John Kemp is a Reuters market analyst. The views expressed are his own
By John Kemp
LONDON, July 19 (Reuters) - Releasing crude oil from the U.S. Strategic Petroleum Reserve (SPR) in response to a rise in prices resulting from the reimposition of sanctions on Iran would be a mistake and ultimately self-defeating.
The SPR has sufficient crude to offset any loss of exports from Iran for many months, especially if stock releases are combined with increased oil production by Saudi Arabia and other members of OPEC.
The statutes governing the operation of the SPR grant the U.S. president broad discretion to order a drawdown, and any order is unlikely to be constrained by Congress or the courts.
But the SPR was established to deal with short-term interruptions of crude supplies and is not suited to managing long-term changes in the supply situation.
In particular, if the purpose is to relieve upward pressure on prices, it would blunt the signal needed to help the market adapt to sanctions.
If the SPR release succeeded in holding down prices, it would discourage the rise in production needed to replace lost Iranian barrels, while allowing rapid consumption growth to remain unchecked.
Deploying the SPR to manage a loss of Iranian oil supplies would ultimately prove self-defeating, and deplete the reserve if pursued for any length of time.
Like a buffer-stock management system, which can even out short-term shifts in supply and demand, but not enduring ones, the SPR is best employed to deal with short-term supply interruptions, not long-term changes.
The United States is considering releasing crude stocks from the SPR, possibly in conjunction with its partners in the International Energy Agency (IEA), according to news reports, to prevent a sharp rise in oil prices.
“The Trump administration is actively assessing whether to dip into the country’s emergency oil stocks while it simultaneously pushes other countries to boost output,” the Wall Street Journal reported on July 13.
A drawdown is not imminent but being considered if increased output from Saudi Arabia and other OPEC members fails to avert another sharp increase in prices, the Journal reported, citing people familiar with the matter.
The president has broad authority to order a drawdown in response to a “severe energy supply interruption” under the 1975 Energy Policy and Conservation Act, as amended (PL 94-163).
The law authorises the president to direct a drawdown in response to an interruption in physical supplies (42 USC 6202) or a significant rise in prices that is likely to have a major adverse impact on the economy (42 USC 6241).
While the decision is subject to conditions set out in the statute, they are written so vaguely that the president has almost complete flexibility.
Congress and the courts have traditionally deferred to the president on national security, so it is unlikely either would constrain a drawdown order.
Presidents have twice ordered emergency drawdowns, in response to the first U.S.-Iraq Gulf War (1991) and Hurricane Katrina (2005).
And the White House has once ordered a non-emergency sale, in response to supply interruptions in Libya and other countries (2011), as part of coordinated action with other IEA member states.
Other sales have been authorised to test the release process, or mandated by Congress for budgetary reasons (“History of SPR releases”, U.S. Department of Energy).
The reserve has also swapped or loaned oil to refiners on a number of occasions to deal with short-term, location-specific shortfalls.
If the administration determines that a release of crude from the SPR would be advantageous, for policy or political reasons, there is nothing to prevent the president from ordering it in the coming months.
PLENTY OF BARRELS
“The SPR’s formidable size ... makes it a significant deterrent to oil import cutoffs and a key tool of foreign policy,” according to the U.S. Department of Energy’s website.
The reserve contains around 660 million barrels of crude, down from a peak of 727 million barrels in January 2010, mostly as a result of budget-related sales (https://tmsnrt.rs/2LwLCMl).
Even so, the SPR holds enough crude to cover refiners’ net import requirements for more than 102 days, which provides a huge degree of supply security.
Import cover has continued to climb in recent years, even as the number of barrels in storage has fallen slightly (https://tmsnrt.rs/2JzsiMI).
Thanks to the shale revolution, U.S. oil production has risen, and net crude imports have fallen from almost 10.1 million barrels per day in 2006 to 6.8 million bpd in 2017.
As a result, the SPR’s import cover has climbed from a recent low of just 59 days at the end of 2000 and 72 days at the end of 2006 to 106 days at the end of 2017.
Some analysts argue the SPR now holds more barrels than is needed for national and economic security reasons (“DOE needs to strengthen its approach to planning the future of the emergency stockpile”, GAO, June 2018).
In these circumstances, the president could easily direct the release of 30 million, 50 million or even 100 million barrels without compromising its ability to meet future supply shortages.
Releasing 100 million barrels would be enough to offset the complete loss of Iranian exports for more than a month.
Assuming some exports continued, Saudi Arabia boosted its own production, and SPR releases were matched by other IEA members, a drawdown could make up for the loss of Iranian barrels for many months.
The SPR contains enough crude to enable the United States to enforce a total or partial oil blockade against Iran for at least six to 12 months, and perhaps longer, while trying to limit the rise in oil prices.
In theory, the United States could try to cut off Iran’s oil exports, partially or completely, while ensuring global oil supplies remained unchanged.
U.S. policymakers appear to be exploring this option, if recent briefings given to journalists are anything to go by.
It is consistent with the president’s repeated public messages on Twitter and television calling on the Organization of the Petroleum Exporting Countries to increase production.
It would facilitate the Trump administration’s policy of “maximum pressure” against Iran while trying to avoid an economically and politically damaging spike in prices.
The administration is likely to be especially sensitive to the political fallout, with congressional elections due on Nov. 6.
But the problem with employing the SPR to manipulate prices is that it will create growing distortion in the global market.
Using the SPR to hold down prices at a point in the cycle when they need to rise to boost production and restrain consumption growth will ultimately add to volatility.
Releasing the SPR might have some value as economic “shock and awe”, especially if the number of barrels offered for sale was large.
However, like every other attempt to manipulate the market, employing the SPR to manage oil prices is unlikely to be successful in the medium term.
It might have a short-term calming effect, allowing the administration to subject Iran to an intense economic siege for several months, in the hope Tehran buckles under the pressure.
But the longer any SPR release is sustained, the more distorting it will become.
- United States hints at sanctions waivers on Iran (Reuters, July 11)
- Could Saudi Arabia replace all the barrels lost from Iran sanctions? (Reuters, July 9)
- Why Trump is pressing Saudi Arabia to lower oil prices (Reuters, July 5)
(Editing by Dale Hudson)
Senior Market Analyst