US-Driven Emergency Oil Reserves Release Deal Seems Closer
United States-driven talks with the United Kingdom, France, and Japan over releasing strategic oil reserves to cushion economic recovery have seen Brent drop somewhat this week, appearing oddly aligned with ongoing French and US presidential election campaigns and risking restricted manoeuvrability in an actual supply disruption crisis that is not entirely unthinkable given Iran's continued threats to close the crucial Strait of Hormuz.
IHS World Markets Energy Perspective
French prime minister François Fillon revealed yesterday (29 March) that he sees a good chance for currently ongoing talks between his country, the United States, the United Kingdom, and France to mature into an agreement on a potential co-ordinated release of oil from these countries' strategic reserves in order to mitigate the growing weight of high oil prices on recovering developed economies.
In reaction to the talk, the leading Brent benchmark has indeed softened somewhat over the past days, which might suggest that talk is all it takes to counter rising oil prices, lacking a concrete underpinning in fundamentals underlying this price movement. Moreover, a push to release strategic oil reserves seems rather politically motivated in a year that will see both French and US presidential elections and high gasoline prices have rarely boded well for re-election hopes.
However, releasing strategic oil reserves for political reasons rather than changes in market fundamentals carries the risk of reserves shortages in an actual crisis, for instance, if Iran were to go ahead with its standing threat of closing the Strait of Hormuz and thereby cutting 20% of world oil supplies.
Co-Ordinated Oil Reserves Release Plans Supposedly Close to Agreement
Approached by the United States, which has seen domestic gasoline prices rise to record highs of around USD3.918 per gallon on average this week, the United Kingdom, France, and Japan have signalled a general willingness to co-operate on a potential release from their strategic petroleum reserves (SPR) in order to bring down climbing oil prices that had reached a peak of USD128.4 per barrel in March and are threatening to slow down a global economic recovery, according to the US. French prime minister François Fillon was quoted by Reuters as saying that he expected to reach an agreement soon and that the release could take place in the coming months. However, the US government confirmed that no agreement has been reached yet and no specific actions have been proposed. It thus remains unclear how much oil could be released from the SPR, with a Financial Times report suggesting that the scope of a potential discharge could surpass last year’s efforts to counter supply disruptions from the Libyan civil war. This time, however, the US has not involved the International Energy Agency (IEA) so far, which cannot object to unilateral co-ordination on SPR releases unless these would cut into a country's mandated minimum reserves level equivalent to at least 90 days of the previous year's net imports.
Fundamentals Out of Sight
The underlying fundamentals that might prompt such a move by the four developed economies remain elusive. Although oil prices have been on the rise over fears that Iran might close the crucial Strait of Hormuz and thereby trap about 20% of global crude supplies, rumours have also been spread that rising crude demand from Asia, mostly China and India, is partially due to these countries’ ambitions to ramp up their own strategic reserves that do not compare to those of the leading OECD economies. However, a closer look at India’s rising oil imports, which have seen a 10.7% increase to 3.74 million b/d between 2010 and 2011, reveals that this development is mostly driven by rising passenger and commercial vehicle sales and hence gasoline consumption, according to the Petroleum Planning & Analysis Cell, a research arm of the Indian oil ministry. Meanwhile, the International Energy Agency (IEA) and the world’s largest oil producer, Saudi Arabia, have been eager to deflect the notion of a global crude supply crisis, highlighting that there has not actually been a disruptive event this year that would warrant an SPR release.
Although SPR talks between the US, the UK, France, and Japan have already had a somewhat easing effect on the closing price of Brent yesterday (29 March), bringing it down to USD122.39 per barrel or 1.43%, it is quite obvious that ongoing negotiations are accompanied by a good amount of political calculus, especially in France and the US. Record gasoline prices in the US, way ahead of the summer driving season, have challenged President Barack Obama’s campaign for re-election in the US in November this year. The crunch on car-loving US consumers has been exacerbated by Republican claims that the administration of US president Barack Obama is opposing hydrocarbon production from new areas in the US, such as the Atlantic Coast and the Eastern Gulf of Mexico, that are currently off limits for environmental concern reasons, particularly in the aftermath of the 2010 Macondo oil spill in the US. Republicans have aggressively pursued a strategy of discrediting Obama’s energy policy as one that jeopardises security of supply by supporting less proven energy sources like renewable while preventing job market growth by keeping a lid on new federal land lease sales. In fact, Republicans are currently floating bills in Congress that would tie an SPR release to provisions forcing the government to open up more federal lands to oil and gas drilling in order to refill the potentially extracted reserves volumes. However, these advances are unlikely to progress to the legislation stage.
Across the pond, France’s president Nicolas Sarkozy has been plagued by similar worries on the part of his potential electorate, supplemented by fears that a high oil price would further weigh on the French economy as the EU is only slowly digging its way out of the euro debt crisis and financial institutions in Europe still being hesitant to lend at pre-crisis levels. From this perspective, an SPR release would be a proactive signal by both presidents to do whatever is in their hands to bring global oil prices back down. The fact that neither country would have much influence over global oil price movements otherwise explains the drastic step being considered, even though it does not justify it.
Outlook and Implications
Even though French officials, who are up for re-election as soon as May, remain hopeful for an agreement on a co-ordinated SPR release, the move would probably only have a short-term effect and alleviate Obama’s re-election worries only temporarily. Even the US Department of Energy has already voiced concerns that a withdrawal from the SPR at this point would complicate a potential fallback on the US SPR in case of an actual emergency. Although there is no concrete crisis in sight for the moment, Iran continues to threaten the closure of the Strait of Hormuz, a crucial passageway for international energy supplies. If Iran were to go forward with such a measure, potentially induced by further crippling sanctions against the country that are not completely unthinkable in the future on the grounds of its advancing nuclear development programme, about 20% of world crude supplies would be trapped in the Gulf region. Not having enough petroleum reserves to fall back on in such a case could have the potential to kill off Obama’s hopes for re-election as Americans are already disapproving of his handling of high domestic gasoline prices. At the same time, such a scenario might even weaken US leverage towards Iran in a possible future intensification of the so far non-military conflict between the countries. In any case, that appears to be a disproportionally high risk to take after all, even in an election year, and it thus remains to be seen whether an SPR release will indeed take place and if so, whether its scope might not remain symbolic rather than substantial.
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