SPR drawdown of little help to heating oil shortfall

The politically driven SPR drawdown won?t help the heating oil problem in the US Northeast and it may even exacerbate it.

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Now that the drawdown of crude oil stocks held in the US Strategic Petroleum Reserve is well under way, it's worth reflecting on what this unprecedented action is going to accomplish in terms of the market.

There is no arguing whether the announced drawdown will have an effect or not on the market?it already has. Oil prices have retreated more than $5/bbl since President Clinton announced the drawdown plan last week. But was that retreat purely a response to concerns about whether heating oil supplies would be adequate in the US this year? If so, it was misguided, about which there will be more discussion later.

In actuality, the impact on oil prices from the SPR drawdown announcement was largely psychological, as it signaled US intent to disregard the intent of the SPR (the nation's first line of defense against a disruption in oil supplies) in order to jawbone oil prices down from their politically precarious peak in a hotly contested presidential election race. It also suggests, for oil prices to plunge that much in such a short time, that the upward pressure on oil prices to the post-Persian Gulf war peak of more than $37/bbl was more hype than not. In other words, the market was ripe for some profit-taking on futures contracts.

Beyond the SPR drawdown announcement, another, more critical development occurred shortly following that disclosure: The American Petroleum Institute late last week reported a pretty hefty jump in US crude oil inventories, about 3.4 million bbl for the latest reporting week, to a total of 287.8 million bbl. That corresponded with an increase in US oil imports that API pegged at 41,000 b/d, to a total of 9.28 million b/d. The US Department of Energy, on the other hand, reported that US stocks rose by only 1.1 million bbl to 286.7 million bbl in the same week. DOE also reported that US oil imports actually declined that same week, by 447,000 b/d.

If accurate, the API data suggest that some of the added production that the Organization of Petroleum Exporting Countries has been pledging to add to the market since April is finally beginning to reach US shores. With OPEC output continuing to remain high, together with a slackening of demand from refiners as a number of US plants go into seasonal maintenance turnaround and with the release of incremental barrels from the SPR, the outlook for crude oil prices has taken on a relatively bearish tone in the past week. That might be mitigated somewhat by a disappointing bidding process for SPR crude, but at this writing, it was too soon to tell whether the entire 30 million bbl of crude would be taken up.

In any event what does this do for heating oil prices, which are expected to drive the market this winter?

The consensus is pretty much unanimous on this score: not much.

As the would-be Pres. Al Gore is fond of pointing out in his denunciations of proposals calling for opening the Arctic National Wildlife Refuge Coastal Plain to exploration and development, that is, that it wouldn't be worth it for a few months' supply of oil….Ahem…If one follows that line of logic, then the US is toying with a mechanism essential to its national security for what amounts to less than 2 days' worth of US oil consumption, or put another way, about 3.3 days of imports.

However, as Gore himself pointed out last year when the possibility of an SPR drawdown was raised, OPEC could quickly and easily respond to this added crude by simply rolling back their pledged production hikes. In fact, the US action undermines Saudi efforts to secure OPEC cohesion on boosting output to moderate oil prices. Almost certainly Saddam Hussein will see this as an opportunity to tell the rest of OPEC that the US is willing to undermine the group for the sake of political expediency?

But, again, what about heating oil stocks? The level of heating oil stocks in the US and Europe is the problem here, not the volume of crude oil on the market. There is not even a problem with the production of heating oil, which has averaged about 1.23 million b/d in the past 4 weeks in the US, or about 13% ahead of 1999's level at this time. But stocks are simply too low, about 38 million bbl for first half 2000 compared with 68 million bbl in the same period in 1998 and 65 million bbl in first half 1999.

The problem is even more specific and even provincial than that, according to Energy Security Analysis Inc. The Wakefield, Mass., think tank contends that the problem lies with heating oil tightness in the US, and the problem is getting worse, not better: "

Even with New York Harbor heating oil prices as high as they are, they are not high enough to pull cargoes away from Europe or even the Gulf Coast (when added shipping charges are factored in). The strength in Rotterdam, ESAI claims, is a buying binge by Germans trying fill 255 million bbl of tertiary storage ahead of what is expected to be a return to cold winters.

Not only would an SPR drawdown not have much impact on New York-Rotterdam differentials, it could even make the situation worse, if the SPR drawdown were to weaken WTI more than it does Brent crude, which, in turn could do more to support gas oil prices in Rotterdam relative to those in New York.

"It is premature to draw down the SPR when temperatures in the Northeast are in the '70s," ESAI said late last month. "A drawdown would be little more than politically motivated price manipulation to assuage consumers."

ESAI reminds that the SPR is intended to be used when there is a shortage.

"There very well may be shortages in heating oil in November and December, and perhaps the SPR should be used then, but with the understanding that while more crude will power prices, it will not provide more hating oil at the end of the supply chain."

Of course, by then, the US presidential election will be over.

OGJ Hotline Market Pulse
Latest Prices as of October 6, 2000

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