Obama's options to ease oil prices: Iran or a risky stock release
An oil price beneath $110 a barrel is no threat to the world’s economic growth, Opec’s secretary-general Abdalla El-Badri told Petroleum Economist after the group’s meeting in June.
An oil price beneath $110 a barrel is no threat to the world’s economic growth, Opec’s secretary-general Abdalla El-Badri told Petroleum Economist after the group’s meeting in June. Since then, the market has rallied. On 22 August, Brent was trading at around $113/b. Bullish sentiment is in command of the market and the global economy is wilting.
As US gasoline prices inch up towards $4 a gallon, meanwhile, the soaring oil price is once again undermining President Obama’s re-election hopes. He has two shots to handle the threat to his presidency: a deal with Iran or a strategic stock release. Both are possible. But if he goes with the release it will have to be cleverly targeted and big enough to shake a sceptical market. Only a bazooka will work.
On Iran, rumours of a deal are beginning to spread, though caution is called for: similar rumours proved false in May. Momentum has come from the US, which, according to some diplomatic sources, has repeatedly used the multilateral meetings between the P5+1 and Iran to seek its own bilateral meetings. Officially, Iran has rebuffed those efforts. Gulf sources, though, say Iran has used other channels to keep that option alive. It is confusing, but it is also clear that the sanctions are hurting both sides: undermining the Iranian economy while lifting oil prices into the red zone for Western consumers.
The sketchy outlines of a deal could allow Iran to keep some minimal uranium enrichment rights, probably under International Atomic Energy Agency oversight, in exchange for a loosening of the sanctions, which the International Energy Agency now calculates have taken around 700,000 barrels a day (b/d) out of Iranian oil exports. Iran would claim victory, but so would Obama.
A diplomat familiar with the negotiations says European governments have been worried that the US would “go it alone” with an Iran deal. But struggling EU economies have much to gain from anything that would soften oil prices, as progress with Iran inevitably would. In euros, they are already paying record-high prices for crude: an oil shock that is exacerbating the economic impact of the sovereign-debt crisis.
That’s why EU countries are now also on board for the US’ reheated plans for a strategic petroleum reserve (SPR) release – which is still more likely than a deal with Iran. In March, when the stock-release idea was first hatched, Germany and France were opposed. Now France, which is also thought to be considering some domestic fuel-tax relief, has joined the UK government (which has already softened its fuel levy) in backing the idea. Both economies are struggling and a fall in crude prices would be welcome.
According to a source, a senior UK cabinet office official was in Washington, DC to discuss the stock-release plan as Petroleum Economist went to press. Market insiders say any release is likeliest in September, after the US holiday season ends and the White House can garner maximum political credit for a move that will be sold as a boost to hard-hit drivers. That would also give time for any progress on the Iran file.
Several wrinkles could undermine the effectiveness of any stock release, starting with Israel. For European governments, Israel’s threats to strike against Iran were behind the new EU sanctions agreed last year and put in place in July. Unless the sanctions work – and work in a way that convinces Israel that they are working – EU governments fear an attack by Israel that would draw the US and European governments into a wider regional conflict. That would be disastrous for oil prices and the global economy.
UK cabinet-level discussions on Iran have included an “extraordinary” attention to Israel’s view, says one diplomat. There is also a theory that Israeli prime minister Benjamin Netanyahu is using the threat of a strike to keep oil prices inflated precisely to kill Obama’s re-election hopes. The two leaders don’t get along. True or not, Israeli threats to Iran could torpedo any US effort to bring down oil prices.
The market is already sceptical about a release, too. Last year’s 60m barrel stock draw lopped a few dollars off the price of Brent, but only temporarily. News that the US is considering another release surfaced on 18 August, but prices barely reacted. The market’s bulls are focused instead on expectations of stimulus spending from the struggling consumer economies, unrest in the Middle East, and North Sea outages – all forces that have underpinned the latest rally.
A shock to the system
Any release now would have to be big enough to jolt the market out of its bullish sentiment. Although some traders say the Brent market has tightened again recently, many producers say it is loose – and are baffled by the strength of prices and the rally’s resilience. Saudi Arabia continues to pump at around 10m b/d, part of its effort to bring prices down. It has also freed up oil supplies by cutting domestic crude-oil burn in power generation this summer. Opec’s production, at 31.4m b/d, remains well above its 30m b/d ceiling. Consumption is soft, as shown by the sharp downward revisions this month to the IEA’s demand forecasts.
In other words, the market isn’t short of oil. So while the pretext for a release would be the loss of Iran’s 1m b/d, the actual volume unleashed onto the market would probably need to be far bigger – maybe even more than was released last year, when the IEA coughed up the equivalent of 2m b/d of supply to plug the gap left by Libya’s outage.
The market would also wonder how long any release would last, especially as some elements within the IEA are opposed to the idea in the first place. The UK’s Department of Energy and Climate Change is against the release, for example, despite Downing Street’s backing for it. Germany is a sceptic. The market would expose any cracks among consumers. If a deal with Iran weren’t forthcoming in the meantime, the price impact could be limited. There’s not much the politicians can do to stop a price spike if traders think a war in the Middle East is in the cards.
Lastly, the release would need tacit approval from the Gulf, which has regained much of its sway over the US oil market. Forget the Bakken, Eagle Ford and the Canadian oil sands; Middle East supplies into the US have grown far more quickly in recent months. In December, US imports from the Gulf amounted to 1.9m b/d, according to the Energy Information Administration. Opec exports to the US were barely above 4m b/d. By May 2012, the numbers had grown to 2.6m and 4.7m b/d, respectively. The Saudis have, in an impressively short period of time, regained a hefty chunk of the weakening US market. The trend has likely continued in the summer months, led by rising Saudi supplies to the US.
Iran has already called for an Opec meeting to respond to any SPR move by the US. Saudi sources say a stock release is a sovereign decision for consumers, and its supply policy remains to soften the price. So the likelihood of a cut in Gulf supplies to accommodate the extra oil is unlikely. Nonetheless, consumers don’t want to cause a shift in Saudi Arabia’s thinking. The kingdom, not the SPR, is the market’s swing producer.
So the White House should think carefully. A deal with Iran is the way to bring prices down and avert economic meltdown. By contrast, a political stock release is risky. If it happens, it has to be big and bold. Anything less and the market’s bulls will demolish it.