is prone to speculation as well as painful booms and busts that can be as hurtful to the economy as they can be helpful.

Back in 2010, Rice’s Amy Myers Jaffe and Mahmoud El-Gamal wrote in Oil, Dollars, Debt and Crises that some force was needed to counter the business super-cycle. Something must step in to spark investment when prices were low, and curtain booms before they turned into bubbles.

Left to themselves, markets often correct and price is truly king, but then again, the corrections often wreak havoc and after all, volatility has a positive connotation to precious few out there. Most of them are options traders.

Obviously, this something Jaffe et al were looking for still does not exist, and there is little hope that either Saudi Arabia or China can be called upon to regulate a global market.

Step into the arena, SPR.

A recent test sale of a 5 million barrel cargo of sour SPR crude has been seen by some as a warning salvo across Russia’s bow. Whether or not that was the case, the writing is on the wall.

With this in mind, could we really say that prior to this, leaving SPR crude idle served any purpose at all?

With 700 million barrels in its holster SPR crude could be offered into the market, with precision, to counter any tenders from companies — and countries — that need to be brought to heel.

Say a South Korean refiner wants to purchase a VLCC cargo of crude from a country that is currently not playing ball with US foreign policy.

A low-ball offer of SPR crude to the rescue.

“If you have a bazooka in your pocket and people know it, you probably won’t have to use it,” former US Treasury Secretary Hank Paulson famously said.

It is obvious that SPR sales are of a similar caliber.

Further, with all the talk of possible exports of US crude, why not start with the 200-300 million barrels of light, sweet SPR crude, as veteran oil economist Phil Verleger suggested in his weekend newsletter.

“Within a year or two if not months, the government will decide to sell this oil to willing buyers,” Verleger said. “They will almost certainly be located overseas. Thus, for one or two years, the United States will be putting SPR light sweet crude into the world market.”

“No less of an ‘authority’ than IEA Executive Director Maria van der Hoeven has asserted that these reserves serve no useful purpose for the United States,” he writes. However, that is not clear, as IEA officials said van der Hoeven has stated her views that strategic stocks should only be used for supply disruptions.

(Ed. note: Changes have been made from the original publication to clarify Van Der Hoeven’s views, following communication with the IEA.)

In much the same vein Verleger sees an important role for the SPR in its ability to influence markets. Traditionally purchases of crude by the US government to be injected into the SPR, for emergencies, are often ignored when in fact they should be considered consumption, Verleger said.

“This distinction is important,” he said, noting that in the next ten years, increased demand will be offset by SPR liquidation.

“These sales will, in essence, negate consumption,” he said.

And this is where the rubber really meets the road.

Verleger says: “Alternatively, strategic stock sales can be seen as a new supply source of oil that might otherwise have come from OPEC or Russia.”

In the end, it is daunting to imagine a Washington bureaucrat in charge of the SPR bazooka. When to threaten it, when to trigger it…all of this will depend on the Administration in the White House. And among many counter-arguments, this is probably the most convincing.

platts



8 Comments on "An SPR bazooka and the central bank of oil"

  1. Plantagenet on Thu, 27th Mar 2014 11:19 pm 

    George Soros, one of Obama’s main financial backers, is also calling for the SPR to be dumped on the market.

    Expect the BO administration to tap the SPR soon.

  2. rockman on Fri, 28th Mar 2014 12:28 am 

    I once bother to repeat myself again. There are laws that cannot be ignored or changed with majority approval of the entire Congress. The POTUS has no authority to change the operations of the SPR. The POTUS didn’t no make the decision to make the 5 million bbl release despite the absurd spin some are putting out. The release was required by congressional law and was scheduled long before the Ukrainian situation developed. If the maximum amount of SPR oil was released over a month period as prescribe by LAW it would add 1% to the global supply for that month. But the LAW also requires that the entire withdrawal must be replaced with in creative short time which would require the gov’t to take 1% off the global market place.

    Given all the recent chatter about unleashing our mighty “oil weapon” it’s amazing that no one in the MSM has bothered to publish the very detailed LAWS governing the use of the SPR. Yeah…right…shocking. LOL.

  3. Northwest Resident on Fri, 28th Mar 2014 1:55 am 

    rockman — I think the MSM is too busy conjuring up bullshit and spin for their adoring audience to worry about actually publishing relevant facts.

  4. Davy, Hermann, MO on Fri, 28th Mar 2014 10:58 am 

    Echoing Rockman and NR. These folks make me laugh but also make me sick because these people are supposed to be the leadership. We have no hope if the leadership is this dumb. The global leadership is rotten to the core.

  5. shortonoil on Fri, 28th Mar 2014 1:12 pm 

    “And let’s be clear here: this would be a price floor for US shale oil producers, say high enough to insure they keep producing, and a price ceiling for US gasoline consumers, say low enough that they don’t stop driving.”

    The best of the shale oil plays, the Bakken, is operating over the full life cycle of its wells (calculated at ten years) at a breakeven, to a small per barrel loss. Even this dismal performance is only possible because of the FED’s ZIRP policies. Interest rates are low enough to make operating these wells possible – which keeps firms like Halliburton happy. The shale plays are zero to very, very low energy sources; the price of crude is still determined by conventional crude. Conventional crude is still ruled by OPEC, and Russia.

    To control price the entire world’s conventional crude price would have to be manipulated. If Platts thinks that the rest of the world’s oil producers are going to lay down, and let Washington control prices for its benefit, they have truly gone over the edge. An SPR bazooka would be more likely to go off, and blow the owner’s head off, than it would be to control world petroleum prices.

    http://www.thehillsgroup.org

  6. Davey on Fri, 28th Mar 2014 1:45 pm 

    As always put well short. I have read the oil market is one of the top manipulated global markets. Very pertinent the reference to zirp and the probably intended consequence of corporate Wellfare. If the average citizen realized the magnitude they would be humored by the American right blame and complain of wellfare for low income Americans. The oil industry is naturally one of the highest recipient yet, referencing shorts look at US shale return figures they need it now and so does the country. Let’s face it we need oil now for survival

  7. shortonoil on Fri, 28th Mar 2014 4:01 pm 

    “Let’s face it we need oil now for survival”

    Yes we need oil now for survival, and we will need it next year, and the year after that. The problem is that petroleum’s capacity to power the economy is declining. As petroleum’s ability to drive the economy declines, our ability to extract petroleum, and produce its products also declines. We see this in fewer, and fewer high quality extractable reserves, increasing capex spending per barrel, and now falling oil industry profits. Tight oil is the bottom of the barrel, and represents a day, not far into the future, when the petroleum industry will no longer be able to support itself. Tight oil only exists now because of an unintended subsidy resulting from the FED’s monetary policy.

    As a society we had better realize that the end of oil era is not far into the future. Avoiding risk by sticky one’s head in the sand is hardly a defensive strategy. Your head may be safe, but your butt is still very vulnerable. Those in the private and government sectors who think technology, and quasi-oil will pull our bacon out of the fat, are going to get what they’ve got sticking up in the air – kicked.

    http://www.thehillsgroup.org

  8. Bob Owens on Fri, 28th Mar 2014 8:42 pm 

    The SPR is for EMERGENCIES! Like “Hurricane destroys New York” or “We have to get the harvest in or we will starve!” type emergencies. This article turns it into political fodder. Wake up America! Stop being stupid.

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