Date: 11/29/2021
Author: Kent Moors, Ph.D.
A few days ago, I made my latest live appearance on the Chinese Global Television Network (CGTN). There are two intriguing elements each time I appear on CGTN. First, the interview occurs between 7 and 8 in the evening US Eastern time. That means it appears in Beijing and Shanghai (with voice over translation) shortly before their markets open.
Second, they provide me with between 8 and 9 minutes of solo time for a more extended conversation. That’s more than I get with any other outlet anywhere. Of interest, the second longest time span I receive is from RTV and CTC, nationwide Russian networks from Moscow (usually 6 to 7 minutes).
This time the discussion flowed from the Biden Administration’s announcement to release 50 million barrels of oil from the US Strategic Petroleum Reserve (SPR) in concert with other main end user countries including China, South Korea, Japan, and the UK. All told, the aggregate amount to be released may reach 70 million barrels.
The SPR encompasses what is now in excess of 605 million barrels of crude located in four primary underground locations. It was set up by Congress after the Arab Oil Embargo in 1973-74 resulted in long lines at US gas stations and a spiking of prices.
The likelihood of a similar embargo these days is virtually zero. For some time, this has become an international oil market where crude exports can no longer be used as a political weapon. Still, the SPR has proven very useful in balancing the domestic American market.
We generally think that SPR releases occur only as a result of a major crisis. Actually, there are three classifications of approved moves out of the reserves usually made to redress regional shortfalls of product. The last several releases from the SPR occurred in response to a lack of distillate fuel in the Northeast. Other releases have followed reductions in normal supplies following natural disasters.
SPR can also move into the US market as a result of some other unusual market or geopolitical event. This is the catchall category initially meant to offset foreign embargos or war. But given that American refineries are no longer dependent upon imports, this has become the domain for domestic political moves like the current one.
The intent is to push prices of refined oil products (especially gasoline and diesel) down by providing more raw material. After all, as I have remarked on several occasions over the past decade and half, gasoline (both its availability and its price) votes.
In the current example, this is an all too transparent attempt to meet one of the main ingredients in rising inflation, now at the highest levels in over thirty years. After all, with supply chain disruptions meaning just about everything associated with the holidays is going to be costing more, it would seem a good idea to reduce the price of driving to shop for all of that.
But this is a cosmetic reaction at best. The attempt will not have any lasting effect. Given what is underway in the energy markets thanks to new variants of COVID, there are now other ways that oil prices will be capped. Unfortunately, those are likely to have negative effects on the very post-pandemic recovery necessary to bring economies back into rhythm.
There are basic reasons why the SPR release will fail. One is the aggregate of no more than 70 million tons of oil likely to be released by the collection of nations amounts to little more than half a day of global demand. My demand estimate is a bit lower than those of the International Energy Agency (IEA) or the US Energy Information Administration (EIA). Still, my global demand figure comes in at slightly more than 104 million barrels a day.
Another shortfall is that the amount will be released over several weeks. The US 50 million, for example, will not be available for 13 to 14 days after the decision is made. There is a similar time delay for other nations involved in the move.
However, the most important reason reminds me of the last time I was personally dealing with this matter. That was in 2011, the Obama Administration was releasing a smaller volume from the SPR in league with a consortium of 26 other countries. The issue then was rising prices coming from lower overall crude supply in the international market. That, in turn, was resulting from a civil war in Libya.
At the time, I was in Athens advising the Greek Finance Ministry in the depths of a debt crisis. A part of that was processing information surfacing that derivative paper cut on Greek debt was being used as collateral in European-based crude oil futures contracts.
I was pressed into commenting on the impending Obama SPR release while at the same time trying to avoid being drawn into a widening Greek political mess. After all, I was not there to blame some paper cutters on the Continent for the depths of a financial morass largely of Greece’s own making. Unfortunately, the minister I was advising threatened to do so at a press conference anyway with a statement that began “As we have just been advised by Dr. Moors…”
So much for my global reputation.
I dodged the bullet, but what I reminded the media about then still holds now. It is the single biggest impediment to using reserve releases as a main weapon against rising oil prices and the single most misunderstood element in the pricing process.
It is all about how crude oil prices are set. This involves the difference between futures contracts (or “paper” barrels) and the genuine oil commodity in trade (the “wet” barrels).
Normally on any given day, there are far more paper than wet barrels in trade. That is because the future contracts are entered into as an investment. The holder seeks to make money on the difference between what she paid for the contract and what it commands when it is sold prior to expiration. The holder has no interest in owning the underlying oil itself.
Meanwhile, the wet barrel involves real oil being bought made available to real end users in the market. As the expiration of the futures contract (that is, as the date for the sale of the physical oil) approaches, market players on both sides will utilize a series of options and other derivatives to arbitrage the two prices (paper and wet) so that they converge on the sale date. The more volatile the market environment, the more difficult the arbitrage becomes.
Most of the setting of oil prices, on the other hand, is a function of the paper barrel (the futures contract). And that results in the maker of that contract having to be especially attuned to where the price of the underlying oil is going. She will also utilize options to hedge against possible losses should the underlying price swing more than expected.
Here is the key to why SPR releases will have only very short-term and marginal impact. The released volume from reserves is factored in on the supply side when the cutter of the futures contract determines the target price of the contract.
The trader will normally price a contract pegged to the expected cost of the next available barrel. If the supply/demand dynamic is moving prices up, the trader will emphasize the pricing spread to the expected cost of the most expensive next available barrel (since that is the direction in which the greatest threat to her profits is moving) and set a contract strike price accordingly. Should the trend be in the other direction, the trader weighs more heavily toward the least expensive next available barrel. Once again, call and put options are used to narrow possible losses.
The important point – in today’s discussion of how SPR releases impact market price as well as my discussion of what happened in 2011 – is this. As soon as an SPR release is made it is no longer an outside force on market dynamics (as a threat of the release had been). It is now part of the volume on the physical supply side itself.
For the SPR to have a longer impact, there must be recurring releases. Otherwise, the trader reverts to the earlier contract formula used, ignoring the SPR altogether. The reliance on reserves does nothing to change the underlying pricing mechanisms in the market. It simply introduces an artificial outlier that disappears as soon as there is an end to the release(s).
As a symbolic gesture, an SPR release may reveal a government’s resolve. But as a genuine tool for reversing the price witnessed at the pump, it is a nonstarter.
Dr. Kent Moors
This is an installment of Classified Intelligence Brief, your guide to what’s really happening behind the headlines… and how to profit from it. Dr. Kent Moors served the United States for 30 years as one of the most highly decorated intelligence operatives alive today (including THREE Presidential commendations).
After moving through the inner circles of royalty, oligarchs, billionaires, and the uber-rich, he discovered some of the most important secrets regarding finance, geo-politics, and business. As a result, he built one of the most impressive rolodexes in the world. His insights and network of contacts took him from a Vietnam veteran to becoming one of the globe’s most sought after consultants, with clients including six of the largest energy companies and the United States government.
Now, Dr. Moors is sharing his proprietary research every week…knowledge filtered through his decades as an internationally recognized professor and scholar, intelligence operative, business consultant, investor, and geo-political “troubleshooter.” This publication is designed to give you an insider’s view of what is really happening on the geo-political stage.
You can sign up for FREE to Classified Intelligence Brief and begin receiving insights from Dr. Moors and his team immediately.
Just click here – https://classifiedintelligencebrief.com/
