“If in the first act you have hung a pistol on the wall, then in the following one, it should be fired”.
Russian playwright Anton Chekhov’s advice on writing applies also to oil, where the US strategic petroleum reserve (SPR) has long loomed over the market, but rarely been used. Now US President Joe Biden intends to give the market both barrels.
Why now, and what will the impact be?
The SPR was set up in 1975, after the 1973/1974 petroleum embargo, and consists of salt caverns and other facilities along the US coast of the Gulf of Mexico. It has been used occasionally, sometimes for political reasons, to reduce the deficit in the market, or after hurricanes have interrupted crude production.
All member states of the International Energy Agency should hold stocks to cover at least 90 days of oil imports. But no other country has reserves the size of the SPR.
On Thursday, Washington ordered the biggest-ever SPR release: one million barrels per day over the next six months, draining nearly a third of its capacity (although 20 million barrels of this was already scheduled). The hope is to bring down oil prices and replace Russian exports lost to sanctions and buyer caution.
The reserve’s maximum-ever fill was 726.6 million barrels; it now holds 568.3 million. In previous crises, 21 million barrels were released in 1990-91 to cover the losses following Saddam Hussein’s invasion of Kuwait and 30 million barrels were sold in 2011 during the revolution in Libya. Most recently, on March 1, President Biden announced the drawdown of 30 million barrels after the start of Russia’s military offensive in Ukraine. But 180 million barrels goes far beyond any of that.
The White House’s announcement also commits that the sold barrels will be bought back in future years, when presumably prices are lower. Other IEA members agreed on Friday to make co-ordinated releases from their own stocks, but without specifying the volumes.
The US and other IEA states are not at their most prepared. Government holdings are at the lowest level since 2005. The SPR is the emptiest since 2002, and will drop to the lowest since 1984 after this action. This reflects the other recent drawdowns but also past sales for more frivolous reasons that were not replenished. There have been doubts on the SPR’s technical status and whether it can withdraw and sell so quickly.
Analysts and politicians even questioned whether the US, a newly minted net oil exporter, really needed a large strategic reserve. This crisis provides the answer.
The announcement came right after the Opec+ meeting where the alliance decided in just 12 minutes to stick to its plan of steady monthly increases. The SPR release may seem to justify caution in Vienna.
But if Opec+ had somehow agreed to boost output substantially, the SPR release may not have gone ahead. At least economically, the Opec+ states win anyway: a somewhat lower price now, but a higher price and more need for their crude next year when their production should be higher.
The action has had two desired effects so far. Oil prices have fallen, with US crude down from almost $108 to just over $99 per barrel. And the time-spread between near-term and longer-dated futures contracts has dropped, as the further-out months have risen by about $4 per barrel.
This is the result of putting more oil on the market now, and promising to buy it back subsequently. To be even bolder, and to limit financial exposure, the US government could even have bought crude for delivery in 2023-2024 at $80 to $85 per barrel, the current futures price.
One hope is obviously to show that the White House is doing something about the pain at the pump and inflation. Another is to signal resolution to Russian President Vladimir Putin that western countries can and will maintain, and also tighten, sanctions.
But more constructively, it is intended to buy time for slower measures to work. American shale drillers complain of shortages of labour and equipment, shareholder demands to limit new investment and an unfriendly attitude to their industry from the Democratic Party.
At current high prices, though, US production should expand substantially over the next year. Drillers now know there is a floor under prices when the US buyback goes into action. Opec+ production will also keep stepping up. On the current schedule, the Covid-related cuts will have been phased out by September and quotas could then be realigned. Perhaps a resumed nuclear deal will also bring back Iranian crude.
Politically, President Biden had to do something. However, the action carries risks. The SPR was designed to cover short-term disruptions. It is not even clear yet how much Russian production has been cut, and if and when it might return. But a wider effort to sanction Russian exports, including secondary sanctions and measures against banking, shipping and insurance, could mean a long-lasting drop.
Other crises could also intervene during this period.
If more Russian oil is off the market, if Opec+ has reached maximum capacity, if oil-consuming countries’ policies continue to favour subsidising instead of restraining consumption, and if the world economy is still doing reasonably well, prices next year will be higher than now.
Inflation-adjusted prices now are still much below their all-time high of 2008; there is room for things to get much worse.
Robin M Mills is chief executive of Qamar Energy, and author of The Myth of the Oil Crisis