Failure at the IEA

Jim Brown
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On June 23rd, the International Energy Agency (IEA) and the US government announced the intention to tap strategic petroleum reserves (SPRs) of the US and other countries, with an eye to reducing oil prices. Were they right or wrong in their actions?

The following is a reprint of an article posted on ASPO by Steven Kopits. I am reprinting it here in its entirety followed by my comments.

Failure and Heroism at the IEA
By Steven Kopits

On June 23rd, the International Energy Agency (IEA) and the US government announced the intention to tap strategic petroleum reserves (SPRs) of the US and other countries, with an eye to reducing oil prices. The US was to provide 30 million barrels (mb) and other countries a similar amount, for a total draw of 60 million barrels.

The market responded sharply, with oil prices falling nearly $6 / barrel within a day or two; the intervention appeared effective. But it was not too be. Within a week, oil prices had recovered the pre-announcement price. They are even higher now. The market simply absorbed and discounted the news.

Brent Oil Chart

What went wrong? In the end, both scale and tactics proved inadequate. Sixty million barrels sounds like a large volume, but represents only 16 hours of global consumption. Further, 30 million barrels represented only 4% of the US SPR, and 60 mb is less than 2% of OECD commercial inventories. Indeed, OECD inventories had varied by 60 million barrels or more at least five times in the last seventeen months. Thus, nearly a third of the time, OECD inventories will naturally vary by as much as the proposed IEA injection. In short, the IEA program was simply not large enough to sustainably move the market.

Nor were tactics appropriate. There was no attempt to talk down the oil prices prior to announcing the program. And by announcing a fixed volume over a fixed period, the IEA removed all uncertainty for oil traders. Finally, without the prospect for sustained increases in oil production following the SPR draws, the effect of the program would clearly be finite. Thus, oil traders simply needed to do the math to calculate that the intervention was no big deal.

As a consequence, the IEA initiative has been judged a failure by the media and many within the oil business itself; it failed to appreciably reduce oil prices over a longer time period.

But in many ways, the IEA's initiative was heroic. The IEA has, over the last two years, consistently warned of the harmful impact of high oil prices, and indeed, current prices appear to be heavily implicated in recent softness in the US economy. But rather than merely wringing its hands in despair, the IEA set out to do something about it.

The result was the SPR draw. While clearly lacking in heft or nuance, the initiative nevertheless accomplished some critical goals. First, it achieved a consensus that intervention was warranted, and with it, that oil prices are actually material to the performance of the economy. This may seem obvious to some, but I find that, when I lecture on the subject, many still see the Great Recession as a purely financial crisis, not as the hybrid financial/oil crisis that the data suggest it was. Therefore, the IEA has advanced awareness of the impact of oil on the economy, and this itself represents progress.

Second, the IEA achieved some sort of consensus among a number of countries that coordinated action was both desirable and feasible. Given the difficulty the advanced economies had in reaching consensus on, say, Libya, the consensus to use the SPRs represents no mean feat. That is a huge accomplishment, however inelegant the outcome may have been in practice.

In creating consensus, the IEA will have also laid some institutional framework for decision-making. The necessary individuals to analyze and approve SPR withdrawals were designated and contacted. Thus, even if the SPR topic is radioactive for a while, the outlines of a coordinating body have been drawn. In institutional terms, this is commendable progress, and to my mind, the single greatest achievement of the IEA's efforts.

And we have also learned about the limitations of an SPR intervention. Without scale and the promise of follow-through, an SPR program will be unable to move the market for long. For now, the IEA may go to nurse its wounds, but this topic will be back. We expect continued high oil prices to hammer the Democrats in the 2012 elections, with an aggressive Republican energy policy emerging in the 113th Congress. But even the Republicans will have little time. Our analysis suggests that oil shocks will be possible as frequently as every three years. Thus, by 2014, the Republicans may well be facing the same oil pressures we see today. And if so, they'll be looking for creative solutions. Deploying the SPR will be back on the table, except this time "we'll do it smart."

So the IEA can afford some perspective. In the media and political arena, it may well have lost this skirmish. But we face a longer war. The IEA has laid the foundations for engaging the oil issue, and can rest confident that its efforts will pay off over time.

Steven Kopits
Mr. Kopits heads the New York office of Douglas-Westwood, energy business consultants

I don't agree entirely with Mr Kopits. I believe the IEA actions were flawed simply because they should not be attempting to influence price using a weapon with limited ammo. The IEA announced a release of 60 million barrels. OPEC produces 30 million barrels per day. If OPEC wanted to play hardball they could simply reduce production a couple million barrels per day and over the next month they would eliminate any impact from the IEA release.

Do you really want to get into a fight when the other side has an unlimited amount of ammo? The IEA is limited in what they can release. Already several countries have said they would not participate in any future releases. Those countries actually releasing crude are faced with the potential of having to replace it at even higher prices. Instead of forcing a fundamental shift in crude pricing the dip was short lived and now that traders see the flack the IEA received they understand there probably won't be another release. Prices are rising again and most analysts are still expecting $120-$130 Brent by year end. This is a money losing deal for any country that participated.

Lastly, do we really want to make OPEC mad? Their fragile coalition was fraying at the edges before the announcement and the IEA move could be just what they needed to stiffen their resolve over future quotas.

The strategic petroleum reserves were never meant to be used as a price tool. They are "strategic" and meant to be used in times of war or national emergency. Prices don't qualify as an emergency.

The IEA gun is the equivalent of a revolver while the OPEC weapon is a machine gun with unlimited ammo. That is not a fight I would want to be in.

Jim Brown

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