PIRINC: Additions to SPR not driving up oil prices

Oil deliveries into SPR also are small in comparison with rising US crude imports, which are a major influence on the market. "In the 4 weeks [ended] Aug. 1, US net oil imports averaged 11.6 million b/d, up 1.3 million b/d from the same period last year," PIRINC analysts reported. "The rise in imports reflects the combination of slightly higher final demands, ongoing declines in US production, and the need to rebuild stocks from exceptionally low levels reached earlier this year."

They said, "Deliveries to SPR in the 4 weeks [ended] Aug. 1 had a minimal role in the increased level of imports. Deliveries were up about 60,000 b/d vs. the same period a year ago. Since the beginning of May, when significant deliveries began, they have been running at about the same rate as over the same period last year."

PIRINC analysts acknowledged, "In principle, any addition to demand, however modest, other things being equal, adds upward pressure to prices, and therefore any reduction in demand would have a similar negative impact on prices." However, they said, the amount of oil going into SPR is known well in advance by the Organization of Petroleum Exporting Countries and other producers and is figured into their supply planning.

Delivery deferred

DOE previously has juggled SPR deliveries to help relieve a market crisis. To offset the loss of Venezuelan oil exports to the world market because of the general strike in that country last December, DOE officials announced they would defer scheduled deliveries of oil to SPR until September. By early January, the amount of oil transported to SPR in exchange for RIK crude had dropped to zero from 350,000 b/d during the first week of the previous December.

There were no additions to SPR for the next few months as US-led coalition forces prepared for their eventual invasion of Iraq to oust Iraqi President Saddam Hussein.

But in April, with the end of major fighting in Iraq and the recovery of Venezuelan production, DOE advised contractors that those deferrals were ended and regular deliveries of oil to SPR would resume in May.

"Oil prices in the market at that time were down from their prewar levels, and the resumption of RIK deliveries had no apparent effect on the market," said PIRINC officials. "Weekly inventory data released by the Department of Energy allowed markets to see the volumes [of oil] involved and [to] reflect them in prices."

Moreover, PIRINC analysts said, "It is important to keep in mind what was underpinning market expectations at that time. In particular, in late April-early May, Iraq production was expected to rebound quickly, with the newly appointed head of Iraq's oil sector anticipating 1.5 million b/d of production 'within weeks.'"

In early March, the price for the August contract for benchmark US light, sweet crudes was at $32/bbl on the New York Mercantile Exchange, "reflecting a premium for potential risk of oil supplies extending beyond the immediate war time frame," analysts said. But in late April and early May, the August futures price was down to $26/ bbl on NYMEX, despite the resumption of RIK oil deliveries to SPR see chart).

As a result of lower oil prices, the nine OPEC members, minus Iraq, began trimming back earlier production increases they had implemented to offset the loss of Venezuelan oil exports during the 2-month strike and to calm market fears of additional losses of oil supplies as a result of the war in Iraq. Saudi Arabia had increased its oil production by 1 million b/d during January-April, but by June it had cut back production by 750,000 b/d, PIRINC reported.

Meanwhile, the earlier rosy expectations among some politicians and analysts of a quick recovery of Iraqi oil production have not panned out.

"The International Energy Agency reports Iraqi [oil] production in June averaged only 440,000 b/d, and July production averaged 665,000 b/d [down from Iraq's prewar production of around 3 million b/d]," said PIRINC analysts. "Slippage in Venezuelan production in recent months, ongoing terrorists acts, and threats in key oil producing countries have added to supply concerns.

Since early May, these changes helped propel the [NYMEX] August contract price in almost a straight line to the $30[/bbl] level and beyond by the time of the July 22 contract expiration date. The actual spot price of oil in early August [averaged] about $32[/bbl]."

Low levels of commercial inventories of crude and petroleum products in major consuming countries—running about 9% below year-ago levels in the US—also have amplified the rise in energy prices, they said.

RIK program

MMS's switch to taking oil in payment for offshore royalties instead of cash provided a means of avoiding disputes with industry over the market value of oil at the wellhead prior to the added cost of transporting that oil to market.

In early 1999, the administration of President Clinton announced plans to use RIK oil as a means of adding crude to SPR. President George W. Bush subsequently endorsed that program as part of his National Energy Plan in May 2001.

Later that year, Bush said he would use that means to fill SPR to a target level of 600 million bbl.

The current RIK program is a reoffering of royalty oil exchange packages awarded in April that are due to expire Sept. 30, said MMS officials. In addition to the new contracts, there are ongoing exchange contracts and direct crude oil movements to add up to 77,000 b/d of oil going into the SPR in an effort to fill its remaining capacity of 107 million bbl.

"These contracts demonstrate MMS's continuing commitment to maximize taxpayer assets, improve government efficiencies, and enhance our nation's energy security by filling the Strategic Petroleum Reserve," said MMS Director Johnnie Burton.