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A bold move, but our oil problems are just beginning

The IEA decision to release 60 million barrels from strategic petroleum reserves (SPR) of member nations has been criticized as politically motivated, too small and too late to matter, or, at best, as a desperate attempt to fend off economic woes. The reality and impact of the decision are more complex than that. The move is a bold, price-suppressing “poke in OPEC’s eye” from nations that have been perpetual price takers in the world oil market. The short-term rationale for the decision, however, should not obscure our real oil problem - geopolitics is combining with economics and geology to put us in an oil crunch that is not likely to abate until our nation moves beyond oil.

The timing and volume of the decision make sense, and one need only to look at the vigorous complaints from Iran to gauge its significance. The Libyan conflict became a factor in February, and it took time to recognize that its 1.3 million barrels per day export volume was lost to the market on a relatively long-term basis, and to fully grasp the impact on the OECD economies. It took time to see that OPEC’s promise to cover the loss had little substance, as confirmed by the recent OPEC meeting.

That the released volume is less than a day of world oil consumption does not diminish its significance for oil prices. Oil prices are driven not by supply and demand directly, but by their effect on oil inventories, and how current stocks of oil compare to past levels. The addition of 60 million barrels of oil is significant relative to presently available stocks (J.M. Bodell, personal communication).

Strategic reserves are not ordinarily counted in comparative inventories and not factored into price formation or price forecasts. The IEA action is an historically unprecedented step to influence price, and the market does not know how far governments may go to support consumers. Oil prices are likely to be suppressed until the market digests the changed conditions created by the IEA action.

Each IEA member has varying reasons to support the decision, but a common European motive is to reduce the negative effect of the Libyan conflict on oil price. The loss of Libyan oil exports is a major factor in the approximately $10 per barrel increase for Brent (North Sea) crude oil, the European price benchmark, whereas prices for West Texas Intermediate, which is more relevant to the United States, have been $10-20 per barrel below Brent prices (despite being lighter and sweeter). Europeans hope the SPR release will lower their oil prices at least through the summer high-demand period, which may provide sufficient time for Saudi Arabia and other Gulf states to boost supply, if they are able. If economic conditions worsen during that time, the reduction in oil demand may result in prices falling further on their own accord.

The IEA decision may have been Europe-driven, but the Obama administration recognizes that rising oil prices have been a headwind to economic recovery, and a looming issue for the 2012 elections. U.S. oil prices, however, had been falling for several weeks before the IEA decision, in part because high oil prices took a toll on demand across the economy, threatening a second dip of recession. The additional supply will have a smaller effect in the United States, but should still push down prices for the near and medium term, and help arrest trends toward renewed recession. Just as the U.S. government seemed to be “out of bullets”, a new bullet emerges - one that does not require an act of Congress.

Middle East and OPEC politics have also been underappreciated in the IEA decision. OPEC is deeply divided over the influence of Iran. Iran, a major oil-exporting nation populated with a Shiite majority and led by Shiite rulers, has been increasing its influence across the Arab world, especially following war and political changes in Iraq.

Iran, however, has little to no spare capacity to increase oil exports. Saudi Arabia, Abu Dhabi, Kuwait and Qatar - which may have spare capacity - are all Sunni-led, but Saudi Arabia’s oil-producing region and the whole of the other countries are inhabited by Shiite majorities. Leaders of these countries are justifiably nervous about rising Iranian and Shiite influence, especially amidst the unrest spreading across the Middle East. An increase in OPEC production or some other force to reduce oil prices, like the IEA decision, is a hit to Iran’s financial resources, and a boost to the relative power of other nations in the region.

Bold and unprecedented as it may be, the IEA decision should sound alarm bells about bigger problems, if they were not already ringing loudly. The only reason that 60 million barrels can have such an impact is because of rising prices and great uncertainty in the world oil market about spare capacity and the ability of any country other than (possibly) Saudi Arabia to substantially increase production, while production from most other countries is declining (i.e. Peak Oil is unfolding before our eyes). Even Saudi Arabia’s capacity to increase output is uncertain.

For those who prefer to focus on speculating oil traders to explain rising oil prices, the IEA decision should only encourage more traders to go long in oil. Blaming speculators can also distract decision makers and the public from acknowledging an impending oil supply crisis facing the United States and the world. Speculation may contribute to higher oil prices, but speculative buyers are driving up prices because the fundamentals say that oil prices are going up even further in the not too distant future.

The real problem facing the United States is that world oil supply is unlikely to meet rising global demand (principally from developing nations), and may decline sooner than many believe. Increasing domestic oil drilling and production may postpone the reckoning, but will not change the fact that U.S. oil production has been on an overall downward trend since 1970, and our dependence on imported oil - not just in the number of barrels we import, but in costs and risks to our economy - is rising.

The only way out is to adapt our economy and our communities to work in a way that requires less oil. And we need to do it fast.

Art Berman - Petroleum Geologist, Principal, Labyrinth Consulting Services

Jan Mueller - Executive Director, Association for the Study of Peak Oil & Gas - USA

 

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