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The Best Science Writing Online 2012
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As Libya's civil war continues to disrupt its contribution to the world's oil supply, the Paris-based International Energy Agency (IEA) has taken action. The IEA, which counts the U.S. among its members, announced on June 23 that it will release 60 million barrels of oil from various governments' strategic reserves, spread out over a 30-day period. The U.S. Department of Energy is supplying 30 million barrels, half the total amount, from its 727-million-barrel Strategic Petroleum Reserve (SPR).
This release marks the third time that the IEA has opened its oil reserves in response to crises. The others occurred at the beginning of the Persian Gulf War in 1991 and the aftermath of Hurricanes Katrina and Rita in 2005.
Unlike those occasions, this release comes several months after the beginning of the crisis that necessitated it. In addition, it may have other motives than taking up the Libyan slack. The decision not only comes in the midst of a market downturn, reflecting worries about the sustainability and pace of the economic recovery, but it also follows an early June OPEC (Organization of Petroleum Exporting Countries) meeting that failed to reach a consensus about increasing the world oil supply.
Experts suggest that releasing the oil into the market could drive down prices and boost the shaky economy. How would this work? After all, 60 million barrels may seem like a large volume, but it's not enough to supply one full day of the world's oil demands. Scientific American asked Jim Burkhard, the managing director of IHS Cambridge Energy Research Associates' Global Oil Group, to explain. Under Burkhard's leadership, the group analyzes the market for the oil and gas industry.
[An edited transcript of the interview follows.]
What's the purpose of the oil reserves?
The purpose of the Strategic Petroleum Reserve is to help the U.S. economy deal with a large disruption in oil supply. The SPR was created in the mid-1970s following the oil embargo of 1973, which exposed the vulnerability of both the world and U.S. economies to a severe disruption of oil. The SPR is an insurance policy to help manage any large-scale disruption.
How does what we're gaining from the reserves compare with what we're losing from Libya, whose civil war began in February?
Before the civil war Libya was exporting about 1.2 million barrels per day, so the amount of oil that's part of this release—it's 60 million barrels by all IEA members, 30 million by the U.S.—doesn't compensate for all of the oil that's been lost because of the civil war in Libya. But it is nonetheless a significant amount, at least in the time window in which the release will occur. The plan is for it to be over 30 days, which would mean two million barrels per day for a month, which, at least for that time period, would temporarily increase global oil supply by about 2 to 2.5 percent.
Do you think that the release is going to lower gas prices?
Oil prices were already on a downward trend in mid-June, but they did fall further following the IEA's June 23 announcement. But keep in mind the oil market is influenced by a vast array of factors—power shortages in China, agricultural policy in India, the weather in northern Europe—many factors shape the price of oil, so attributing too much importance on any single factor can be a bit misleading. What we can say is that, at least immediately following the announcement, it did lower prices. But whether that's sustained is a big question mark.
So do you think that its value might be more symbolic?
It does have symbolic value, it does have impact on oil market psychology, because prices for any commodity are shaped by future expectations. What do we think future economic growth will be? What do we think will be the pace of automobile ownership in China? Our future expectations play a big role in determining how much we're going to pay for something today, whether it's a barrel of oil, a car or a house. What this decision signaled is that the members of the IEA are willing, at least in this instance, to use government-controlled oil reserves, even if there's not a massive large-scale oil disruption.
What constitutes a large-scale disruption?
When it was formed, the IEA defined a large-scale disruption as removing 7.5 percent of world oil supply. So Libya falls short of that metric, but it is nonetheless a significant disruption.
Will opening up the Strategic Petroleum Reserve when it's not a large-scale disruption have implications for its future use?
Let me take a step back for a second. This release does come after several months of a significant disruption. It also comes at a time when the outlooks for the global economy and the U.S. economy have deteriorated. So this release could also be viewed as a sort of economic stimulus. There aren't too many tools left in the tool kit to stimulate the economy. Most stimulus measures around the world are either being wound down or removed. If oil prices were to fall because of this release, that would be like a tax cut for consumers, which could in effect act as a stimulus. That is, if this is successful at driving down oil prices in a sustained way.
Now, your question: There's been no statement made that this is a definitive change in policy. Again, the raison d'etre of the SPR in the U.S. is as an insurance policy against a large scale-disruption. If it were instead to be used on a regular basis to try to influence prices, that would likely, over time, diminish the capability of the reserve to deal with a large-scale disruption.
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11 Comments
Add CommentThe the most significant reason for the change in policy on the use of the SPR has been overlooked by Jim Burkhard. This change in policy creates much more uncertainty for commodity speculators and commodity index investors (e.g. S&P GSCI). Speculators and index investors are typically long, not short, in their commodity positions. This additional SPR factor raises fear that they might be crushed by an SPR release. This fear will continue long after the 30-day period of releasing reserves is over. This can also go in the opposite direction of increasing reserves. The additional counter-balancing factor in the market serves to disrupt price momentum. This will happen simply based on expectations of a possible SPR release (or purchase). It was a great move that should lower the amount of speculation.
Reply | Report Abuse | Link to thisIf memory serves me correctly, the times that the SPR has been tapped in the past, the oil had to be replaced, which took that amount off the market, as well as costing a premium also. This seem to me a rather dumb move, considering that the difference in price paid on the oil then vs now. Also, to replace the same amount today, will still reduce that amount in the market place. I might add, the Saudi's have said that if the U.S. goes ahead and sides with Israel against the Palestinians gaining statehood in the U.N. in September, that the oil supply will be cut back. That will result is less oil in the market, higher prices, which considering the budget situation in the U.S., doesn't bode well for the taxpayer. In essence, a very dumb idea, except for those who finance this deal.
Reply | Report Abuse | Link to thisThe SPR (as well as the Fed) is an inherent money making machine. The average price for the SPR is $29.79/bbl. The SPR never pays a premium. This is because it has very long horizon (effectively infinite) and it primary objective is not personal profit. It would be very unlikely that the 30 million barrels are replaced at a higher cost (especially if adjusted for inflation).
Reply | Report Abuse | Link to thisI guess perhaps I'm in the twilight zone here, but perhaps you can show where the price of oil @ $29.79/bbl comes from? That wasn't the story that was told the good citizens of the U.S. while P.O.T.U.S. Bush # 2 was in office. As far as adjusting for inflation, that's a smoke screen, for perhaps that's what the price is that the KABUKI will be paid, but to replace it, will be many times that price.
Reply | Report Abuse | Link to thisCurrent inventory is 726.6 million barrels. Total invested to date is about $22 billion ($5 billion for facilities; $17 billion for crude oil).
Reply | Report Abuse | Link to thishttp://www.fossil.energy.gov/programs/reserves/spr/spr-facts.html
Front month contract today for Nymex WTI is $95.24. What makes you think that if they sell it at approximately $95/bbl, they will have to buy it back at more than $95/bbl?
Why is inflation a smoke screen? The SPR was created in 1975. Are you trying to say that $1 in 1975 had the same purchasing power as a $1 today? Or that $1 today will be worth the same as $1 in 2025? That $22 billion is a real asset and could have been used for something else. To ignore inflation is ridiculous.
The Strategic Reserve was created to be used in case of crises. The only crisis here is for Obama's re-election chances.
Reply | Report Abuse | Link to thisIf they sell for $95.00 a bbl today, but don't replenish that sold amount until say 6 months afterward, the price could be $130.00 then, so are you saying that the replacement price will be the same $95.00 to replace, while the going market price is $135.00? As for the inflation figure, well, "KABUKI" is in the cards. Besides, in 1975, oil cost more than $1.00 a bbl. But we can quibble over that one if you want, though we both know it's a non starter.
Reply | Report Abuse | Link to thisSorry for the mistake, the replenish price should read $130.00, not $135.00. Old oil eyes.
Reply | Report Abuse | Link to thisNo, they buy and sell at the market (they actually auction it). The price could be $65/bbl in 6 months, then they made $30/bbl. If the price was $130 in 6 months, I doubt they would replace the oil at that time.
Reply | Report Abuse | Link to thisI did not say oil cost $1 in 1975. Can you multiple? What cost $1 in 1975 would cost $4.20 in 2011. The average price of crude oil in 1975 was $12.21/bbl. Adjusted for inflation that would be equivalent to $51.28/bbl today. (multiple 12.21 by 4.20)
I guess I don't know math, even though I'm a retired oil company engineer. So tell me, what was the price of oil that Bush sold, and what was the price paid to replace, during his time in office? Did the U.S. reap a bonanza? Did they lose money? Do we even know how much was removed or how much was replaced? Also, which of the Oil companies have the ability to remove & replace the oil? You seem to be knowledgeable in this, so I assume the answer is available.
Reply | Report Abuse | Link to thisAgreed!
Reply | Report Abuse | Link to thisWhile the article emphasizes the release of oil reserves coordinated by the IEA, the American government alone, during the Clinton Administration, used the occasional release of limited amounts of oil reserves for the same purposes, to very good effect. The refusal of the Bush Administration to release reserves of oil to fight speculation in oil was compounded by their insistence on actually building the oil reserves during times of artificial upward price movement.