Iea's Weakening System

The International Energy Agency has good reason to voice alarm over Germany's plan to join the U.S. in partly liquidating its strategic inventory of crude oil. The German and U.S. actions strike at the core of IEA's reason for existence.

IEA grew out of the Organisation for Economic Cooperation and Development, which represents industrialized countries, during the Arab oil embargo of 1973-74. Its chief concern is security of energy supply for 24 member countries. Its tools are information and a system for emergency oil sharing from strategic stocks.

The latter of those tools looks rusty indeed when member governments dip into oil hoards to raise funds. Hence IEA's observation that Germany's plan is "unfortunate." The agency notes that the drawdown won't take Germany's forward stock cover below IEA guidelines. Like a 10-12 million bbl sale from the Strategic Petroleum Reserve likely to be approved by Congress, however, the German move certainly hints at a weakening of support.

IEA should respond by making its emergency supply system look like something that might actually work.

Program a bluff

At present, the program is effective only as a bluff against oil exporters inclined to withhold oil sales for political purposes. Such a bluff has less value now than it did in the 1970s. Exporters most likely to play politics with oil have more to lose from the antics than they did before. And the market is better able to make up the deficits. Chances for a repeat of the Arab oil embargo have not vanished in the past 2 decades, but they certainly have diminished.

Chances for other forms of supply disruption have increased. Oil trade involves growing numbers of countries and movement across more international boundaries. Wars and natural disasters happen. The world has probably experienced neither its last political surprise from key producing regions nor its last disturbance to oil trade.

To offer benefit to participants, IEA's emergency program needs to promise supplementary supply to a market adjusting to disrupted trade. It doesn't do so now.

The problems are IEA's sharing requirement and trigger mechanism. Members are supposed to share oil when one of them loses 7% of its supply. Yet isolated shortages don't occur in a working market. A buyer losing supply from one source competes for supply from other sources. A large supply loss raises price, which cuts consumption. Effects quickly wash through the trading system and may be most evident in price. Lost volumes may be measurable only at the point of export and in any case will be replaced by supply summoned forth by the higher price. So a costly disruption can occur without registering anywhere near a 7% shortfall at any one point of consumption.

Under all reasonably imaginable supply emergencies, therefore, IEA might never initiate sharing if it adheres rigidly to the existing trigger. And it will remain institutionally reluctant to initiate strategic withdrawals because of the political risk that members will refuse to share in stressful times.

The program thus annuls the one main benefit that strategically stored oil offers beyond discouraging mischief by exporters: It can prevent panic hoarding and ease the costs of market adjustments to a supply disruption. Its effectiveness suffers to the extent the market doubts that the oil will be available when needed. The market has reason to harbor such doubt now. And IEA members have reason to discount the benefits of participating in the oil-sharing program.

Reason to participate

IEA should give members better reason to hoard crude. It should: 1) drop the sharing requirements, which are unnecessary and erode confidence in the system, and 2) install a withdrawal trigger based on valid market signals. If it takes those steps and members still use hoarded crude for fund-raising, it can conclude that insurance against supply emergencies isn't worth the cost to beneficiaries.