U.S. President Joe Biden has promised to make an average of 1 million barrels per day of crude available from the Strategic Petroleum Reserve (SPR) for the next six months after consulting with other IEA members.
The unprecedented release of 180 million barrels is intended to ease concerns about supply and curb upward pressure on prices following Russia’s invasion of Ukraine and the imposition of sanctions in response.
The inventory release is meant “to serve as a bridge until the end of the year when domestic production ramps up,” according to a statement issued by the White House on Thursday.
Sale revenues will be used to restock the SPR in future years, ensuring it remains available to respond to future emergencies (“President Biden’s plan to respond to Putin’s price hike at the pump”, White House, March 31).
The aim is to ease upward pressure on spot prices by increasing the amount of oil immediately available, while supporting long-dated futures contracts and encouraging more drilling by pledging to buy back the oil later.
In effect, the White House has committed itself to a giant 180 million barrel spread trade to relieve anxiety about a sudden reduction in oil exports from Russia as a result of the war or sanctions.
SHORTING THE SPREAD
In recent weeks, traders have been trying to “buy” the calendar spread, purchasing futures contracts with nearby delivery dates and (in some cases) selling contracts with longer to delivery.
As a result, prices for near-dated futures have risen much faster than for those expiring later in 2022 and 2023, as traders anticipate a sudden shortage of crude, heavy fuel oil and diesel exports from Russia.
Brent futures for deliveries in June 2022 had climbed by almost $41 per barrel (54%) by March 25 compared with the end of 2021, while futures for deliveries in December 2023 had risen by just $19 (27%) over the same period.
Brent’s six-month calendar spread reached a record backwardation of more than $21 by early March and was still trading in a backwardation of more than $18 at the end of last week.
Intense upward pressure on near-dated futures contracts has rippled along the supply chain and helped drive up retail prices for gasoline and diesel ().
The White House plan in effect uses the SPR to take the other side of the trade, “selling” the spread by selling physical oil into the spot market with a promise to buy it back later.
The main impact should therefore be on the calendar spreads themselves mostly via prices of futures contracts nearest to delivery.
Following the SPR announcement, Brent’s six-month calendar spread has already narrowed to a backwardation of $9, still historically high, but the lowest since before Russia’s invasion in late February.
The spread between futures contracts for June and July has halved to less than $2 per barrel from a peak of more than $4 early last month.
Pledged SPR sales should reduce anxiety about a physical shortage of petroleum and relieve some of the recent illiquidity in futures markets by creating a de facto willing counterparty to traders betting on higher oil prices.
Before this week’s announcement, President Biden had already directed the release of 32 million barrels of crude from the SPR in November 2021 with the oil to be replaced between 2022 and 2024.
Earlier sales were conducted in response to the civil war in Libya (30 million barrels), Hurricane Katrina (11 million barrels) and the first U.S./Iraq war (17 million barrels), with smaller volumes on other occasions.
But the current release dwarfs previous ones and implies the purpose of the reserve is changing from offsetting physical shortages to managing prices as well (“Historical SPR oil releases and exchanges”, U.S. Department of Energy).
Governments have always maintained stocks of food and other essentials to ensure supplies to vulnerable urban populations, military forces, respond to famines and other catastrophic supply disruptions, and manage prices.
The SPR was created in the 1970s in response to the Arab oil embargo and its primary purpose was envisaged as maintaining military preparedness and managing risks stemming from supply disruptions and physical shortages.
But the SPR is becoming more like China’s National Food and Strategic Reserves Administration which has military and strategic functions but also routinely buys and sells stocks to smooth out excessive volatility in prices.
The National Food and Strategic Reserves Administration draws on an earlier tradition of “ever-normal” and other granaries maintained by the Qing and Song dynasties.
Ever-normal granaries regularly bought and sold grain to even out variations in prices from season to season and year to year, as well as responding to shortages and famines.
In recent years, China’s reserves administration has also bought and sold oil, industrial metals and agricultural commodities with the explicit intention of reducing excessive volatility. The state reserves administration has purchased commodities during business cycle downturns to support prices and hard-pressed producers – then sold them again during booms to try to cool surging prices.
The increasing frequency and scale with which the SPR is being employed strongly suggests its function is evolving along similar lines.
Refilling the ever-normal granaries was always controversial, harder than drawing them down, since it tended to drive up prices and could prove unpopular with consumers. Ever-normal granaries were normally refilled at harvest time, when grain was plentiful, and especially after a bumper harvest, when prices were low.
Ever-normal granaries often went through cycles of depletion and refilling that could last years or even decades at a time (“Nourish the people: the state civilian granary system in China 1650-1850”, Will and Wong, 1991).
The White House has stated that it intends to refill the SPR in future years – when prices are likely to be lower than they are currently.
Assuming the promise is kept, the ideal time to refill the reserve will be during the next oil market downturn, when the SPR would not be competing against consumers for scarce barrels, purchases could help prop up prices and support domestic producers.
If that proves to be the case, the SPR will have become a de facto price-risk manager.
John Kemp is a Reuters market analyst. The views expressed are his own.