Emergency stock release to curb oil prices – for better or worse?

High and increasing oil prices could jeopardise the economic recovery and reduce the chances of President Obama being reelected. The sharp upswing in oil prices is also a major concern for other net oil-importing countries.

The Brent oil price has increased by 20% since mid-December as tension continues to escalate between the West and Iran, with sharper rhetoric and increased threats of military confrontation in an area where 30% of the world’s oil production is taking place. In addition, a number of supply interruptions in oil-exporting countries such as Sudan, Yemen and Syria have sparked concerns over global oil supplies.

Market players are now speculating in a new coordinated release of crude stockpiles by the US, the EU and other large oil importers if oil prices continue to rise. Democrats urged Obama last week to tap the nation’s Strategic Petroleum Reserves (SPRs). US Treasury Secretary Timothy Geithner indicated last week that there was “a case” for releasing crude from the country’s strategic petroleum reserves. But will a new strategic stock release really work and does a high oil price in itself qualify for an emergency stock release?

First of all, one lesson learned after last year’s coordinated emergency stock release of 60m barrels of petroleum by the International Energy Agency’s (IEA) 28 member countries that it is difficult to change the market’s expectations about the future supply/demand balance and thereby price expectations with short-term solutions to what the market sees as more medium-term challenges. The effect of the stock release was short-lived. Oil prices plunged by USD 9/barrel to USD 105.12/barrel within two days, but were back at the pre-release level within 14 days. We expect a new coordinated stock release will have a short-lived effect, as continuing political tension, especially as the tension between Iran and the west is growing, will drive up the risk premium and thereby oil prices again.

Second, should we override the market’s own mechanisms to adjust to the current market conditions? Higher oil prices will dampen oil demand growth.

Third, the recent oil price spike has to a large extent been driven by the EU/US sanctions and oil embargo. While both the US and EU sanctions will be fully enforced on 1 July, the US and EU sanctions appear to be having an earlier-than-expected impact on Iranian oil exports. The recent oil supply tightening and thereby upswing in oil prices can to a large extent be explained by self-imposed market interruptions. Does this qualify for the use of the emergency stocks?

The terms to use the emergency response tool vary. According to the US Department of Energy, “The Strategic Petroleum Reserve exists, first and foremost, as an emergency response tool the President can use should the United States be confronted with an economically threatening disruption in oil supplies”. The US has released crude oil 17 times since 1985, 4 times as test sales and emergency drawdowns, 11 times as emergency agreements with private companies and 3 times as non-emergency sales.

In contrast, a coordinated IEA stock release has happened on three occasions only, the Gulf war in 1991, Hurricane Katrina in 2005 and after the Libyan oil supply disruptions last spring. According to the IEA, the “collective response actions are designed to mitigate the negative impacts of sudden oil supply shortage by making additional oil available to the global market through a combination of emergency response measures, which include both increasing supply and reducing demand”. “Although supply shortages may bring about rising prices, prices are not a trigger for collective response action, as these can be caused by other factors and the goal of the response action is to offset an actual physical shortage, not react to price movements”.

It is questionable if the current situation qualifies for the release of emergency stocks as the market at the moment is still fully supplied, a supply shortage as a result of sanctions/embargo can hardly be sudden or unexpected and higher prices are not a trigger for action. An event that could trigger the use of the emergency stocks is, for example, if Iran closes the Strait of Hormuz as 20% of the world’s oil passes through the Strait.

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