LONDON, April 1 (Reuters) – US President Joe Biden has pledged to make available an average of 1 million barrels a day of crude oil from the Strategic Petroleum Reserve (SPR) over the next six months, after consulting other IEA members.
The unprecedented release of 180 million barrels is expected to ease supply concerns and contain upward pressure on prices following Russia’s invasion of Ukraine and the imposition of sanctions in response.
The stock release is intended to “serve as a bridge until the end of the year when domestic production ramps up,” according to a White House statement on Thursday.
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Proceeds from the sale will be used to replenish the SPR over the coming years and ensure it remains available for future emergencies (“President Biden’s plan to response to Putin’s price rise at the pump,” White House, March 31).
It aims to ease upward pressure on spot prices by increasing the amount of oil immediately available, while supporting long-dated futures contracts and encouraging further drilling by promising to buy back the oil later.
In fact, the White House has committed to a gigantic spread trade of 180 million barrels to allay fears of a sudden drop in oil exports from Russia as a result of the war or sanctions.
REDUCING THE SPREAD
In recent weeks, traders have attempted to “buy” the calendar spread by buying futures contracts with nearby delivery dates and (in some cases) selling longer-delivery contracts.
As a result, prices for short-term futures contracts have risen much faster than those expiring later in 2022 and 2023 as traders anticipate a sudden shortage of crude oil, heavy oil and diesel exports from Russia.
Brent futures for June 2022 delivery were up almost $41 a barrel (54%) through March 25 compared to the end of 2021, while futures for December 2023 delivery were up just $19 (27%) over the same period were.
Brent calendar six-month spread hit a record backwardation of more than $21 in early March and was still trading with backwardation of more than $18 late last week.
Intense upward pressure on short-dated futures contracts has spread along the supply chain, helping to push up retail prices for gasoline and diesel.
(Chart book: https://tmsnrt.rs/3iYeHmd)
The White House plan uses the SPR to take the other side of the trade, “selling” the spread by selling physical oil on the spot market with a promise to buy it back later.
The main influence should therefore be on the calendar spreads themselves, mainly via prices of futures contracts that are closest to delivery.
Following the SPR announcement, the six-month Brent calendar spread has already narrowed to $9 backwardation, which is still an all-time high but the lowest since the invasion of Russia in late February.
The spread between June and July futures contracts has halved to less than $2 a barrel from a peak of over $4 early last month.
Committed SPR sales should ease concerns about a physical oil shortage and alleviate some of the recent illiquidity in futures markets by creating a de facto willing counterparty for traders betting on higher oil prices.
VOLATILITY MANAGEMENT
Prior to this week’s announcement, President Biden had already ordered the release of 32 million barrels of crude oil from the SPR in November 2021, with oil to be replaced between 2022 and 2024.
Previous sales have been in response to the Libyan Civil War (30 million barrels), Hurricane Katrina (11 million barrels) and the first US-Iraq War (17 million barrels), on other occasions with smaller volumes.
But the current release dwarfs previous ones and implies that the purpose of the reserve is changing from compensating for physical shortages to managing prices (“Historical SPR Oil Releases and Exchanges”, US Department of Energy).
Governments have always maintained stocks of food and other necessities to ensure supplies to vulnerable urban populations and armed forces, to respond to famine and other catastrophic supply disruptions, and to control prices.
The SPR was formed in the 1970s in response to the Arab oil embargo and its primary purpose was to maintain military readiness and manage risks arising from supply disruptions and physical shortages.
But the SPR is becoming more like China’s National Food and Strategic Reserves Administration, which has military and strategic functions but also routinely buys and sells stocks to smooth out excessive price swings.
The National Food and Strategic Reserves Administration draws on an earlier tradition of “always normal” and other granaries maintained by the Qing and Song dynasties.
Ever-normal granaries bought and sold grain on a regular basis to smooth out price fluctuations from season to season and year to year and to respond to shortages and famines.
In recent years, China’s reserve administration has also bought and sold oil, industrial metals and soft commodities with the express intention of reducing excessive volatility.
The Reserve Bank has bought commodities during economic downturns to support prices and pressure producers — then sold them during booms to try to cool rising prices.
The increasing frequency and extent with which the SPR is being used strongly suggests that its function is evolving in a similar fashion.
Refilling everyone’s granaries was always controversial, more difficult than emptying as it tended to drive up prices and could prove unpopular with consumers.
Ordinary granaries were typically filled at harvest time when grain was in abundance, and especially after a bumper harvest when prices were low.
Ordinary granaries often went through cycles of depletion and refilling that could last for years or even decades (“Nourish the people: the state civil granary system in China 1650-1850”, Will and Wong, 1991).
The White House has said it intends to replenish the SPR in the coming years – when prices are likely to be lower than they are now.
Assuming the promise is kept, the ideal time to replenish the reserve is during the next oil market downturn, when the SPR would not be competing with consumers for scarce barrels, purchases could help support prices and the support local producers.
If this is the case, the SPR has become a de facto price risk manager.
John Kemp is a market analyst at Reuters. The views expressed are his own
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Adaptation of Louise Heavens
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