When one of the world’s biggest producers announces its official selling price (OSP) the market pays attention. Asian refiners, the key market for Saudi Arabia, have been offered cargoes at a steep discount for next month compared to September. It might be taken as an admission that the latest round of the coronavirus and supply chain bottlenecks are having a palpable impact on oil demand and comes just a few days after the OPEC+ producer group agreed to up its production level by 400,000 bpd until the end of the year.
The deep cut in Saudi OSP and the aftershock of Friday’s disappointing US job data that strengthened the dollar yesterday were enough to put bulls on the backfoot. Under these circumstances a daily loss of 40 cents/bbl in an otherwise quiet session due to US Labor Day can be viewed as quite an achievement. The question now is how long the Delta variant will weigh on demand forecasts. The good news is that Chinese exports expanded at an unexpected pace in August and crude oil imports also rose month-on-month. The market is shaking off the Monday blues.
Additional hint about the oil balance will come tomorrow in the form of the Short-Term Energy Outlook from the EIA. The view here is that solid global oil demand growth estimates (ie no downward revision) will encourage buyers once again as it would imply that global and OECD oil inventories are likely to be depleted, at least for the next few months, even with the anticipated increase in OPEC+ output. Under this scenario the highs of July could come into focus soon.
The role of SPR
Extreme weather conditions cause serious disruptions in the US and especially in the main oil hub, the Gulf of Mexico on a more frequent basis than before. Although the previous US president would dismiss the voices of those who blame the adverse conditions on climate change and would label it as Chinese hoax, the fact of the matter is that supply disruptions, both crude oil and products, are becoming the part of everyday life. We are in the middle of the hurricane season and the state of Louisiana, including its oil sector, is still recovering from the devastation caused by Ida. The hurricane shut in almost 2 mbpd of crude oil production and more than 2 mbpd of refining capacity. Earlier this year the Texas freeze that came in the form of three severe winter storms also caused a major power crisis and knocked out energy infrastructure. In the middle of February domestic crude oil production fell from 11 mbpd to 9.7 mbpd and refinery utilization in PADD 3 more than halved in the space of two weeks and bottomed out at 40.9% during the week ending February 26.
The detrimental impact of extreme weather on oil supply can be and is mitigated by using government-controlled emergency stocks, the Strategic Petroleum Reserve (SPR). Ever since the creation of the IEA, after the 1973 oil crisis, one of the primary roles of the agency has been to ensure energy security in case of natural disasters, technical problems or political events that threaten supply. Member countries, more or less the OECD part of the world, are required to hold emergency stocks equivalent to at least 90 days of net oil imports of the previous year. In case of unexpected supply disruptions member countries can decide to use emergency stocks to alleviate the negative affect of a particular event.
With the rise of domestic oil output from 5 mbpd in 2008 to 12.3 mbpd in 2019 the US dependence on foreign oil has been drastically reduced. No surprise then that the biggest oil consumer of the world that needed as much as 12.5 mbpd of foreign crude oil and products 16 years ago on a net basis is now turning net exporter. Last year combined crude oil and product exports stood at 651,000 bpd and year-to-date the country imported a little over 400,000 bpd of foreign oil.
In other words, the US would be required to hold a minimal volume of oil in emergency stocks, if any, strictly based on IEA requirements. The country, however, manages a vast strategic inventory, precisely for events that took place in February or two weeks ago. The US SPR is the worlds’ largest of its kind and was created to reduce the impact of unforeseen disruptions that my occur. Oil stocks are owned by the federal government and are stored in salt caverns at four different sites along the Gulf of Mexico.
The US government uses the SPR in a variety of forms. Emergency drawdowns take place when oil facilities are significantly damaged, just like in 2005, after Hurricane Katrina. The emergency drawdown in 2011 was a coordinated release of a total of 60 million bbls from IEA members in the wake of the Libyan supply disturbance. SPR can also be used, just like last week, for exchange deals. The Department of Energy loaned 1.5 million bbls of crude oil to Exxon Mobil and 300,000 bbls to Placid Refining Company to ensure adequate oil supply. These loans will have to be paid back in kind at a later date, usually with interest. Test sales are also conducted by using SPR and so are non-emergency transactions. The latter category covers mandated sales, the latest example of which is the release of 58 million bbls of SPR oil over eight consecutive years that started in the financial year of 2018 to finance infrastructure projects.
A prominent and unique feature of the US SPR is that it only contains crude oil. As a comparison, in OECD Europe products make up more than 50% of government-controlled stocks. On one hand it is understandable as 30-40 years ago the country was forced prepare for crude oil shortage as imports from traditional Middle East suppliers might have become volatile and unreliable in case of a rise in geopolitical tension. Crude oil is also cheaper to buy and store than products. The winds of changes, however, started to blow when US dependence on foreign oil shrank. It has been laid bare by Hurricane Ida, which caused an equal if not bigger damage to product supply than to crude oil production. Consequently, the impact of the weather-related acts of God might be better managed if the US held products, as well as crude oil in emergency stocks.