The Oil Blundercrats: President Obama and the IEA

[bluhn-der-krat]

-noun

1. An official, who in attempting to appease the left works without exercising intelligent judgment, thereby harming or jeopardizing national interest through the implementation of a series of self-serving policies that ultimately result in gross, stupid, and careless political mistakes .

A great man once declared that “[t]ruth will rise above falsehood as oil above water,” this maxim held for a long time and even penetrated Capitol Hill and Pennsylvania Avenue. But the people wanted ‘change’ simply for the sake of change. And now the declaration reads: “truth will be mixed with falsehood, as oil with ethanol.”

President Obama’s decision to release 30 million barrels of Strategic Petroleum Reserve (SPR) this month qualifies him as one of the great energy blundercrats in modern American history. The administration’s justification for the release of these critical barrels of crude, which are in reserve for emergency and war purposes only, seems simple but is really insidious. According to the administration, the ‘market’ is desperate for the light sweet crude that Libya would have exported. Which market, to be clear? Well, not the United States, because Libyan crude is exported almost exclusively to Europe. But nevertheless, more world crude supply should translate to lower product prices. Unless of course it does not. As one Senior Administration official said, not to worry, because our price-meddling heroes will just tap SPR again:

“At the end of the first 30 days of action by the IEA member, we will review the results…the U.S. stands ready to do more if necessary to address this issue.”

The president now considers himself a one-man market maker armed with 727 million barrels of taxpayer oil and he is not afraid to use them in an election cycle. On a dip, he can draw his bureaucratic paw and say “see what I did to control the price at the pump, p.s. available for hire in 2012”. This of course is supposed to be music to the ears of the uninformed and the unemployed. Gasoline prices had already declined ten percent from the start of the driving season, but only because the economy is a disaster.

Putting aside the moral issue of the president trashing administrative and market precedent like a stack of leftover ribs, it is better to go through the (de)merits of this policy at an economic and geopolitical level. It is likely much worse than you first imagined.

The world requires 88 million barrels of oil each day to function. Approximately 60 million barrels of this demand is for gasoline, diesel, and jet fuel – anything related to transportation. In essence what the total IEA SPR release of 60 million barrels comes down to for the world’s refineries is the equivalent of one day of global transportation demand. Not very prudent.

The rationale given by the IEA is that the MENA disruption has caused a supply shortage that can be made whole by this release. If that were true, then someone at the IEA doesn’t own a calculator. Libya had a total production on average of 1.5 million barrels per day. Libyan production has been off-line since February. This would put the world at a deficit (through May) of 132 million barrels. If the OECD refineries were experiencing serious supply tightness, we would expect stock draws of close to that much. Yet OECD crude and product draws are down only 8.3 million barrels during that timeframe, and are sitting about on par with the five year average. In this Libyan instance of supply disruption, the price mechanism has worked as the regulator. In any case, Libyan supply isn’t coming back anytime soon, to continue to offer to fill this deficit with SPR is not do-able in the long-run.

There’s so much more to be annoyed about. The details of the SPR sale can be pieced together from the “Apparently Successful Offers Report“, released by the Department of Energy (DOE) on June 23rd. Valero came out as the largest single winner at 6.1 million barrels of crude, which for them amounts to less that one week of throughput. Most importantly, it appears that 25 of the 30.6 million barrels of offers are going to be delivered by vessel rather than by pipeline. Translation: the vast majority of the 25 million barrels of SPR crude are probably not going to be refined into gasoline at home, but shipped overseas as price would naturally dictate. Chinese SPR, anyone?

However, deciphering the SPR purchase price is like playing the ‘Price is Right’ for oil nerds. The SPR report lists prices paid, but they are not quite accurate and must be masterfully rearranged. The deal was that oil was to be sold on a differential basis to a Light Louisiana Sweet (LLS) price, and that price was to be established during a five-day window around the time of delivery. The reason the price of SPR oil is based on LLS and not West Texas Intermediate (WTI) is two-fold. Most of the country’s refining is located in PADD III (Gulf Coast). Refiners work with the LLS price and this price ultimately determines product prices and crack spreads. Secondly, it would have been the LLS-Brent spread that determined the demand from bidders at the sale.

The weighted average price reported by the SPR office was $107.20/bbl, about $1.30/bbl less the closing price of LLS on June 30th. The five-day average price between June 15th and June 21st (weekends excluded) was $112.78/bbl. The price in the “Apparently Successful Offers Report” is the successful differential, applied to this base price of $112.78/bbl. The weighted average differential versus LLS to be paid for SPR crude is thus $107.20 – $112.78/bbl or -$5.58/bbl. This means the lowest winning bid was $7.80/bbl under LLS, and the highest bid was $3.02/bbl under LLS. To put it simply, if all the oil moved versus the June 30th LLS price of $108.50/bbl, the weighted average purchase price across all barrels sold would be $102.92/bbl, not the inflated DOE price of $107.20/bbl. By now it should be clear that neither can the IEA or the DOE do math but that they sold 30 million barrels of emergency crude at an average discount of $US5.58/bbl.

Discounted premium crude is the binary opposite result of what one would expect of a market suffering from a drastic emergency. The fact that both the Brent and WTI forward curves are in contango at the front end, only further prove the point.

Furthermore, the timing of this release could not have been more ill-conceived. In theory the IEA effort was supposed to go along side with the Saudi’s planned increase of 1 million barrels a day. The Saudi’s made this decision in the wake of a cantankerous OPEC meeting that resulted in a formal decision to leave production quotas unchanged. As an astute observer of Saudi calculus, this much of a production hike seems unlikely now. Given the IEA’s new found propensity to use taxpayer oil to replenish market deficits, why would the Saudi’s ramp up production to the highest level in over two decades? Not only could this lower total Saudi net revenues but it would also surely ruffle OPEC feathers. The president brilliantly agreed to offer up SPR right before the Saudi’s were about to relieve the market potentially long-term production.

Lastly, it would be interesting to know what the president and DOE economists think will happen to crude and gasoline prices when the government has to buy back the SPR? There was another declaration also written in the 17th century: “to every action there is always an equal and opposite reaction.”

Blundercrats.

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