Markets Insight
March 18, 2014 7:14 am
Release oil from US reserve to hurt Russia
World oil price could drop $10-$12 per barrel
Russia’s seizure of Crimea has prompted political leaders in Europe and North America to seek meaningful measures to convince Russia to pull back its troops.
The SPR now holds 694m barrels of crude. The federal government acquired the oil between 1977 and 2009 as a safeguard against severe disruptions of world oil markets. The original intention was to create a billion-barrel reserve, to offset any prolonged interruption of US oil imports during some future conflict.
The US no longer needs such a large strategic reserve. The SPR cannot be entirely eliminated due to the International Energy Program commitment to hold reserves equal to 90 days of imports, but the US could easily sell 500,000 to 750,000 barrels per day for up to two years without breaching this obligation.
Kremlin pain
By my calculation, if the US did this and all else remained equal, the world oil price would drop $10-$12 per barrel.
Although that would be only about a 10 per cent reduction in price, it would still inflict substantial pain on the Kremlin. A crude oil price decline of $10 per barrel would cut Russian export income by around $40bn, which amounts to roughly 10 per cent of the 2012 fuel export income Russia reported to the World Trade Organisation. Russia’s GDP could fall as much as 4 per cent.
In addition, lower oil prices would offer significant benefits to European consumers who depend on natural gas from Russia, including those in Ukraine. That is because Russia links – or tries to link – the price of natural gas it exports to Europe to crude oil prices.
Thus, by liquidating the surplus SPR oil, the US would give Europe lower natural gas prices. In the US, lower crude oil prices would cut gasoline prices as much as 25 cents per gallon. And the profit generated from any sales of SPR oil – which costs, on average, $28 per barrel – could go to deficit reduction.
There are two big “ifs” to this scenario, however. The first is that Congress would probably have to authorise any SPR oil sales, especially if the oil was to be sold to foreign buyers. Approval could take weeks or months. However, Congress could surprise, especially if the step were seen as a way to impose sanctions on Russia.
Saudi reaction
The Saudi Arabian leaders would probably welcome crude oil sales from the reserve as a clear effort to weaken Russia.
Saudi Arabia’s economy, unlike Russia’s, can tolerate lower oil prices because budgets are premised on lower oil prices, and because the country has accumulated large financial reserves that can be drawn when prices fall. Most likely the Saudis would say and do nothing as long as the US limited its price reduction goal to, say, 10 per cent rather than 50 per cent.
No doubt oil traders and producers in the US would agree. Some have argued that relaxing the US ban on crude exports would be preferable to an SPR release. However, increasing supply is the only way to have a real price impact on global markets.
Easing the export prohibition would not accomplish this but permitting the exports of oil now held in the SPR would.
Moreover, US strategic stocks are no longer strategic but rather surplus government property. Sooner or later the oil will re-enter the market, just as inventories of other commodities accumulated for crises have been sold when no longer needed.
In this case, strategic stocks may indeed serve a strategic purpose if the price declines curb Russia’s belligerence.
Philip K Verleger Jr retired from the University of Calgary where he was the David Mitchell-EnCana Professor and now heads PKVerleger LLC; he was director of the Office of Energy Policy at the US Treasury in the Carter administration.
In particular, they seek measures that would affect Russia immediately, putting internal pressure on the country’s leaders to stop their aggression while leaving the rest of the world unharmed. Some propose accelerating natural gas exports from the US to Europe. However, this is no better than computer “vapourware” because the gas would not arrive for years.
A viable alternative to gas exports is releasing oil from the US Strategic Petroleum Reserve (SPR). These stocks are available today and could have a speedy impact on Russia. Given that the country depends on oil and natural gas exports for its survival, such an action would have a quick and significant effect if the release depresses oil prices.
The US no longer needs such a large strategic reserve. The SPR cannot be entirely eliminated due to the International Energy Program commitment to hold reserves equal to 90 days of imports, but the US could easily sell 500,000 to 750,000 barrels per day for up to two years without breaching this obligation.
Kremlin pain
By my calculation, if the US did this and all else remained equal, the world oil price would drop $10-$12 per barrel.
Although that would be only about a 10 per cent reduction in price, it would still inflict substantial pain on the Kremlin. A crude oil price decline of $10 per barrel would cut Russian export income by around $40bn, which amounts to roughly 10 per cent of the 2012 fuel export income Russia reported to the World Trade Organisation. Russia’s GDP could fall as much as 4 per cent.
An SPR oil release could also exacerbate the rouble’s decline and further increase the country’s internal economic difficulties.
Thus, by liquidating the surplus SPR oil, the US would give Europe lower natural gas prices. In the US, lower crude oil prices would cut gasoline prices as much as 25 cents per gallon. And the profit generated from any sales of SPR oil – which costs, on average, $28 per barrel – could go to deficit reduction.
There are two big “ifs” to this scenario, however. The first is that Congress would probably have to authorise any SPR oil sales, especially if the oil was to be sold to foreign buyers. Approval could take weeks or months. However, Congress could surprise, especially if the step were seen as a way to impose sanctions on Russia.
Saudi reaction
The second “if” concerns the reaction of Saudi Arabia. The world’s largest oil exporter would also see a reduction in income. It is likely, though, that the Saudis would acquiesce because they are locked in a struggle with Russia over Syria and Iran.
Saudi Arabia’s economy, unlike Russia’s, can tolerate lower oil prices because budgets are premised on lower oil prices, and because the country has accumulated large financial reserves that can be drawn when prices fall. Most likely the Saudis would say and do nothing as long as the US limited its price reduction goal to, say, 10 per cent rather than 50 per cent.
No doubt oil traders and producers in the US would agree. Some have argued that relaxing the US ban on crude exports would be preferable to an SPR release. However, increasing supply is the only way to have a real price impact on global markets.
Easing the export prohibition would not accomplish this but permitting the exports of oil now held in the SPR would.
Moreover, US strategic stocks are no longer strategic but rather surplus government property. Sooner or later the oil will re-enter the market, just as inventories of other commodities accumulated for crises have been sold when no longer needed.
In this case, strategic stocks may indeed serve a strategic purpose if the price declines curb Russia’s belligerence.
Philip K Verleger Jr retired from the University of Calgary where he was the David Mitchell-EnCana Professor and now heads PKVerleger LLC; he was director of the Office of Energy Policy at the US Treasury in the Carter administration.
Copyright The Financial Times Limited 2014
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