The international oil markets have been quite turbulent for the past several months. The wave of protests sweeping the Arab world and the loss of Libyan sweet crude have fueled fears of shortages and have driven oil prices higher. Last week, on June 23, the western industrialized countries therefore decided to play their trump card: the strategic oil reserves. Over the course of the coming month, 60 million barrels of oil will be released onto the market from the emergency supplies of the United States, Japan and some European countries.
With this decision, the Western countries venture to play for high stakes. If all goes well, their decision will calm the oil markets until Saudi Arabia steps in with increased production from its reserve capacity. If things go bad, however, they not only run the risk of injecting even more uncertainty into an already volatile market but also to jeopardize their improved relations with the oil-exporting countries that took years to build up.
Many oil traders will probably have choked on their coffee last week when they heard that some of the strategic oil reserves would be released. The announcement by the head of the International Energy Agency (IEA), Nabuo Tanaka, came indeed as a surprise. Oil prices seemed to have peaked in April, or at least to have stabilized since a few weeks. More importantly, Saudi Arabia and other Gulf states with spare capacity had promised to ramp up their production, even though a majority of OPEC members expressed itself against such a production surge when they met in Vienna on June 8. Nevertheless, the IEA countries felt that they had to act by releasing stocks.
The IEA was established in the aftermath of the first oil crisis of 1973-74 with the primary aim to act as a crisis manager on the oil market. To that end, the agency commands a powerful weapon: each member country is obliged to maintain strategic oil reserves of 90 days. It is only the third time ever that these stocks have effectively been used. The first time was in 1991 after the Iraqi invasion of Kuwait and the second time was in 2005 when Hurricane Katrina wiped out much of the oil production facilities and refineries in the Gulf of Mexico. Both market interventions are considered to be successful.
The western oil-consuming nations have traditionally treaded very carefully with these buffer stocks, which were long considered the “oil market equivalent of a nuclear weapon” as Javier Blas wrote in the Financial Times on June 23. These stocks were never intended to be used as a tool to manipulate the price of crude oil. Instead, they were designed as a last-resort lifeline to be used only in the most extreme circumstances, such as in the case of a severe disruption of oil supplies due to a terrorist attack. The fact that the emergency supplies were not used during major market disturbances such as the Islamic Revolution, the second Gulf War, or the oil price shock of 2008 illustrates the prudence with which the IEA has handled these reserves.
Moreover, in recent years, there seemed to be a gentlemen’s agreement between the IEA and the OPEC countries with spare capacity (mostly Saudi Arabia) with regard to responding to supply shortages. This is remarkable because these two clubs, the IEA and OPEC, were very hostile towards each other until the late 1990s. The agreement was that, when a supply shortage would occur, the IEA member countries would let the OPEC countries act first, before undertaking any actions itself. Sarah Emerson put it very succinctly in a 2006 article in Energy Policy: “30 years of energy security policymaking by the consuming countries of the IEA came to a head in the conclusion that OPEC’s spare production capacity, read Saudi Arabia, would officially be the first line of defense in an oil emergency.”
Today it appears as though the IEA has switched to a new doctrine. For the first time in history, the agency has used its strategic petroleum reserves in a preventive way, not because there is an actual oil supply shortage, but because it believes that such a shortage is imminent. The upcoming summer driving season, the reconstruction of Japan and the end of the maintenance period for many European refineries will push oil demand up in the coming weeks. The IEA has not waited for the shortage to happen, but it has made a bolt move to anticipate it. According to some observers, the decision of last week’s Thursday may be the prelude of a more interventionist oil market policy, in which the western countries will use their buffer stocks to adjust the price of oil.
In such an interventionist policy, however, lies a double threat.
First, while it is true that a stock release can bring temporary relief to a tight oil market, its longer-term effects are far more uncertain. The global strategic petroleum reserves currently stand at record levels but, obviously, they shrink as soon as they are tapped and they will have to be replenished later on (possibly at higher prices). Tapping the reserves for oil price manipulation leaves us with a smaller buffer, which makes us more vulnerable to acute crises caused by unforeseen events, such as terrorist attacks, natural disasters or political embargoes. Uncertainty about the IEA’s doctrine may also increase volatility in the market because it creates confusion with the oil traders. Furthermore, if oil stocks are not used to offset temporary shortages, but to address protracted (structural) oil shortages, the consumers of oil are not forced to adapt their behavior, thus aggravating the underlying problem.
Second, an interventionist oil market policy could undermine the relations between oil producer and consumer countries. While the IEA move was reportedly made in close coordination with Riyadh, it actually places Saudi Arabia in a difficult position. The IEA kept stressing that its stock release was meant to supply the markets with extra crude until additional Saudi Arabian oil production would come online. If the Saudis succeed in increasing their production within a month, they may infuriate other OPEC countries even more and fuel the dissension within the self-proclaimed oil cartel. If they fail to do so, then they pose the IEA for a big problem because the Paris-based agency will then be under pressure to prolong its stock release.
Importantly, besides being bifurcated between these two allegiances, Riyadh’s room for maneuver is limited in yet another way. Over the past months, it has made huge public expenses to buy off domestic social peace. As a result, the Kingdom now needs a much higher oil price than it did just a few years ago to balance its budget. Whatever action they agree on, the decision-makers in Saudi Arabia are likely to tread on someone’s toes in the coming weeks.
Thijs Van de Graaf, Department of Political Science, Ghent University