July 22, 2011

More Reserve, Please, in Releasing Strategic Reserves

This piece from the Financial Times reports the end of the International Energy Agency’s release of strategic oil reserves, which amounted to 60 million barrels for 30 days after June 23, 2011.  It notes, interestingly, that the IEA may have felt compelled to take action when OPEC did not raise its own output, but then says that Saudi Arabia is now pumping an extra 20 million barrels per month (700,000 per day). 

Analysts said the IEA’s unexpected decision to employ strategic stockpiles had exerted only a temporary restraint on oil prices. Immediately before the announcement, Brent crude, the most important benchmark, was trading at around $112.50 per barrel. When the IEA board made its decision on June 23, the price fell as low as $103.62, only to rebound strongly in the weeks that followed.

Brent was trading at $118.25 on Thursday, significantly above the level seen before the IEA chose to use the stockpiles held in its member states. “If their objective was to lower oil prices, it clearly hasn’t succeeded,” said Caroline Bain, senior commodities editor at the Economist Intelligence Unit.

The original decision may have had as much to do with politics as market conditions, she added. On May 19, the IEA board publicly threatened to release strategic reserves if Opec failed to increase its own output. The oil cartel then declined to raise production quotas during an acrimonious meeting in Vienna on June 8. “They had threatened Opec that they would act, so they perhaps felt they had to go ahead with it,” added Ms Bain.

The IEA secretariat cited a more recent increase in production from individual Opec members as a further reason for not repeating the decision to draw on reserves. Last month, Saudi Arabia is believed to have pumped an extra 700,000 b/d, bringing the kingdom’s total output to 9.7m b/d.

This helped total Opec production to climb to just above 30m b/d – slightly higher than the level before Libya’s civil war deprived the market of most of that country’s production in February.

I thought the IEA’s original release was a dumb idea. If impressing OPEC was the purpose, a one month release surely would not do it. Did anyone at this august organization, at the time the original decision was made, ask the question: what about month two?  Better yet: have you ever heard about the Boneless Wonder?

The timing was also weird. Prices were well off the highs of the spring. Perhaps this was an instance of a multilateral body of 28 members acting with all deliberate speed, or such as it can muster. The IEA did nothing when panic gripped the markets from late February to the end of April, and acted bravely seven weeks later, when oil had already fallen 15 percent! (When the oil market did crack on April 30 or so, it coincided with a market call by Goldman Sachs saying it was time to sell oil and three other commodities, suggesting that the Vampire Squid has more market-moving moxie than the IEA.) 

The above (hope you can make it out on your browser) is a six-month chart in four-hour increments. You can note June 23 by the big volume surge about a sixth of the way in from the right. The etf, which has a different price than the futures contract for Brent, fell from 76 to 69 after the announcement.

An objection that goes unmentioned by the FT is the potential for insider trading that the IEA’s decision brought forth. Given that decision was the product of multilateral body, a lot of governments had to know the details of the forthcoming announcement, which caused (as FT noted) nearly a $10 short-term move in the Brent futures price, and some serious drift in the days preceding. I’m not alleging insider trading, but rather insisting that any decision with vast potential for insider trading must have some serious countervailing merits. The IEA’s original release had none.

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