July Oil Market Report assesses impact of IEA stock release

13 July 2011

This month provides a first detailed look at Oil Market Report projections for 2012, while also incorporating consolidated annual 2009/2010 oil data for non-OECD and OECD countries, respectively. | With higher underlying non-OECD demand (but persistent weakness in the OECD), and a string of 2011 supply-side outages, over and above the one in Libya, the market ledger this month looks slightly tighter than a month ago. Our balances for first-half 2011 show demand continuing to run ahead of supply, if a little less rapidly than in 2H10. Of course, upward price momentum has also come from the absence of 1.5 mb/d of light/sweet Libyan crude. The ‘call on OPEC crude and stock change’ is now 31.3 mb/d for 3Q11 (a significant, if as-yet unquantifiable, portion of this will come from the IEA’s Libya collective action). The ‘call’ then fluctuates between 29.8-31.4 mb/d through end-2012. Major producers have recognised that demand for their oil is rising, with the seasonal uptick in 3Q11 refinery runs, and more generally as economic growth and short-term fuel substitution keep global and emerging market demand growth robust. We welcome rising OPEC volumes seen in June (30.03 mb/d output), but the market needs still more oil for 3Q.

This backdrop is simply a more vivid version of the one underpinning the IEA action, which commenced on 23 June. Member governments agreed to release 60 mb of strategic stocks for an initial 30 days, amid an ongoing disruption to light-sweet Libyan oil supplies, the anticipated rise in 3Q11 refiner and end-user demand and a likely hiatus before incremental OPEC barrels reach the market. Much ink has been spilt subsequently suggesting that the IEA action comes three months too late, depletes emergency stockpiles and has failed to reduce rampant crude and motor fuel prices. However, we feel compelled to point out that critics cannot have their cake and eat it too.

Market intervention in late-February, when the Libyan crisis broke and prices surged by at least $10/bbl, would have been tempting, were price control really the prime motivation. But the presence of a supply disruption, and sharply higher prices is not, by itself, justification for a collective action. Market context is also important. Refiner crude demand was falling seasonally in March and April, but rising sharply in June and moving higher still in July and August, despite modest refining margins. Early-year industry stocks looked comfortable back in March, and there was a presumption then that other OPEC producers would immediately step in to boost supply to replace Libyan outages. In contrast, the absence up until June of major OPEC increases implied a real possibility that commercial stocks could fall to the bottom of their seasonal range, risking a renewed, damaging and sustained surge in international prices in 3Q11. The IEA therefore decided to act to address this supply-side issue, even though prices were then trending lower.

Moreover, the collective action is about providing short-term physical liquidity to the market: a combination of draws in strategic stocks of light-sweet crude and products and the added flexibility of reduced mandatory obligations for refiners. So far, the action involves just over 1% of total IEA inventory - hardly a depletion of reserves for future emergencies. That said, oil made available by the collective action will continue to have a physical impact through July and August. Market appetite for the oil made available so far has been greater than during the Katrina action of 2005. In particular, the US Strategic Petroleum Reserve (SPR) release will likely result in the re-routing of alternative light-sweet crude supplies into Europe and Asia. Member governments have flexibility on the timing and pace for any stock replenishment and look likely to exercise that. Indeed, all 12 IEA countries involved still have emergency reserves well above 90 days of net imports.

Marker crude prices fell by $5/bbl immediately after the action was announced. Since then Brent futures have oscillated between $105-$119/bbl, and WTI between $91-$99/bbl. At writing, flat prices of $116/bbl (Brent) and $95/bbl (WTI) are close to those seen immediately prior to the action, but will doubtless fluctuate further in the weeks ahead. However, it is blinkered to focus on specific price levels, which were never the rationale for the action. Narrower sweet-sour spreads, modestly stronger refining margins and an easing of the steep backwardation evident before the release on the other hand all suggest a more benevolent market reaction. We acknowledge that the impact of the collective action will only be truly evident in hindsight. However, recognising the flexibility and market liquidity it has already provided, we take a resolutely positive view so far.

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