Instability is the new stability

The growing awareness among international oil chiefs that oil price stability is unlikely to return any time soon is entrenched by the latest report from the International Energy Agency.

The growing awareness among international oil chiefs that oil price stability is unlikely to return any time soon is entrenched by the latest report from the International Energy Agency.

IEA's February Monthly Oil Market Report says instability is likely to become the watchword for crude markets and the industry for years to come-doubly so if the economic slowdown in North America has the expectedly baleful impact on global demand.

The Paris-based organization said the problem is being precipitated by the disingenuous, or at least short-term, behavior of oil producers. It said that will lead to "a hard landing" for the oil market.

Incompatible objectives

"Producers talk as if their goal were strictly to stabilize markets, but they act as if they were primarily focused on maximizing revenues. Are the two objectives compatible?" IEA asks rhetorically. "Can prices be stabilized at the high end of the producers' target range regardless of economic conditions?"

The answer is necessarily "no." The result of attempts to manage supply in such a way as to maintain unsustainably high crude prices is backwardation-in which oil for immediate delivery sells at a premium to oil sold now for future delivery-and backwardation causes market instability.

"Sooner or later high oil prices boost competition on the supply side even as they undermine demand," emphasizes IEA. "By choosing to maximize revenue now, producers run the risk of a hard landing later on."

Nor will the fallout from instability stop at the producers. Volatility will undermine planning and development and throw oil company budgets and spending programs into chaos. But worse yet, as IEA points out, "by shorting the market, [producers] are encouraging the very outcome that they profess to combat."

Tight markets mean enforced competition between refiners for limited barrels and bid up prompt supply. "Faced with the prospect of falling futures prices," notes IEA, "companies are unable to hedge forward without locking in paper losses."

Distortion and instability

The upshot is market distortion and instability.

The wider effects are well known. In the short-term, low stocks limit response to severe weather, pipeline disruptions, and spikes in demand. They contribute to regional supply imbalances and price instability.

In the medium term, high prices can drive pressurized economies into recession, cutting demand for goods and services and then for crude and product imports.

Economies the world over will have to fend for themselves. As for the oil companies, with the likes of Royal Dutch/Shell and BP each reporting annual profits this month of just under $15 billion, let's hope the megamajors see fit to sock away something for the day volatility once again means $10/bbl oil.

All eyes will necessarily be fixed, yet again, on the next Organization of Petroleum Exporting Countries meeting in March.

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