Crude Bucks Efforts by the IEA to Tame Prices

July 11, 2011

The Wall Street Journal

CAROLYN CUI

Oil is back on the upswing, flying in the face of international efforts to keep prices low.

After an initial drop, crude-oil futures are back above the levels seen before the International Energy Agency in late June announced a plan to release 60 million barrels of oil from emergency stockpiles, ending Friday at $96.20 a barrel on the New York Mercantile Exchange. The U.S. will release 30.6 million barrels toward that total.

That futures contract is up more than 6% from the lows hit after the announcement. U.S. gasoline futures prices are up 11%, suggesting more pain at the pump in the weeks ahead.

The rebound in Brent crude, a European benchmark, has been even steeper. Brent futures are up 13% from the lows. Last week alone, they surged almost 6%.

Investors have overlooked the added oil and focused instead on expectations that relentless demand for oil, especially from consumers such as China, will continue to drive prices higher as the global economy recovers. Several Wall Street banks have raised their price targets for oil, arguing the IEA move won't alleviate long-term supply worries. The gains underscore how little control governments have over oil prices, and financial markets in general.

This is the third time the IEA has coordinated the release of strategic reserves among its member nations. The move was widely viewed by analysts as an alternative form of "quantitative easing," aiming to drive down oil prices and prop up the economy, although the Paris-based energy watchdog for industrialized nations said the decision was mainly driven by the loss of Libyan production and an anticipated uptick in seasonal demand from refiners.

Traders were initially concerned the additional supplies could swamp the market and send prices to a prolonged slump, as seen in the previous emergency releases.

IEA members had released oil in 1991 after Iraq invaded Kuwait, causing prices to drop more than 30% in a single day and then stay muted for years. In 2005, strategic reserves were tapped again to quench the supply shortage after Hurricane Katrina hit the Gulf of Mexico, and it took four months for prices to come back.

This time, the downdraft lasted three trading days.

"Whatever is causing buoyancy in the financial markets is causing people to think demand for oil in the future will be greater than they might have thought," says John Shages, who oversaw the U.S. Strategic Petroleum Reserve, or SPR, program from 2004 to 2007. He currently runs the Washington, D.C.-based Strategic Petroleum Consulting, advising private clients on SPR issues.

The rebound has been so swift that it sparked talk about the possibility of another coordinated release of oil. IEA member nations have more than four billion barrels of crude oil and products. More barrels would put even greater weight on prices. Both the White House and the IEA have said they could release more from strategic stockpiles if the market remains tight. "Traders are assuming this is a one-off thing, but they might be wrong about that," says Mr. Shages.

Goldman Sachs analysts last week reiterated their view prices for Brent crude would rise, targeting $130 a barrel over the next 12 months. Brent ended Friday at $118.33. Analysts at J.P. Morgan Chase raised their forecast for Brent oil 5% to average $112 a barrel this year and increased the price target for U.S. benchmark oil to $98 from $93.

The release of emergency stockpiles won't significantly affect the global balance between supply and demand, and "oil demand growth fueled by moderate [economic] growth expectations will be sufficient to draw down crude oil inventories," which will pressure prices upward, Goldman Sachs analysts wrote in a research note.

The U.S. Department of Energy's Strategic Petroleum Reserve on Monday is expected to confirm the winners among the banks and companies that bid for the oil in an auction. J.P. Morgan and Barclays were two financial firms among the successful bidders in a preliminary result, according to the DOE. Financial institutions often act on behalf of their refining clients who don't have the facilities to accommodate the delivery.

Details of the SPR sale that have already emerged suggest that the crude won't be converted into useful products like gasoline and diesel as quickly as originally thought. More than 80% of will be loaded onto barges and other vessels, according to the preliminary results of the auction, indicating some of the crude will be held in storage for some time.

With U.S. commercial oil inventories hovering around all-time highs, some oil traders may want to store the SPR oil at sea, a maneuver that gives them the flexibility to sell the oil later.

Some say there may be an aftershock in oil markets when the crude is actually released—most likely in August. That is when traders could begin to see the additional oil show up in the Department of Energy's weekly petroleum inventory reports. The 30.6 million barrels of crude oil from U.S. reserves is roughly equivalent to 9% of the U.S.'s commercial stockpiles.

"You will see a secondary effect when the physical barrels arrive," said Lawrence Eagles, global head of oil research at J.P. Morgan.

The U.S. has the world's largest emergency oil stockpile. Created in 1973 as a result of the Arab energy crisis, the reserve consists of 727 million barrels of oil in deep underground salt-dome caverns in Texas and Louisiana—enough to meet the nation's consumption for about 35 days. Still, even a continued campaign of releasing oil by the U.S. and the rest of the IEA is likely to have its limits says Harry Tchilinguirian, head of commodity market strategy at BNP Paribas. Unlike the Federal Reserve's quantitative-easing plan, which also had mixed success, "you cannot print oil," he says.

<- Go Back