IEA's Big Mistake

Jim Brown
 
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On Thursday the IEA, manager of oil supplies and statistics for 28 nations, announced they were releasing 60 million barrels of crude oil from strategic reserves. The USA would provide 30 million of those barrels. This could go down in history as a turning point in IEA history.

The International Energy Agency (IEA) announced they would release two million barrels per day for thirty days in an effort to shore up tightening supplies from the loss of production in Libya. The reserves would come from multiple countries and be drawn from the 1.5 billion barrels currently in reserve in the 28 IEA countries.

Reportedly the reserve release was decided upon after high-level discussions with Saudi Arabia. After the OPEC meeting failed to change the output quotas Saudi, Kuwait and the UAE said they would immediately increase crude production by a total of 1.5 million barrels per day over the coming months in order to offset the expected 1.5 mbpd production shortfall in the third quarter. Oil demand increases in the summer and fall thanks to summer driving and the use of oil to generate electricity in places like Saudi Arabia in order to run air conditioners in the sweltering hot summer temperatures. Saudi Arabia alone is expected to burn as much as one million additional barrels per day to generate electricity for cooling. This is a temporary three month demand period but it is still demand.

Saudi can pump its own oil to burn for electricity. In theory it has the additional capacity to produce up to 12.5 mbpd. That theory has never been tested until now. In May Saudi claimed it produced 8.8 mbpd and would boost that to 10.0 mbpd in July. On the surface that sounds like a significant increase but after subtracting their additional demand of up to 1.0 mbpd for electricity the actual amount of new oil to market is a very small 200,000 bpd. Add in Kuwait and the UAE, which are expected to increase production by possibly as much as 200,000 bpd and the net gain for the market was only 400,000 bpd despite all the bluster and big promises.

I am sure the "high-level" discussions with Saudi covered what additional oil would (could) actually be produced and of what flavor. In the initial Saudi comments after the OPEC meeting they said the extra oil would be sour crude and be sold to China where EPA rules are less stringent. China's demand has increased by something on the order of 800,000 bpd since the same period in 2010.

The IEA ran the numbers and saw a shortfall of light sweet crude. Libya's missing 1.6 mbpd of oil production is light sweet crude. There are no other countries other than the U.S., Canada and Brazil with any material new production of light crude. In every other country the supply is dwindling so the loss from Libya is serious. The IEA believes some production will be resumed once Qaddafi is gone but that as much as 1.0 mbpd may not be back online until 2015. Nigeria has some excess light capacity but they are constantly suffering outages from terrorist attacks and work stoppages. The situation is so bad the international companies like Shell are attempting to sell their operations in Nigeria to avoid the problems. A successful sale will only make matters worse because companies in Nigeria currently bidding on the assets don't have the expertise to grow operations.

The IEA has been warning for months of the impending shortage in world production in Q3. Nobody has been listening. They repeatedly begged OPEC to increase production to head off high prices. OPEC refused either because they did not want to push prices lower or because they don't really have any excess capacity that does not belong to Saudi, Kuwait and the UAE.

The IEA saw the impending collision of increased demand meeting insufficient supply and panicked. You have to wonder just how much information Saudi Arabia actually gave the IEA to push the group to make such a big decision. The IEA really can't fix the problem. This is only a band-aid on a wound that will eventually fester and become infected. Oil supplies are declining, OPEC does not have the excess capacity it claims and global demand is growing.

The 60 million barrels is a drop in the proverbial bucket. With Libya offline for going on 120 days now the lost production is approaching 180 million barrels. A loss of 1.5 mbpd is 45 million barrels per month. If the IEA replaces that production in July then what happens in September and October and all the months after that? If Qaddafi does leave and by some miracle they get 500,000 bpd back online over the next twelve months will the IEA continue to release 30 million barrels every month for the next three years? Not only NO but hell NO!

The IEA has screwed up big time. They panicked not over the impending tightness in oil supplies but over the expectations for higher fuel prices as a result of that shortage pushing the global economy back into recession. They have warned about this for months. They are very afraid high prices this close to the 2008 recession could produce a lasting decline in the global economy.

Unfortunately they panicked. They probably saw a greater sense of urgency because they are the keeper of the statistics about future oil supply and demand. They know what is coming and they are doing whatever they can to impart a sense of urgency to the world governments. I believe they hope that by forcing a drawdown in strategic supplies they can force governments to take action to reduce future demand or to increase future production. This release is kind of a Chicken Little moment for the IEA. They have been warning for months of the impending problem and nobody listened. They had to shock the world by releasing strategic oil in hopes of producing some changes.

I believe this was the wrong way to accomplish this warning. What they have done is set a dangerous precedent. When this 60 million barrels is gone and the shortage still exists are they going to release another 60 million? I seriously doubt it BUT nations around the world will expect them to take action. They released oil to push prices lower in June, why not do it again in August, September, etc?

The answer is simple. They are releasing oil from "strategic reserves" that has been stored up over several decades to be available to the host country in times of war or national emergency. Why would these countries continue to see the reserves they worked so hard to build released so that Europe can have lower fuel prices?

I can see everyone agreeing this time due to the urgency in the IEA's voice. However, next time it will be more difficult to convince them to part with their personal reserves. These are not IEA reserves. These are reserves held by Canada, U.S., Germany, France, etc for their own use in an emergency. $115 Brent crude is NOT an emergency. It is a fact of life that was brought on by supply and demand imbalances.

Regardless of what happens in Libya these imbalances are only going to become more common until they become permanent as little as 12-18 months from now. Prices are going back up relatively soon and the poor nations will be looking at the IEA for help in lowering prices again.

We need to look at this as a political move as much as a reaction to supply imbalances. Higher fuel prices were pushing up inflation and slowing growth all around the world. The U.S. saw a sharp decline in activity in May when gasoline prices neared $4. This is an election cycle and the IEA, although it is a group of 28 nations, is basically a U.S. lapdog. If the U.S. says jump the IEA would ask how high.

Critics have blasted president Obama for using the IEA in this manner or allowing the IEA to distribute strategic reserves to lower prices. Candidate Obama objected to President Bush releasing the oil from the SPR after hurricane Katrina in 2005 because the oil was for emergencies not for price manipulation. Now that his reelection campaign is in full swing I guess his mind was changed.

The U.S. does not need the oil. Only three weeks ago the crude inventories in the U.S. were at 373 million barrels and a three-year high. They were only about 10 million barrels away from a multi-decade high. There is a glut of oil in the U.S. and absolutely no reason to add to it with oil from the SPR. The president should have known this but he acted anyway.

It is possible for buyers to charter tankers and arrange for SPR oil to be delivered to a coastal port where they can fill up for the long drive to some refinery in Europe. It would be time consuming and expensive but entirely possible. It is not very likely. It will be very interesting to see how many barrels of SPR oil are actually dispersed in July.

The U.S. SPR has 727 million barrels of oil with about one third light sweet and two thirds sour. If they do take the oil they will want the sweet and that will reduce our strategic supplies of sweet by more than 10%. The average cost of the oil in the SPR is $23.40 per barrel. Do you think the voters will be glad to see our oil going to Europe so their gasoline prices will be lower?

There are actually some other countries trying to build up their strategic reserves today because they perceive some tough times ahead. India is adding 40 million barrels to their reserves by 2012. China is constantly adding to their reserves with a target of 500 million additional barrels by 2020. Since the released SPR oil is available to anyone who wants it, we could actually see another country taking SPR oil and putting it in their own reserves. Odds are slim but definitely nothing preventing it.

Another problem for the IEA is the message they sent to OPEC. Some believe it was an offensive use of the SPR barrels to push prices lower in the wake of an OPEC meeting that held quotas level. While that may be the case it may also prompt OPEC countries that don't specifically like the U.S. and its IEA allies to reduce production to prevent prices from declining. OPEC knows their oil reserves are limited. Within decades they will no longer have enough production to export. It is in their best interest to limit production increases and maintain a slow and steady pace. Unfortunately inside OPEC countries oil demand is growing more rapidly than even demand in China. They have to measure exports against budgetary requirements and internal demand. They may elect to let the IEA supply a few more barrels while limiting their own exports to maintain the price.

The IEA is moving down a slippery slope because the amount of oil they can convince member nations to release is limited. That is why they are called "strategic" reserves. These are not excess reserves or a piggy bank that can be tapped when the money is needed. These are for wars, catastrophes, etc and the IEA will find itself talking to a brick wall very quickly if they try to repeat this price rescue again.

The IEA release is the equivalent to 16 hours of global demand. It is the drop in the proverbial bucket. The Shell CEO reminded the world on Friday that the EIA has predicted a -330,000 bpd drop in oil production from the Gulf of Mexico in 2012 thanks to the permit halt and nine rigs leaving the Gulf. That equates to another 120 million barrels of lost production in 2012. I doubt the IEA is going to request the other 27 nations to release another 120 million barrels of oil because the U.S. leaders halted drilling just as global demand began to increase sharply. If President Obama really wanted to see lower gasoline prices he should have allowed the permits and let those 50,000 people go back to work rather than sending the crews to Brazil and Africa. Instead he was afraid of another Horizon disaster on his watch and the damage to his reelection hopes.

If you have any doubt about the approach of peak oil the results of the last week should have changed your mind. When Saudi Arabia's excess capacity claims appear to be evaporating and 8 of the 12 OPEC countries adamant about not (or can't) producing any more oil the end result is clear. The end of cheap oil is rapidly approaching and the IEA can't do anything but muddy the water to slow it down.

Enjoy the cheap gasoline while you can because without another global recession preventing demand exceeding supply, the collision between demand and supply will be here before we know it. The U.S. military believes there will be significant shortages by the end of 2012 and the shortages could grow to as much as 10 mbpd by the end of 2015. How will that affect your driving habits?

Jim Brown

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