Oil Games: Why Redefining "Strategic" is Inevitably Bad for US Security

Oil Games: Why Redefining

Earlier this month, the US and its allies sent a muscular message to Iran over its nuclear program, committing to ever-crippling sanctions targeting its oil livelihood, even if it means dangerously high oil prices amid a particularly dangerous juncture for the world’s economic recovery.

“Looking ahead to the likelihood of further disruptions in oil sales and the expected increased demand over the coming months, we are monitoring the situation closely and stand ready to call upon the International Energy Agency to take appropriate action to ensure that the market is fully and timely supplied,” the G8 said in statement May 19.

While a politically attractive headline, the problem is that Washington-led Western powers are flirting with the futile and inevitably counterproductive tactic of releasing emergency reserves for an unprecedented second time in as many years.

America’s Strategic Petroleum Reserve, along with the IEA’s Response System, are meant as a last resort, not an oil piggy bank to hedge geopolitics against any one country. Stock releases “are designed to mitigate sudden oil supply shortages,” according to the IEA, but Western pressure on Iran’s oil industry is neither “sudden” nor should it spur “shortages,” especially because Iran still has plenty of clients.

“It’s an unwarranted interference in these circumstances. When you start messing with the strategic reserves to lower prices you end up with an egg in the face,” said Paul Stevens, senior energy research fellow in Chatham House. “The IEA is shooting itself in the foot. Its prime function is to observe oil markets and operate in an emergency, and by no stretch can this be considered an emergency, unless Israel does something stupid.”

Iranian exports fell a discreet 3 percent in April from the month before to 3.28 million barrels per day, according to Bloomberg. Meanwhile, US oil inventories are at a 21-year high and global commercial oil stocks continue to rise as Europe’s economic woes limit global demand, making any emergency stock release unjustifiable.

Considering the odds and what’s stake, it would be foolish for Obama to play this card. Tapping emergency reserves as part of a broader geopolitical standoff, even if its Iran’s nuclear program, would confirm big oil consumers have redefined how they use their emergency reserves, in effect undermining long term investment in the oil sector, increasing market volatility, and opening the door to market manipulation from big producers.

Any oil price relief, if any, would be short-lived because strategic reserves are not designed for long term supply constraints. If the calculation is purely for electoral motives, as many suspect of President Barack Obama, it could keep pump prices artificially contained for just enough time to win a reelection, but US security would be undermined in the long run.

More critically, drawing on reserves to offset an embargo would undermine the very purpose of emergency reserves in case of a real emergency, like a war with Iran.

“If these reserves are used to adjust prices, in case of a real emergency the stocks will be depleted. They will try to lower the prices for short term, but they lose this cushion, and God forbid that there is a war,” said Manouchehr Takin, senior upstream analyst in the Centre for Global Energy Studies, and an OPEC insider.

“There seems to be plenty of oil. I don’t think there is a need, and outlook is that more oil will come to the market,” Dr. Takin said.

Redefining strategic

The US convinced several countries last year to release oil stocks under coordination of the IEA to offset shut-in Libyan production of sweet crude. The price impact was muted in a question of weeks and the market only regained its balance with extra OPEC production and decreasing demand in rich countries.

Before that, the only other two releases were in the aftermath of the Katrina Hurricane, which shut a quarter of America’s oil output, and after the first Gulf War in 1991, in both cases obviously justified as “sudden” and also as a significant supply disruption. But it wasn’t used during the decade of sanctions that crippled Iraq’s output, nor had it ever been used against Iran.

Another emergency stock release would threaten the free-flow of oil, the pillar that keeps oil markets functioning, and one set by the US itself. It’s known as the Carter Doctrine and basically stipulates that the US will not tolerate political interference in oil markets.

It’s the only way to secure stable energy supplies and a market driven by supply and demand, not unstable politics. Those who threatened that, like Saddam Hussein, suffered the wrath of the US and global powers. Arab countries that first used oil as a weapon against Israel learned never to threaten markets again.

The unwritten rule though allowed invertors to know that no matter what wrangling global politicians were involved in, the market would not be interfered. War might break out, but the rules wouldn’t change. Obama is rewriting the rules, with yet uncertain consequences.

At stake is not just opening the door to market instability as traders try to filter out geopolitics from supply and demand. Iran is hiccup compared to what China and Russia will do to secure their oil interests. They do not look kindly, albeit for opposite motives, at what appears to be Western oil market manipulation.

The biggest risk of all lies with big oil producers, especially Saudi Arabia. The Kingdom does not want its role as unofficial market regulator threatened. It has oversupplied the market for months and stored supplies globally to sooth Western governments over market disruptions.

Riyadh is happy to see Iran’s influence curtailed, but like other major oil producers, it doesn’t benefit from the kind of market volatility that a stock release implies. “What confidence can producer have if they can’t trust the system?” Dr. Stevens asked.

“US and Western countries criticize OPEC for interfering in the market. OPEC says that they just want to protect their revenues. But in this case using strategic reserves [for political purposes] is interfering in the market,” Dr. Takin said. “And there are dangers. Interfering in oil market, other than a broad regulatory policy, this is not the job of governments.”

© 2013 Energy Tribune

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