Jawboning crude prices down gets into high gear

Efforts to jawbone crude oil prices back down are in full swing in Washington-but the real thing will happen in Riyadh ahead of the OPEC meeting.

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There's a lot of effort under way to jawbone the price of crude oil back down from its currently lofty height.

The biggest warning shot across the bow of OPEC came this week, when two US senators called on the Clinton administration to promise to drawn down the Strategic Petroleum Reserve to moderate red-hot crude oil prices in case OPEC doesn't agree to increase production quotas. In a letter to US Energy Sec Bill Richardson, the senators suggested that OPEC "isn't living up to its commitment" to produce more crude oil if the price of oil remains outside the agreed band of $22-28/bbl for more than 20 days. Therefore, their logic went, it is incumbent upon Clinton to act on a mechanism put in place in the event of an oil supply crisis.

As OGJ Online reported this week, Sens. Charles Schumer (D-NY) and Susan Collins (R-Me.) wrote Richardson Tuesday, urging him to tell OPEC that the US would consider oil swaps from the 569 million bbl SPR. They asked Richardson "to make clear to OPEC ministers that, should they fail to honor their commitment to produce sufficient amounts of oil to ensure reasonable global prices, the US is prepared to release oil from the SPR to protect our consumers and our economy.

"With global demand projected to outpace supply by nearly 250,000 b/d in the third quarter of 2000 and by more than 1.7 million b/d by the fourth quarter, we once again face the likelihood of sky-high gas[oline] prices and significant pressure on our overall economy. As things stand right now, $2/gal gasoline this summer seems almost certain," the letter said.

"At the very least, OPEC must be compelled to uphold its agreement to increase supply should the price of oil exceed $28/bbl for a period of 20 days. The price has been fluctuating between $28 and $31 for 18 days now; should OPEC fail to act on its commitment to moderate the oil market, the US must be prepared to respond by releasing oil from the SPR through a swaps policy.

"We cannot allow our economy to be held hostage by foreign oil producers. We have the perfect tool to leverage OPEC's influence on the global oil economy, and the time to use it is now."

The senators say that, under the swap program, oil companies would be allowed to draw down SPR crude and repay it with larger volumes later, the difference being the amount of oil that oil companies bid. The senators say the swap program could be used to gradually build the SPR to 1 billion bbl.

"Getting the SPR to 1 billion bbl, along with a viable swaps policy, would go far toward protecting the US from future oil shocks based on supply shortfalls," they said.

However, SPR officials said the four SPR storage sites in Texas and Louisiana only have combined capacity of 700 million bbl.

The senators apparently are either selective in their choices of price data, oblivious to the variations in prices among the world's crude oil grades, or simply guilty of the usual nationalist provincialism that seems to pervade members of Congress.

The price band the two senators refer centers on the average price of a basket price of OPEC crudes, not WTI or NYMEX crude, of which they ostensibly were thinking. The NYMEX crude futures contract does not even duplicate WTI, which is a common misconception. It is really an analog for a light, sweet crude roughly patterned after WTI crude qualities. Even in dealing with paper barrels, the exchange must use an analog-for reasons best known to lawyers-for WTI, of which the cumulative production to date probably does not equal a year's worth of trading on NYMEX (nitpickers relent, please, this is mere hyperbole to make a point).

So, to really make their case, the senators should have waited for NYMEX crude or spot WTI to stay consistently above $30bbl for 20 days, which has not happened. But because this is political grandstanding and not thus based in reality, the real message here is that two senators from the US Northeast-where the heating oil debacle became a major political issue this year, thus transcending party lines-want Richardson to repeat his bullying of OPEC ministers. Given Richardson's taking credit for the last OPEC production increase (think vice-presidential aspirations), it's doubtful he needs much encouragement.

The hubris of the senators' letter would be alarming were it not so pathetic: the subtext being Americans' birthright of being supplied cheap oil forever, in defiance of the laws of supply and demand, regardless of the consequences to those suppliers or even to the future supplies. That sort of arrogance mightily angered some in OPEC at their last meeting, when Richardson was burning up frequent-flyer miles and calling ministers to the phone in the middle of sensitive negotiations to bully and wheedle them into taking risks with their nations' economies in order to accommodate what is, boiled to its essence, the presidential campaign of a man who has vowed to phase out the use of that same commodity that is the bedrock of those economies.

Some ironies just write themselves.

In any event, the real jawboning will happen without Richardson. While some in OPEC-notably Iran, Indonesia, and the UAE-have argued against a production increase, it again falls to the triumvirate of Saudi Arabia, Venezuela, and non-OPEC stalwart Mexico to set the agenda, as they have in precipitating all the key production cut accords of the past 18 months. Another meeting of Saudi Oil Minister Ali al-Naimi, Venezuelan Energy and Mines Minister Al

The question is whether high crude oil prices are the temporary result of sky-high gasoline prices-which, in turn, are the result of record-low gasoline inventories-or the longer-lasting result of inadequate crude oil supplies. The trouble is that guessing either way itself has an impact on the market, and by the time everyone figures out the right answer, it's too late, and the price spiral (up or down) begins anew. Remember the Asian crisis? OPEC made the wrong guess at that time and pumped too much crude into the market just at a time when economies and demand were starting to collapse. Just like you can't turn a tanker on a dime, the juggernaut that is the oil market cannot be quickly rerouted.

The best guess here is the triumvirate will emerge from their Riyadh meeting with hints that OPEC might hike output at the Vienna meeting, then do their own jawboning to effect a small increase that probably won't be accepted by all, especially Iran, and point to the likelihood of rogue Iraq stepping up output. Couple that with the likelihood of fresh reports of likely increased quota cheating by OPEC, expected modest increases by non-OPEC nations, and the replenishment of gasoline stocks, and we set the stage for a modest price retreat for the summer, thus buying some time to divine the entrails of supply and demand in the second half. OPEC hawks can declare victory by not having to invoke the price-band rule and softening prices, OPEC doves can declare victory by watching prices moderate to acceptable levels (the Holy Grail of a "soft landing"), and Richardson, Clinton, and Gore can all take credit for taming the oil price beast.

But there is always the Saddam wild card, and the increasing likelihood that it will be played in an presidential election-especially with a president (and presidential aspirant) whose radar is always locked on the way the polls move. Depending on what kind of results Saddam gets from his manipulation of Clinton & Co., the market could be in for a wild rollercoaster ride-up or down, or maybe both-in the third or fourth quarter.

Déjà vu, anyone?

OGJ Hotline Market Pulse
Latest Prices as of June 2, 2000

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