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ROAD TO NOWHERE – IEA CHARTS A COURSE THROUGH OIL MARKET TURMOIL, BUT DOES IT GO ANYWHERE?

Written on: April 18, 2022

By Jason Lindquist

Increases in crude oil and gasoline prices have caused widespread concern in recent months, made worse after Russia’s invasion of Ukraine that added even more uncertainty to the market. With the average U.S. price for regular gasoline now topping $4/gal — nearly 50% above where it was a year ago — the rising fuel costs have been especially painful for everyday drivers and threaten to slow or derail a global economy still recovering from the pandemic-induced recession. Government officials in the U.S. and elsewhere, while urging oil producers to ramp up output, have turned to their strategic reserves as a way to quickly balance the market and rein in prices. In today’s RBN blog, we look at the International Energy Agency’s (IEA) latest announced release from oil reserves, how the global drawdowns are intended to create a bridge to when increased production comes online, and the skepticism about whether those plans will work out as intended.

Crude oil prices have been on a steady rise over the last year. WTI settled at $104.25/bbl on Wednesday, up from about $44/bbl in early January 2021 and $63/bbl at the start of January 2022 before spiking to $123.70/bbl on March 8, not long after Russia’s invasion of Ukraine. Until recent years, an increase in crude oil prices of that magnitude would result in a corresponding increase in producer activity and rig counts, leading to a significant boost in production. But as we noted recently in What’s Going On? and I Can’t Go For That (No Can Do), that’s not happening now for a number of reasons. (More on that in a bit.) While U.S. crude oil production has moved up to 11.8 MMbbl/d, according to the latest weekly data from the Energy Information Administration (EIA), it’s still well below the pre-pandemic peak of about 13 MMbbl/d.

To bridge the gap between today’s demand and the time it may take to bring new production online, the U.S. and others have been increasingly turning to their own strategic reserves.

Fig. 1: Source of Barrels, Apr. 6 Inventory Release. Source: IEA

The latest move to address global supplies and keep a lid on oil prices comes from the IEA. On April 6, it announced that it would release 120 MMbbl from emergency reserves through contributions from 19 countries, including 60 MMbbl from the U.S. (See Figure 1 at right.) It was the second release coordinated by the IEA in about a month. A release of 62.7 MMbbl of crude oil and refined products was announced on March 1 from 25 countries (including 30 MMbbl from the U.S.). Over the next six months, the IEA estimates that 240 MMbbl of emergency oil stocks will be added to the market.

On March 31, President Biden announced plans to release 180 MMbbl of crude from the Strategic Petroleum Reserve (SPR) over six months, as we noted in I Want to Break Free. This would increase the flow of U.S. oil into the market by about 6% — 11.8 MMb/d of current U.S. production plus 1 MMb/d from the SPR — and boost global supply by about 1%. The Biden administration has been very active in using the SPR in an attempt to blunt price increases. It authorized a 32 MMbbl exchange in November 2021, in which barrels would be delivered by the end of April but would need to be returned to the SPR during fiscal 2022-24, and a 30 MMbbl withdrawal was announced shortly after Russia’s invasion of Ukraine. (An unrelated sale of 18 MMbbl from the SPR that was approved by Congress under the Bipartisan Budget Act of 2018 will also take place during fiscal 2022-25.) The U.S. SPR is the largest emergency stockpile in the world with an authorized capacity of 714 MMbbl.

Market Impact

Fig.2: WTI and Gasoline Prices, Jan 2021 – Present. Source: RBN Chart Toppers. Line indicates Russia’s invasion of Ukraine

It’s a murky business, at the best of times, to try to distinguish what drives up or pulls down crude prices each day, but the massive amounts of crude promised to the market over the next six months seem to have halted the run-up in oil prices, at least in the short-term. As noted in Figure 2 at right (Russia’s invasion of Ukraine marked by red line), WTI peaked at $123.70/bbl on March 8, and although daily price swings have been significant given the recent market uncertainty, it was still at $107.82/bbl on March 30. WTI fell by more than $7/bbl the next day — after the U.S. announced its release of 180 MMbbl.

U.S. gasoline prices have also fallen since the SPR release. The average price of regular gasoline was $4.215/gal on April 1, shortly after the U.S. announcement. By April 13, the average price had fallen to $4.083/gal, down 24.2 cents from March 13. The drop came as U.S. gasoline demand rose by 170 Mb/d to 8.7 MMb/d and gasoline inventories fell by 3.6 MMbbl in the week ended April 8, according to the latest EIA data. But it’s far from guaranteed that the releases will be effective in limiting crude oil or gasoline prices over a longer period and there are several other factors influencing the market, including the situation in Ukraine, the long-term impact on demand from a surge in COVID-19 cases in China, and whether planned interest rate hikes in the U.S. will slow economic growth.

As for the long-term effect of the coordinated releases that are meant to bridge the gap from supply shortage to higher production, it remains to be seen whether producers will respond to appeals from the administration to ramp up output. As we noted previously, that sort of response takes time and will be contingent on the long-term expectations of the government’s stance on the energy sector. But even if U.S. producers wanted to ramp up output, there’s a limit to how fast that can happen. It takes time to prepare a drill site, drill and complete a new well, and begin producing even if you can find enough rigs and completion crews to do the work. And while there are some short-term levers producers can pull, such as completing previously drilled but uncompleted wells (DUCs), the number of available DUCs has been dwindling (see I Can’t Go For That, Part 2) and it will take additional rigs just to overcome the drill-time differences of needing to both drill and complete wells.

U.S. oil and gas producers have been adding rigs on a consistent basis since last year, with the total rig count climbing by 16 to 689 in the week ended April 8, according to Baker Hughes. That’s the highest figure since the start of the pandemic in March 2020 and indicates that increases in production could be forthcoming. However, the addition of so much extra crude from the SPR to the market in the next six months could change that equation. Further, there’s little chance that crude production will be 1 MMb/d higher — the daily rate of the SPR drawdown — six months down the line.

It’s also worth noting that the U.S. and others participating in the crude oil releases this year will want to replenish those reserves somewhere down the line, adding to future demand. A 180-MMbbl draw on U.S. inventories over the next six months, in addition to other announced SPR releases, would leave the SPR at its lowest level since 1983: about 345 MMbbl, or about 48% of the system’s 714 MMbbl capacity. (We assume that it will take a month from the announcement date for the first crude oil to flow out of the SPR sites, and that the withdrawals will continue through the end of October.) Of course, any extension of the 1 MMb/d withdrawal regime for more than 180 days would reduce the crude oil stocks even further.

No Sure Thing

In addition to keeping a lid on prices in the short term, the coordinated releases are intended to build a bridge to the increased production that could theoretically be ready to come online later, once the scheduled releases end. While it’s possible that the coordinated inventory releases by the IEA and the U.S. will help the market rebalance in the short-term, it won’t resolve a structural supply deficit that has been years in the making. As we noted in our recent I Can’t Go for That (No Can Do) series, whether that increased production happens depends on a lot more than just the usual supply-and-demand fundamentals, favorable news in Ukraine, or a drama-free U.S. hurricane season. E&Ps face a number of challenges, including inflation, severe shortages of labor and material, soaring energy costs, ESG concerns, and an investor-focused strategic shift from growth to free cash flow generation. So, while the SPR releases might help keep a lid on prices in the short-term, they are, at best, as OPEC said, a temporary Band-Aid. At worst, the addition of SPR volumes might have the unintended consequence of hampering the acceleration of production, leaving a wider supply deficit in 2023 when the coordinated releases end.

Whatever the U.S. response, OPEC also told the EU on April 11 that it was impossible to replace Russian crude oil volumes and that sanctions could keep 7 MMbbl/d of crude oil and other liquids from the global market and lead to a supply shock — although there are indications that heavily discounted Russian oil is still flowing. The OPEC+ group, which includes Russia, has stuck to its plans of measured production increases despite the run-up in oil prices, which it says are due to factors outside the group’s control. It plans to increase production by 432 Mb/d in May.

Given all the complicating factors, the IEA’s planned road through the short-term oil market turmoil may not directly lead to its intended destination – more stable markets and global producers boosting output.

Jason Lindquist is Managing Editor at RBN Energy, a leading energy market consultancy and analytics company based in Houston, Texas.

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