Streetwise Professor

August 18, 2014

Wage Asymmetric Warfare: Unleash the SPR!

Filed under: Commodities,Economics,Energy,Military,Politics,Russia — The Professor @ 3:25 pm

The decline in the price of oil-Brent is down almost to $100/bbl, and Urals-Med is below that level-puts pressure on an already stressed Russian economy. And it especially puts pressure on a stressed Russian government budget, which balances at about $110+. What’s more, Russia is looking to replace private western funding with state support for its banks, and some corporations: recall my post yesterday which described how Sechin is panting after tens of billions of government money to replace western creditors. Further, Putin has made all sorts of promises, including lavish spending on the military and on infrastructure (e.g., a hugely expensive bridge over the Kerch Strait to Crimea). All of these add to the strains on the Russian budget.

Some of this is due to a weakening of the Russian economy for independent factors. Some of it is due to the sanctions.

The effectiveness of the sanctions could be enhanced by putting even further pressures on the Russian government. The most direct means of doing so would be through the price of oil, and short of persuading the Saudis to do a reprise of their 1986 act of flooding the market with oil, the best way to do that would be to release oil from the Strategic Petroleum Reserve.

Especially given the burst in US domestic oil production, the already weak case for maintaining a large reserve is even weaker. Moreover, since much of the oil in the SPR is Brent, and thus could presumably be exported, this would be a way of mitigating the distortions associated with the existing crude export ban.

The number of barrels that would actually flow to the market would presumably be somewhat lower than the amount released from the SPR, because some of the public storage would be replaced by private storage. (As I argued in 2011, this effect depends on market expectations regarding how the SPR would be used.) But the direction of the price effect is clear, and the price impact would not be trivial.

Putin is waging asymmetric war in Ukraine. (Though it is becoming less asymmetric, and more conventional, by the day.) Sanctions are an asymmetric form of warfare. A release of the SPR would be another asymmetric move that would impact Russia directly, and indirectly by enhancing the financial strains produced by the sanctions. There’s no substantive economic case for retaining the SPR at its current levels. Seems like an obvious move. Will Obama make it?

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  1. It has long seemed obvious that judiciously-timed SPR draws and builds would be a better means of controlling oil price, or oil price volatility, than position limits. Limits were invented to manage the price of wheat in the 1930s yet to my untutored eye the price of wheat doesn’t seem any less volatile than it was ~100 years ago.

    Manipulating positions isn’t working so why not manipulate actual supply instead? OPEC for one cannot possibly object with a straight face.

    Comment by Green as Grass — August 19, 2014 @ 2:24 am

  2. The US doesn’t need such a large strategic crude reserve, it’s true. It’s supposed to meet 90 days of net oil imports, which is about 215mn bl less than is currently in the caverns. It’s mostly sour — about 62pc — but that’s not the problem with using it as an economic weapon against Russia.

    You can’t export SPR oil. There’s the export ban, for starters. And even with a presidentially granted exemption, you’d be hard-pressed to load it on ships. SPR releases are meant to go to local refineries. Crude goes into pipelines or onto barges. There’s very little actual crude export infrastructure on the Texas and Louisiana coasts, and what there is is busy moving Eagle Ford crude round to the east coast or to eastern Canada.

    Releasing SPR crude will mostly affect US producers. That’s the lesson of the 5mn bl test sale earlier this year. US sour crude markets were much more depressed by the SPR release than Urals pricing was.

    And even if all these factors are overcome and there is a big price impact from an SPR release, Opec will respond. It’s their revenue that’s threatened too, after all.

    Also, I don’t get why the US needs to release SPR crude to reduce price volatility. Oil markets have not been this stable for this long in well over 40 years.

    Comment by Down With This Sort Of Thing — August 19, 2014 @ 5:22 am

  3. Position limits have been claimed to lower the price, and support the price, and make it less volatile, at various times. If, alternately, you drew down the SPR when prices rose and replenished it when they fell, you’d be using your reserves counter-cyclically against demand shocks to either side, which should reduce volatility, were that your goal.

    Comment by Green as Grass — August 19, 2014 @ 6:23 am

  4. as far as i know breakeven price for shale oil is 60-80 $, and those companies are heavily debt overburdened so oil release may put at risk them too

    Comment by erik — August 19, 2014 @ 7:50 am

  5. Are you sure that most of the SPR is Brent? That seems unlikely and therefore export is going to be restricted.

    You will also note that the SPR region is overflowing with oil, domestic, with imports being curtailed somewhat significantly over the last several years.

    If these two points are correct, then an SPR release will have more of an impact on WTI and WCS rather than Brent.

    You might also consider that an SPR release would have had more of an impact in a world without China and it’s growing energy demands.

    I think an SPR release considering these points is a weak option.

    Comment by tw — August 19, 2014 @ 1:39 pm

  6. @tw-I don’t know if “most” is Brent. I said “much is Brent,” and my source for that statement is this report on the SPR by the Senate Subcommittee on Investigations. Even though it is old, only a small portion of the oil that went into SPR back in the day has been removed, so I imagine that most of the Brent is still in there.

    My point re releasing oil that would be eligible for export is exactly responsive to your point re SPR region.

    China demand is what China demand is. That is a statement about the level of the demand curve, but what is relevant is its slope. The world demand curve for oil is downward sloping, and given the current level of Chinese demand, an increase in supply will reduce prices. Given the short run inelasticity of oil demand (on the order of 10), small changes in supply can have a large price impact.

    The ProfessorComment by The Professor — August 19, 2014 @ 8:59 pm

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