Obama’s plan to release 30 million barrels of oil from America’s Strategic Petroleum Reserve (SPR) will likely sway the investment landscape in the next six months. As investors, our primary task is to assess the initiative’s likely impact on financial markets and navigate accordingly, even though we believe such a policy makes poor economic sense down the road.
Emerging market demand has been the main driver of high oil prices in recent years. The other factor propelling high oil prices is the US Federal Reserve’s lax monetary policy. In August 2010, oil was approximately USD $70; now, as the QE2 comes to an end, we see oil hovering around $95 a barrel. The perception of aggressive money printing has lifted investment demand for oil and other commodities.
Recent polls indicate that Obama’s approval ratings are slipping mainly because of economic issues. With his re-election looming, Obama desperately needs to deploy all available tools to reinvigorate the US economy. The Federal Reserve has invoked two rounds of quantitative easings (QE). With unemployment high and commodity prices surging, increasing doubt has been cast on the overall benefits of quantitative easings. Thus, it is politically difficult for Bernanke to initiate another round of QE, at least as long as the oil price stays above $80. The decision to supply the market with oil from the SPR may be an attempt to lower prices as a backdoor way to stimulate the economy, since other large fiscal programs are paralyzed by the gridlock in Washington.
This politically calculated action makes shrewd politics and should be positive for the financial markets near term, but its long-term consequences are decidedly more problematic.
• The 60 million barrels to be released from the IEA (including the US) represent 16 hours of global consumption. The news hit speculators in the oil market very hard but is hardly consequential in the bigger schemes of things.
• The Strategic Petroleum Reserve (SPR) holds 727 million barrels of oil, which are intended to be a buffer against emergency disruptions. The last two times the SPR was tapped was in 1990 during the Gulf War and in 2005 after Katrina. Deploying the SPR as a market intervention mechanism sets a disturbing precedent; should governments speculate and actively manipulate the price equilibrium of a commodity?
Distorting market signals encourages the uneconomical utilization of resources, defers price discovery, and may lead to even greater swings in prices when prices have to rise to reach equilibrium eventually.
Oil speculators are certainly playing a significant role in high oil prices. But releasing the SPR to deter speculation is counter-productive; it’s like attempting to kill a swarm of mosquitoes with a giant axe. Instead, regulators could achieve more efficient results by eliminating margin buying of commodities (decrease speculators' ability to wager with borrowed money) and restrict commodity-hoarding ETFs. Suppressing speculation will not fundamentally resolve the shortage of oil, but at least it will produce a more accurate gauge of real supply and demand.
• Another problematic scenario would be a continuation of the oil price’s uptrend in the future. Should more of the SPR be released to offset the ever-increasing demand? While the oil stockpile may seem enormous, it only amounts to eight days of global consumption (about 25 days of US consumption). The reserve is not an unlimited pool of oil. And at what point should governments abandon market intervention to preserve the strategic reserve? The market may then panic if it senses the governments will have to either ration oil or let the prices reach a higher undistorted equilibrium. Given the insatiable thirst for oil in emerging markets and declining production in aging “elephant oil fields,” the point of unsustainable market intervention may not be that remote.
• Oil is a global commodity and can be readily transported to different local markets. Artificially suppressing the oil price will give exporting countries a chance to redeem their US treasuries and convert them to their own petroleum reserve at a lower price. This could be a marvelous opportunity for China to fill up its SPR in Dalian and Zhoushan.
Sporadic market interventions are no substitute for a long-term and coherent energy policy.