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Disturbing White House “Oil Raid” In Progress…

by | published August 16th, 2018

History, as we well know, doesn’t repeat itself – but it often rhymes.

Right now, we’re seeing a disturbing, albeit familiar scenario play out in the Trump White House ahead of midterm elections: a political ploy that could have deep, far-reaching consequences for the U.S. energy market.

Lest you think I’m unduly hard on this administration, I came down hard on Obama’s folks for suggesting the exact same thing.

It was a bad idea in 2011, and it’s a terrible idea now.

It all starts with 660 million barrels of oil stored in four huge salt caverns on the Gulf Coast.

This is the Strategic Petroleum Reserve (SPR), and the White House is threatening to raid it.

Here’s why that’s a terrible idea – and what it means for you…

Raiding The SPR May Look Like A Good Supply Solution – but It’s Not

The recent decline in oil prices has put a disturbing White House move on the back burner. But only for a while. All indications remain that the resumption of Iranian sanctions, the continuing collapse in Venezuelan production, combined with ongoing strife caused problems in Libya and Nigeria, as well as a significant tightening in the global supply balance will move up prices.

Many are now suggesting a price of well over $100 a barrel as early as the first quarter of next year.

Against this backdrop, the White House with one eye on the midterm elections and the other on the well-known political adage that “gasoline votes” is floating a trial balloon to raid the Strategic Petroleum Reserve, releasing up to 300 million barrels into the market over the next decade, and potentially cutting the reserve supply in half

Established after the 1973-74 Arab oil embargo resulted in famous long lines at US gas pumps, the SPR has currently about 660 million barrels of oil (out of a maximum capacity of 720 million) in four huge salt caverns on the Gulf Coast in Louisiana and Texas.

The idea was to have excess crude oil stored from which refiner oil products could be produced during times of crisis. Now the country has never had to draw from the SPR in response to another OPEC-based decision to cut exports to the US.

That will never happen again, and the discovery of huge domestic shale and tight oil reserves have transformed where American refineries obtain their crude.

But the SPR is still employed to balance access when natural disasters (hurricanes) or severe pipeline outages (such as two interruptions of finished product to the Northeastern US). That’s where the Trump administration idea comes in.

Photo: Surface view of the Big Hill, Texas SPR site.
The Center for Land Use Interpretation

Once the international oil market returns to some stability, the upward trajectory of prices will cause a spike in the cost of refined products. The rising expense for everything from high-octane gasoline to diesel and low sulfur heating fuel may prove politically damaging.

As a result, Trump’s folks have been putting pressure on Saudi Arabia to increase production, thereby reducing the pressure from a supply side constriction. The Saudis and Russia did announce last month an increase in volume. That is likely to result in about 1 million additional barrels a day coming on line beginning next month.

Unfortunately, the supply outages from Venezuela, Libya and Nigeria alone are already expected to be taking at least 1.2 million barrels out of the market. In short, the situation continues to tighten.

Hence, the move to raid the SPR.

This is, at best, a very short-term solution. The entire capacity of the reserves matches about 30 days of national oil needs. True, rising US-based production could offset that. But to do so will depress the very wellhead prices operators need to maintain profitability. The primary pricing problem is global and an American ability to continue increasing exports into that market is becoming problematic.

However, the real problems of raiding the SPR for a short-term political gain have arisen before. Over seven years ago, the Obama Administration and the International Energy Agency (IEA) had introduced a joint reserve release to offset what were then oil prices moving above $130 a barrel.

At the time (June 2011), I was in Athens advising on the connection between oil markets and the widening financial implosion in Greece. My take then on why Obama should not drain the SPR comprises the same argument against Trump doing it now.

The two are distressingly similar.

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Draining The SPR Won’t Help You Now, And Will Hurt You Later

In the June 24, 2011 Oil and Energy Investor, I wrote the following:

“It is now approaching 6 p.m. here in Athens. The city is winding down its normal daily activity, and people are already anticipating the next major protest – tomorrow.

I will be there, talking to some of the opposition leaders. Will let you know what I find out on Monday.

Meanwhile, my attention is fixed on the combined action yesterday, by the Obama Administration and the Paris-based International Energy Agency (IEA), to release 60 million barrels of crude oil reserves into the market this month.

The IEA will provide 30 million, and Washington will add 30 million more from the U.S. Strategic Petroleum Reserve (SPR).

Established after the Arab oil embargo of 1973-1974, the IEA represents the interests of the developed – largely Western – economies. It had been discussing possible approaches to the widening pressure on global oil prices for some time. Yesterday’s announcement was the coordinated Washington-Paris response.

It immediately drove crude oil prices down more than 4.8% in New York (the West Texas Intermediate (WTI) benchmark for NYMEX trading), while slashing the Brent price in London by more than 6%.

Both recovered a bit before the close, but the impact has clearly been to reduce price – at least in the short-term.

As far as the policy goes in that respect, it has accomplished its purpose.”

However, I then observed that the perceived benefits of the raid would be far outweighed by the negatives in the very near future:

“Government action to use reserves is an artificial device. It does nothing to change the market dynamics. In fact, when you suppress the price, even marginally, demand is likely to increase even further.”

Lower energy prices always result in the consumption of more energy.

Yet, available supply is not the problem – not when crude oil prices were going up through the end of April, nor when they were going down throughout much of May.

The problem has been the inability of traders to determine an acceptable price for crude, given its prevailing market price.

The problem, therefore, has been in trade, not in supply. By adding to the supply side of the equation, Washington (and the IEA) has merely distorted the situation further.

And now…

Two Things Will Result

First, the actual price of the crude oil will now encompass the reserve injections, with traders setting new risk approaches that include the artificially determined volume. It will further distort the actual trading market without providing significant benefit.

That’s because this additional supply will not drive the price of crude down to a level that will result in substantial savings to end-users.

The $4 decline in New York oil prices resulting from yesterday’s move will save the average U.S. driver about 10 cents a gallon for gasoline. And that’s assuming the policy of adding volume to the market from reserves is even continued beyond the first month (and it now must be, or the resulting volatility will quickly provide a very unstable trading environment).

Elsewhere, such as here in Greece, the $6.50 decline in the Brent price will save about 11 euros at the pump, making the average price about 6.7 euros ($9.65) a gallon.

Both nice, but hardly likely to start an economic recovery on their own.

And then, with demand rising, prices will begin feeling upward pressure whether there are government-stimulated crude injections or not.

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Second, assuming this policy of injections continues, the reserves will need replacement. That means the U.S. and other governments involved will need to purchase additional crude from oil producers.

These purchases will offset the “advantage” of using the reserves to begin with.

However, the price commanded by purchases of “replenished” volume (which will be done at market prices, by the way) will merely serve to become the price at which the market will base futures contracts.

Any way we look at it, using up the SPR will:

  1. provide additional supply (which is not the issue),
  2. increase demand (a genuine pressure for rising prices moving forward), and
  3. distort the dynamics by which the market determines actual pricing levels.

This is not a cure; it is a surrogate. Once the use of strategic reserves ends (this is not, after all a permanent fix), the volatility will intensify.

All government has done is remove the methadone… The addict is still an addict.”

The more officials would like you to believe matters have changed, the more they stay the same.

Sincerely,


Kent

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  1. Alibaba
    August 17th, 2018 at 02:40 | #1

    Only Government can do that stint! Because is doing it with OUR money! Try hard to fill SPR when oil price was hovering around 100$/barrel, just to sell it now for 68$/barrel! Nice job! Any private business doing that would go bankrupt in no time, but not almighty US government!… And some are proudly calling Trump a “business man”!… Yeah!

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