SPR

April 18, 2022

Limiting Oil Price Increases: Supply and Demand Side Measures

Oil Price Increases

Brent crude price increased from $81.75/barrel (b) on 7 January 2022 to a peak of $127/b on 8 March 2022.  It fell to about $101.07/b on 6 April 2022 following the news of supply side measures such as release of crude from Strategic Petroleum Reserves (SPR) in developed countries.  Brent crude prices on 6 April 2022 were over 50 percent higher than prices in April 2021. Though post pandemic recovery is among reasons for growth in oil demand, oil price increases have been driven mostly by sanctions on Russian oil imports since March 2022. Russia is the third largest oil producer and the largest exporter. Its exports of about 5 million barrels/day (mb/d) of crude representing roughly 12 percent of global trade.  Russia also exports approximately 2.85 mb/d of petroleum products that represents around 15 percent of global refined product trade. Around 60 percent of Russia’s oil exports go to Europe and another 20 percent to China. In 2021, imports from Russia accounted for 8 percent of all US petroleum imports, consisting of 3 percent share of crude oil imports and 20 percent share of petroleum product imports.

The increases in prices are being felt everywhere. Even though crude prices are yet to hit levels seen in 2008, currency exchange rates along with taxes imposed on petroleum products have taken the retail price of petroleum products to record high levels.  According to the IEA (International Energy Agency), monthly spending on oil products for transport and heating increased by more than $40 per household (nearly 35 percent) in developed countries and by nearly $20 per household (nearly 55 percent) in developing countries.  In the United States, where increase in retail price of petrol affects political sentiment strongly, the average retail price of petrol has increased from less than $2.5/gallon (₹50.13/litre) in January 2021 to more than $4/per gallon (about ₹80.21/litre) in March 2022.  In India the retail price of petrol has crossed the psychological barrier ₹100/litre in many parts of the country sparking protests.   

Supply Side Measures

Increase in supply is one of the many means to address the problem of high oil prices.  Coordinated release of SPR by developed countries that have the largest reserves, increase in supply from OPEC (oil producing and exporting countries), increase in supply from non-OPEC countries, increase in supply from Iran following relief from sanctions are among supply side measures that are being considered. On 1 March 2022, 31 member countries of the IEA agreed to release 60 million barrels of oil from their emergency reserves to send a message to global oil markets that there will be no shortfall in supplies as a result of the sanctions on Russia. In the last week of March 2022, the United States announced that it will release 1 mb/d of crude oil from the SPR from May 2022 that will continue for six months totalling 180 million barrels.  Following the announcement of SPR release from the USA, Brent crude futures for May, fell by about $5.54/b or 4.8 percent $107.91 a barrel. The IEA members agreed to release 120 mb/d of SPR crude on 7April 2022. This will include 60 mb/d of crude from the release of 180 mb/d announced by the US earlier.  In total IEA member countries and the USA will release 240 mb/d of their SPRs. 

The announcement of the US SPR release, described as the biggest in history, was made on the same day OPEC decided to increase production by 400,000 b/d.  But given that OPEC decisions are informed more by geopolitical concerns than by market fundamentals it is unlikely that OPEC will increase supply substantially.  Moreover it is not certain that OPEC countries have spare capacity to ramp up production as most have not been able to meet existing targets. If sanctions against Iran are relaxed there is a possibility that it can make a significant contribution to supply later in the year.  There is also the possibility of increase in oil production from US shale plays but so far, the expectation that oil production from US shale producers can be ramped up and down rapidly depending on market forces has proved to be inaccurate.     

Demand Side Measures

In response to the increase in oil prices, the IEA has come out with a ten-point recommendation to reduce oil demand in advanced economies that account for 45 percent of oil demand. The recommendations are (1) reduce driving speed on highways by 10km/h (2) work from home for up to 3 days (3) make Sundays car free (4) use cheaper public transport (5) reduce traffic by alternating between odd and even number plated vehicles (6) increase car sharing (7) increase efficiency of freight transport (8) encourage faster adoption of electric vehicles (9) avoid business travel (10) use highspeed overnight trains instead of planes.  

According to the IEA, these ten measures, if implemented successfully, will reduce oil demand by 2.7 mb/d within 4 months and reduce the pressure on oil prices.  The long-term objective of this programme is to engineer structural decline in oil demand that will put advanced countries on a secure path to net-zero.

Challenges

While both oil supply increase and oil demand decrease are necessary to address the problem of high oil prices, they are not as straightforward to implement as they sound.  Announcement of SPR release may not always result in decreasing the price of crude oil.  Following the announcement by the IEA that 2mb/d of oil will be released over 30 days on 1 March 2022, the price of Brent crude increased by 4 percent from $101.06/b to $104.97/b reflecting concerns over the size of the release as well as doubts over  the capacity to release crude as stated.  In November 2021, the US government announced release of 50 mb/d of crude from mid-December, but crude prices increased by $11.2/b or 15 percent and the US released only 20 mb/d of crude. Analytical studies show that the effect of SPR release on prices have been modest. The cumulative effect of the SPR releases after the invasion of Kuwait in 1990 was a reduction of $2/b in the real price of oil after 7 months. Even if there is a reduction in oil prices in the short term, SPR release tend to increase the real price of oil in the longer term.  SPR drawdowns contribute to higher demand expectations and higher price in the longer term when reserves are replenished. Studies on the Chinese domestic oil market response show that the effects of the SPR on suppressing domestic oil price are small in all scenarios. Focussing on the demand side of the market could be counterproductive to efforts of reviving the global economy after the pandemic.  The IEA recommendations are addressed to OECD (organisation for economic cooperation and development) countries but accelerated growth in non-OECD countries that account for 54 percent of oil demand may offset the effect of a decrease in oil consumption in OECD countries.  The IEA recommendation to shift mobility to efficient alternatives, if successful, will depress industries such as aviation contributing to job losses. As demonstrated by the pandemic, national economies may not want to pay the price of job losses to keep oil prices down.  Loss of tax revenue from oil consumption may also affect government spending plans in OECD countries that collect substantial revenue from high taxes on oil consumption.  History shows that curbs on oil demand are rarely popular and increase in supply take time.  In the short term, there are few solutions to the problem of high oil prices that do not upset lifestyles for the rich and livelihoods for the poor. 

Source: International Energy Agency

October 9, 2015

The Problem of Plenty – International

Lydia Powell and Akhilesh Sati, Observer Research Foundation

Last week we observed that the problem of plenty is playing out differently in the domestic and international contexts. In the domestic context the problem of plenty was partly a consequence of insufficient demand but in the international context it is clearly a problem of excess supply, especially of oil and gas. But low oil prices which are often quoted as the cure for low oil prices is having an impact on supply.

Though the physical oil market continued to show signs of weakness (too much oil) the financial or the paper market appeared volatile with large shifts in short and long positions. It appears that no one is sure how long the least efficient shale drillers in the US will last in an environment of low oil prices. According to the Financial Times, US shale drillers ran a deficit of $32 billion in the first half of 2015 equal to the entire deficit of the sector for 2014. This was followed by news from energy information & analysis (EIA) of the US that there was a meaningful reduction in US oil output. In September US production was about 9.13 million barrels per day (b/d), a 500,000 b/d reduction in output from peak production levels. The reduction in supply from the US was equal to the total output from a small country like Libya. This reduction was in spite of an increase production of conventional crude from the Gulf of Mexico. A reduction in supply is expected from other non-OPEC producers as well.  According to the international energy agency (IEA) non-OPEC oil production is expected to fall by 500,000 b/d by 2016, the sharpest drop in the last 25 years.

Crude Oil and LNG Prices

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Source: Bloomberg

The unexpected stability of low oil prices led Goldman Sachs to predict (around mid September) that oil prices would drop to $20/bbl. But how reliable are Goldman predictions? Goldman predicted that oil prices would touch $250/bbl in 2009. The average price for crude in 2009 was about $56/bbl.

Oversupply is changing the industry in many ways. According to data from Baker Hughes the number of drilling rigs in the US has fallen by over 1100 since October 2014. Over supply and low prices has also led to a decline in investment in the sector. Moody’s said in a recent report that oil companies can expect a decline of $ 80 billion in cash flow. A Wood McKenzie report said that $ 1.5 trillion worth oil and gas projects faced the risk of a cash crunch. The report also said that only 10-11 upstream projects will be completed as opposed 50-60 which was the norm.

Gas Production and Consumption- USA

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Source: Bloomberg

While the ‘market’ is pushing towards the logical response of reducing supply, non market forces seem to be working in the opposite direction. Among the many non market forces are China ‘energy security’ driven filling up its 600,000 million barrel Strategic Petroleum Reserves (SPR) and Russia’s geo-politics driven pumping of 10.74 million b/d which is a post Soviet record. Analysts are speculating a downward pressure on prices when China eventually winds up its SPR filling. They are also speculating on the impact of talks between Saudi Arabia and Russia on prices. Some think that Russia is colluding with weak OPEC members against the strong ones such as Saudi Arabia to cut production to increase prices.  Overall no one is sure how this complicated game that mixes geo-politics with economics will play out.

The issue of US crude oil exports continued to be debated but the commercial incentive to export crude is no longer strong. Crude oil exports from the US would have made sense (for the US companies) when WTI traded at a discount to Brent but now the discount is so small that crude exports look uninteresting commercially.  But geopolitical and strategic analysts always have a view that runs counter to market views. According to them export of crude and gas from the USA will put down Putin and also reduce the clout of other energy tyrants in the Middle East.

Moving on to the European continent, North Sea oil producers were said to be facing an existential crisis.  Though there have been spending cuts across the world in the oil & gas sector, the off shore oil sector has been particularly vulnerable as this sector has some of the highest costs in the world. Many of the fields are in decline and require constant injection of capital. Some are said to be facing the risk of shutting down. As many companies share infrastructure if one shuts down others may also have to shut down. The downturn in oil prices also contributed to Shell shelving its arctic drilling plans. The project had also suffered a set-back from disappointing geological results.

Crude Oil Future Trading ($/bbl)

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Source: Bloomberg

There was also news on China moving towards establishing an oil price bench mark in October that could become the most important after WTI and Brent. Given that China is the biggest oil importer (and India the third largest) it makes sense to have an Asian index but as the Chinese index is to be priced in Yuan and not dollars it may take time to gain acceptance.

There was news of the problem of plenty in the LNG sector as well. According to a new report by Wood Mackenzie most US LNG projects totalling about 60 million tonnes (mt) of capacity are moving ahead. G2 LNG a new US company is said to be planning a new LNG export terminal specifically targeting countries with which US does not have a free trade agreement. The new LNG capacity in the US will add to the 140 mt capacity that is being constructed globally. Projects under construction alone can double existing LNG capacity in the next one or two years.

The glut in the gas market has led to economic and political changes. Encouraged by falling prices and growing supplies Japanese buyers are said to be refusing to sign contracts with destination clauses (contracts that prevent reselling). India’s Petronet is lifting only 70 percent of contracted capacity from Qatar and is paying about $8/mmBtu which is 36 per cent less than the contracted price. On the political side, abundant supplies have encouraged the EU to impose market manipulation charges on Russia’s Gazprom. Russia has also been pushed to settle gas prices with Ukraine.

Gas Futures Trading

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Source: Bloomberg

The problem of plenty was also behind depressing commercial news on falling value of energy companies and the prospect of distressed companies putting themselves up for sale and growing prospect of consolidation in the offshore services business. Among key mergers, takeovers and impending takeovers were Shell’s takeover of British Gas (which has been approved by the EU), GE’s purchase of the power equipment business of Alstom, Oil Search’s rejection of Woodside’s bid, GE emerging as contender for Halliburton’s assets, Total’s sale of its oil sands assets to Suncor and so on. A shakeout is generally good for the sector in the long term but not necessarily in the short term, especially for those who are likely to lose their jobs.

September brought some good news (or perhaps bad news in an environment of plenty) on a major gas discovery in Egypt. According to ENI which discovered the field, it is a supergiant with over 30 trillion cubic feet of gas. This piece of good news for Egypt and ENI may be really bad news for Israel and Nobel energy as they had expected Egypt to the biggest customer for the gas from their giant gas field Leviathan.

On the non hydrocarbon sector the media was engrossed with news on renewable energy which is understandable given that countries are vying for the largest renewable energy share title in Paris later this year. China was said to be planning for a nationwide carbon cap and trade by 2017 which is something that India should watch. One last bit of non hydrocarbon news in September was that Chinese companies may be building nuclear plants in the UK. For China bashers this is not necessarily good news!

Views are those of the authors                    

Authors can be contacted at lydia@orfonline.org, akhileshs@orfonline.org

Courtesy: Energy News Monitor | Volume XII; Issue 17