No shock and awe after US-led emergency oil release

Oil prices rose after the US-coordinated release of emergency petroleum stocks was announced on Tuesday, as the volume of extra petroleum offered to the market proved smaller than traders anticipated.

The United States will make available 50 million barrels from the Strategic Petroleum Reserve (SPR), with deliveries beginning in mid-December and lasting through end-April 2022.

The release includes 18 million barrels of outright sales previously mandated by Congress as part of the budget, which will be accelerated, and 32 million barrels of new swaps, which must be replaced no later than September 2024.

The release "will be taken in parallel with other major energy consuming nations," including China, India, Japan, South Korea and the United Kingdom, the White House said in a statement.

India has announced it will release 5 million barrels. Britain will allow refiners and importers to reduce their inventories by up to 1.5 million barrels, on a voluntary basis.

Japan has indicated that it will release a few million barrels, though the amount has yet to be worked out. South Korea is discussing the details of its participation with the United States.

But China has so far been non-committal, with the foreign ministry saying only that it would "organise a release of crude oil from state reserves according to its own actual needs".

Unless China subsequently announces a very large draw down in its inventories, the global total is likely to be in the range of 60-75 million, far less than the 100 million barrels or more some in the market had expected.

As a result, spot prices and calendar spreads both rose after the announcement, reversing some of their downward trend since the start of the month.

Front-month Brent futures rose by more than $2.60 per barrel on Tuesday, the largest one-day increase for three months, consistent with the stock release being smaller than expected.

Brent's calendar spread for the six-months between January and July 2022 rose by more than 40 cents per barrel, implying traders expect oil supplies to remain tight next year.

SPR ANTICIPATION

Spot prices and especially spreads had been softening since the start of November, well before the release was formally announced. Some of this may have been in response to intensifying speculation about a future sale.

The White House is likely to claim this shows the effectiveness of the stock release by reversing traders' partially self-fulfilling expectations that spot prices and spreads would continue climbing.

But it is hard to disentangle the impact of speculation about a stock release from other factors weighing on oil prices.

By the start of October, portfolio managers had amassed an exceptionally large bullish position in petroleum futures and options contracts, especially in NYMEX WTI.

Lopsided positioning has often preceded a reversal in the previous price trend as hedge funds and other money managers realise some profits, which seems to have happened in this case.

The last month has also seen a seasonal resurgence in coronavirus infections in North America and Europe, with new lockdowns and other restrictions in some areas, which could curb growth in oil consumption.

Rising inflation has sharpened expectations the major central banks will have to start raising interest rates earlier than previously anticipated, which could additionally be negative for oil consumption next year.

At the same time, there has been an increasing amount of commentary about a rise in US shale production boosting global crude supply in 2022.

Even before the SPR announcement, hedge funds and other money managers sold the equivalent of 134 million barrels of petroleum futures and options in the six weeks between Oct. 5 and Nov. 16.

It is impossible to determine how many of these sales were in anticipation of the SPR announcement and how many were related to other changes in the consumption and production outlook.

But the most probable answer is that hedge fund sales were motivated by SPR anticipation, profit-taking, a deteriorating oil consumption outlook, and expectations for faster shale output growth in combination.

LESSONS FROM 2011

The last major coordinated stock release was announced in June 2011, when members of the International Energy Agency agreed to release 60 million barrels in response to the disruption of Libya's oil exports by civil war.

The release caused an immediate but modest fall in spot prices and a larger fall in spreads, though both had been falling before the announcement, and the further falls were wholly reversed within a few weeks.

Post-event analysis of the market reaction to the stock release in 2011 suggested several lessons that are applicable a decade later ("Market reaction to the IEA stock release: perception management", Reuters, Sept. 19, 2011).

(1) Stock releases have only a limited and short-term impact on prices and spreads. They may alter the trajectory of the market compared with a scenario in which no stocks are released but this is unclear.

(2) Stock releases take so long to organise that by the time they are announced prices are often falling as the worst of the sense of crisis was already passed.

(3) Oil traders are instinctively sceptical about the effectiveness of government intervention, especially using a finite stock of reserves to influence prices based on a continuous flow of production and consumption.

(4) Policymakers therefore need to have all the details of the release worked out in advance of the announcement to create a convincing narrative around intervention and maximise the psychological impact of reserve releases.

The White House appears to have learned some but not all of these lessons. US officials were ready to announce the detailed mechanics of SPR sales immediately on Tuesday.

But the lack of firm commitments from Japan, South Korea and especially China in the first 24 hours after the announcement has undermined the psychological impact international coordination was supposed to provide.

Ultimately, the confirmed release of less than 60 million barrels, with a vague unconfirmed promise of more, but still probably less than 75 million in total, was less than traders anticipated, causing prices and spreads to rebound higher.