Answering the call
The market was screaming for action and the International Energy Agency acted. Despite the critics of the surprise release of 60 million barrels by the US and the other 27 members of oil consuming nation’s oil from the International Energy Agency, the truth is they made the right move. It was clear that if you listened to what the market was saying it was telling you quite clearly that the combination of sub-par North Sea production and the war in the Middle East was causing a serious enough disruption to warrant some help from the International Energy Agency.
The market, as judged by the record breaking spread of Brent Crude over the West Texas Intermediate, showed the refining market was broken and the International Energy Agency was correct in trying to fix it. This is one of the reasons that strategic reserves are there and that is to make up for major disruptions of supply by things like acts of God and by acts of war. Not to mention that as the IEA says disruptions that undermine the fragile global economic recovery.
Believe it or not this move was just not done to move price but to replace lost supply due to a major disruption because of war. This is a disruption that constrained the supply of light sweet crude that was causing a major headache not only in Europe but was starting to impact supply in the United States. East coast supplies into New York harbor have been falling, causing a spike in gas prices and impacting US consumers as Brent crude started to spin out of control.
While oil supply in the US is at the highest level since 1980, because of the war in Libya, supplies in Europe are at a five year low. Every day that Libya is off line 1.5 million barrels of high quality crude from the marketplace. Don’t get thrown off by the argument that 60 million barrels is not enough to make a difference because it would just about cover US demand for the weekend, this is about quality not quantity.
While Saudi Arabia is pumping the most oil they have in 30 years to try to fill the void, the quality of their crude is not going to help the European refiners that can’t refine the sour crude the Saudis are putting out there. The truth is that an influx of light sweet crude into the market place could bridge the gap until North Sea production can get caught up. This should not only beef up supply on the East Coast of the United States, but also Europe as well.
Now don’t get me wrong, I am not in favor of using our reserve for political purposes to try to manipulate price just for the sake of price but, when there is clear evidence that a disruption caused by a war or other external factors like a war, then that is a legitimate reason to tap into our reserve. On top of that there is a precedent for what they did. The IEA moved to replace supply after Iraq invaded Kuwait, so disruptions because of war are a legitimate reason for a release. The other time there was a release was when the IEA released oil in 2005 after hurricane Katrina when Europe came to our aid in the aftermath of the storm's devastation.
The other misnomer is that this oil was just US supply, yet according to the agreement with the IEA, we set aside supply for global disruptions. The IEA says that member countries use three approaches to meet their stockholding obligations: Industry stocks, government stocks and agency stocks. Most countries use a combination of these. Nineteen member country governments require certain companies to hold a minimum amount of compulsory stocks, related to the size of the companies’ respective operations. Nine member countries directly own government oil stocks, typically financed through the central government budget and held exclusively for emergency purposes. In 12 IEA member countries, governments or industry have established a separate agency to hold all or part of the stocks. The structure of these agencies varies but, in all cases, compulsory stocks can only be released with government authorization.
Now this ridiculous notion that this was done to send a message to speculators is ridiculous. This is not about price but about supply. Oil prices were already under pressure due to weak data in China and the US and flashing red lights in Europe! No I am not talking about another IMF type scandal but European Central Bank President Jean-Claude Trichet saying that risk signals for financial stability in the euro area are flashing “red” as the debt crisis threatens to infect banks across Europe and the world.
Yet not to worry because according to a Reuters report Greece reached an agreement with EU/IMF inspectors on a five-year austerity plan. Keep moving, nothing to see here. But perhaps a large reason for the weak moves in commodities and weak stocks is the end of QE2. The training wheels are coming off and we will see a period of adjustment as the QE2 stimulus goes away. We will see a stronger dollar and weaker markets as the short sellers won’t worry about having to fight the fundamentals and the Fed.
Phil Flynn is senior energy analyst for PFGBest Research and a Fox Business Network contributor. He can be reached at (800) 935-6487 or at pflynn@pfgbest.com.
