MARKET WATCH: Energy prices tumble with word of SPR oil release

Sam Fletcher
OGJ Senior Writer

HOUSTON, June 24 -- Energy prices dropped sharply after the Obama administration and a coalition of 27 other members under the International Energy Agency agreed to barrage markets with 60 million bbl of crude from their strategic reserves within a 30-day period.

In New York, West Texas Intermediate crude dropped more than $4/bbl, while North Sea Brent crude fell almost $7/bbl in London on June 23. IEA will coordinate the release at a rate of 2 million b/d, with 30 million bbl to come from the US Strategic Petroleum Reserve (OGJ Online, June 23, 2011).

The crude will be offered to refiners in “a straight sale” rather than in exchange for later barrels. This would provide a cash injection to those governments participating in the release of emergency oil supplies.

Moreover, with oil consumption declining among member countries of the Organization for Economic Cooperation and Development, the IEA participants will need less inventory to satisfied the required stock-to-demand ratios. So it may not be necessary to replace the sold crude at a later date, said Olivier Jakob at Petromatrix, Zug, Switzerland.

The American Petroleum Institute and several—mostly Republican—politicians have accused President Barack Obama and the IEA of using crude supply losses from the Libyan revolution as a fig leaf to hide the real intent of reducing energy costs in a weak world economy. They fault Obama for using emergency crude supplies to manipulate energy prices—a use not intended for SPR—and claim he should instead permit more drilling in the US. Even some Democrats agree the replacement of Libyan supplies would have been a more logical reason if the action had been taken when those supplies were first disrupted in March.

Certainly officials didn’t wait months before taking action the last time SPR crude was released following Hurricanes Katrina and Rita in 2005. However, as markets have shown, just the announcement of the release has a faster effect on energy prices than a slow but steady increase in drilling. Plus Obama, a candidate for reelection, is more likely to get political credit if this lowers the retail prices for gasoline.

Jakob pointed out, “Bulls are already making the case that 60 million bbl is less than 1 day of world oil demand and is therefore a drop in the ocean. But then the total lost crude exports from Libya represent so far only 1.6 days of world oil demand. One cannot have it both ways: either the lost supplies from Libya are significant and the stock release is significant, or the lost supplies from Libya are insignificant and so is the stock release.”

Analysts primarily agree the IEA release of oil will put more downward pressure on the higher Brent crude prices than on WTI.

“Oil prices have been retreating, but not fast enough to suit policy makers,” Adam Sieminski, chief energy economist, Deutsche Bank AG, Washington, DC. “The IEA sees the release as an effort to break the logjam, while giving the Saudis time to gear up output and maybe buying a bit of time to see if the opposition forces in Libya can ship some oil. The ‘natural’ correction in the market was not coming from rising supplies, but rather from demand being crushed by a slowdown in the global economy. This is not the IEA’s preferred economic solution to the loss of supply.”

However, he said, “The IEA’s stock draw is a risky move in our view since it is mostly a short-term fix to a problem with many long-term components. Saudi output is rising in June, with more estimated to be coming in July, and so there has been some concern that the IEA release might undermine their efforts. In our view, probably not, since the available Saudi oil is heavier and higher in sulfur than the missing Libyan barrels. The IEA release will be US light, sweet crude and light, sweet European products.”

In Houston, however, analysts with Raymond James & Associates Inc. noted some members of the Organization of Petroleum Exporting Countries have cautioned the IEA's decision could trigger a retaliatory response, possibly prompting producers to “mend fences” within OPEC in attempt to inflate oil prices.

“OPEC countries have stepped up spending this year to create jobs and build housing and now rely on a higher oil price in order to cover these costs. Some believe that if Brent continues its slide below $100/bbl, OPEC may consider cutting output. It is of some analysts’ opinion that this action by the IEA will backfire if it alienates oil producers, lessening the incentive to raise production,” they said.

There are other potential effects. SPR oil will be released in amounts of 10 million bbl each from Gulf Coast storage at Bryan Mound, West Hackberry, and Big Hill. For delivery of that crude to buyers, Jakob reported, there will be a waiver of the Jones Act that among other things requires commercial transportation in US waters to be aboard US-flag ships crewed by US citizens. Despite requests, that requirement was not waived during the clean-up of the Macondo oil spill last year. Obama’s labor union supporters may not like the waiver.

Although the US plans to release 30 million bbl of sweet crude from Gulf Coast government storage, commercial Gulf Coast storage is already near record-high levels with “only about 17 million bbl of crude oil storage space left,” Jakob said. Once the release begins and if successful, commercial Gulf Coast storage quickly will be filled. And there is not much storage space to which to pipe crude in the Petroleum Administration for Defense District (PADD) 2, which includes the key exchange point of Cushing, Okla.

“The administration said it would review the situation in 30 days and is ready to do more,” Jakob reported. “If it succeeds in filling the US Gulf Coast stocks to full capacity, then it can follow later with a smaller program to keep those stocks at record levels.” While waiting for SPR sales to begin in August, it will “be difficult” for traders to buy oil based on any weekly report of draws of crude from commercial storage “as we now know that any stock draw will be followed by SPR supplies,” he said.

Jakob added, “Given the limited amount of storage capacity currently in the US Gulf Coast and in the Midwest, it is likely that some import barrels will have to be redirected to Europe and the Far East, especially crude oil of West African origin. This should put Brent under pressure, on a time-spread basis but also in the Brent-Dubai [spread], which has already dropped overnight. The time structure of Brent already moved from backwardation to a flat structure and could continue the move to a small contango.”

Energy prices
The August contract for benchmark US light, sweet crudes whipsawed between $89.64-94.47/bbl June 23 before closing down $4.39 at $91.02/bbl on the New York Mercantile Exchange. The September contract dropped $4.38 to $91.54/bbl. On the US spot market, WTI at Cushing also was down $4.39 to $91.02/bbl in step with the key futures contract.

Heating oil for July delivery gave back 17.32¢ to $2.78/gal on NYMEX. Reformulated blend stock for oxygenate blending for the same month decreased 13.57¢ to $2.84/gal.

The July natural gas contract fell 12.4¢ to $4.19/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., declined 13.2¢ to $4.29/MMbtu.

In London, the August IPE contract for North Sea Brent crude fell $6.95 to $107.26/bbl. Gas oil for July lost $37.50 to $889/tonne.

The average price for the Organization of Petroleum Exporting Countries' basket of 12 reference crudes was down $1.88 to $106.08/bbl.

Contact Sam Fletcher at samf@ogjonline.com.

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