LONDON: Talks between some of the world’s richest oil consuming nations over whether to release billions of barrels in emergency oil reserves are moving to a question of “when” rather than “if” to act.
The view in the oil markets is that the US, UK, France and Japan are likely to agree soon on a release of their strategic petroleum stocks, to prevent crude prices soaring further when European Union sanctions on Iran are introduced in July. Benchmark Brent crude was trading at about $125 a barrel on Tuesday, a few dollars below the post-financial crisis highs it hit last month.
“The pressure to use the strategic petroleum reserve is rising”, says Robert McNally, head of consultancy at The Rapidan Group and a former senior oil official at the White House. “I get the impression it is coming up this spring or summer.”
Guy Caruso, oil expert at the Center for Strategic and International Studies and a former senior official at the US Department of Energy, agrees: “They are exploring the option [of a release] in the relatively near term.”
But the talks have thrown up a stumbling block that could delay, or even prevent, the use of the strategic reserves. It centres on a legal question of whether current supply disruption is serious enough to warrant a reserve release.
According to US law and the treaties underpinning the International Energy Agency, the western countries’ oil watchdog, the consuming countries’ stockpiles can only be used for “severe energy supply interruption” and “serious” disruptions.
The definition of what is “severe” and “serious” is open to interpretation. Under a narrower understanding of the law – the IEA’s international energy programme – a serious interruption only occurs when it exceeds 7 per cent of IEA supplies, or more than 3m barrels a day. The IEA, however, has a lower threshold under its co-ordinated emergency response measures, which provide “a rapid and flexible system of response to actual or imminent oil supply disruptions of any size”.
Furthermore, US law says in broad terms that Washington can tap its reserves when there is a “significant” reduction in supply that triggers a “severe increase” in the price of oil that is likely to “cause a major adverse impact” on the economy.
Right now, disruptions to oil supply involve only a handful of countries from Colombia to South Sudan and account for about 750,000 b/d. On its own, that is unlikely to meet the broad or narrow interpretations. Indeed, Maria van der Hoeven, IEA executive director, has argued that currently there is “no serious disruption of supplies”.
Still, some IEA member countries, including the US, see these outages as nearing a level that requires action by consuming nations. The agency itself has sent mixed signals, with some officials sounding more worried than other about tightening oil markets, supply outages and rising oil prices. The IEA has long argued it has a specific mission: to offset serious disruption such as that caused by a war in the Middle East. Others see it more as an oil bank, to be used flexibly to offset the impact of high oil prices.
The strategic reserves are a powerful weapon. Oil prices have fallen sharply after each of the three times that IEA countries have tapped them. The most dramatic impact occurred in 1991 during the Gulf war, when the price of Brent plunged from more than $30 a barrel to $19.70 in less than 24 hours. The nearly 40 per cent price drop on January 17 of that year is the largest recorded fall in percentage terms.
The impact of the other two released was more muted. Crude fell 2.5 per cent after a release in 2005 when hurricane Katrina closed down output in the Gulf of Mexico. Prices tumbled about 6 per cent in 2011 when the US sold 30m barrels to compensate for the loss of Libyan supply. However, crude swiftly recovered.
But all three releases managed to halt a rally in prices. Without them, the market would have faced a dangerous draw down of the commercial stocks held by refiners, which could have inflated prices. Many analysts believe that without the release last year, Brent prices could have hit $150.
This could be the scenario cine July 1, when the EU embargo on Iranian oil officially starts. Industry officials believe that Iran would lose between 500,000 b/d and 1m b/d of exports, meaning the outage is likely to qualify as serious. “We believe that the oil market could lose, on average, around 700,000 b/d of Iranian oil,” says a Gulf-based official.
John Shages, who oversaw the US oil reserves during the Bush and Clinton administrations, believes the reserve is likely to be used. “I would not release it just right now,” he says, “but certainly I would have the finger on the button and be ready as we are on the cusp of needing it.”
If prices are rising. the legal technicalities are unlikely to deter governments. Yet, some argue that by mid-June the need for a release could have receded.Saudi Arabia is raising its output, and together with extra supplies from Iraq and Libya, it could help to offset the losses from Iran.
“There are some signs that the supply tide is turning,” says an oil official who opposes the use of the reserves. When the IEA released its stocks last year, it did so only until Opec countries boosted output. Action could be shortlived.