Why the US is Really Releasing Oil Reserves

By James Anderson

The loss of Libyan sweet crude, and the scarcity of other sources, seems to be the most logical answer.

Yesterday, the International Energy Agency (IEA) called an emergency press conference to announce that the US and its partners will release 60 million barrels of oil in the next 30 days to offset the disruption of the flow stoppage from Libya. The US will “dump” (my words) a million barrels a day from the Strategic Petroleum Reserve (SPR) into the Texas and Oklahoma markets to help alleviate global shortages.

As you can see by the chart below (from the Energy Information Administration (EIA), US domestic crude oil stocks have been consistently below historical averages for the past year, well before the shutdown of Libyan oil. As we head into the summer driving season, the release of an extra million barrels a week from the SPR should help relieve any spot shortages, and minimize any price spikes this summer.

Wait a minute, this chart's upside down! It really looks like this:

Obviously, the release of an extra million barrels a week when inventory is higher than normal reeks of the obvious -- politics. The only real question is what is the political agenda? The choices are many.

(To read about the changing face of advertising from Professor Pinch, click here.)

Let's go through the obvious choices which the press are beating into the ground since the announcement made yesterday morning.

• President Obama did it to increase his election chances next year. Lower pump prices = better polls.

Seems a bit early for that. Next June, that might be more logical.

• He did it to hurt oil speculators, much like a currency intervention.

Possible, but oil peaked the first week of May, and it's been in steady downtrend since.

• Obama and the Europeans did it to stick it to the OPEC pricing hawks, Iran, and Venezuela.

Couldn't happen to a nicer couple of guys, but this seems like pleasant collateral damage, not the primary reason.

• He did it because the Europeans wanted it and like the Libya bombing, he eventually folded under European pressure.

Definitely a Rush Limbaugh-type analysis, but the Europeans did want it badly.

• He did it because the Fed is out of bullets and direct commodity manipulation is the only remaining bullet.

Hmmm...

• Finally, we have the actual reason that the IEA stated. The loss of Libyan sweet (low sulfur) crude production cannot be made up through increased sour (high sulfur) production elsewhere because European refineries that lost Libyan sweet crude cannot handle sour crude.

This seems to be true. It also explains why the British and French forces have stepped up the air attacks on Libya to try to force Qaddafi out. They don't care who is running the show as long as sweet crude is pumped. There is nothing like altruism and protecting civilians when oil is concerned.

(To read Conor Sen's thoughts on contagion concerns, click here.)

I think the most logical answer is the final statement, though the president had no problem with the benefits from the first five possibilities. All of this understates the real issue. The loss of 1.6 million barrels a day of sweet crude called the Saudi bluff that they could increase production enough to negate that loss. They clearly haven't/couldn't and Europe blinked. In my opinion, this is the first test that Peak Oil (the world will be unable to produce enough oil to meet demand) is right around the corner.

With any kind of reasonable economic growth, the demand for oil will continue to increase. China is well beyond the "chicken in every pot" stage, now it's "a car in every garage." They want to be like America, except they are now at the stage we were back in the 1950's. Any global economic growth will drive oil consumption in Asia. Political unrest in the Middle East that halts the delivery of crude oil beyond the stoppage on Libya has significant potential to spike oil well above the recent peak.

The downside of owning oil is what happened yesterday. Political games can occur, but the IEA shot a reasonable amount of powder yesterday. The US Treasury can issue massive amounts of debt and the Fed can print paper to buy it, but they can't print oil.

(To read Jeff Harding's piece on the European Monetary Union, click here.)

The oil futures market has asymmetric risk. The commodity futures markets got started by farmers and food manufacturers hedging each others' risks. Farmers would sell the current year production to lock in a profit, and the food processor would buy to lock in costs. The oil futures market is different. If you are a speculator and think that crude oil is priced too high, you can sell a futures contract against it. Since you are not producing oil, you have nothing to produce against a Middle East disaster that spikes oil to $200 or worse. You could wake up the next morning and have the markets limit up against you for days.

The events of yesterday make me more comfortable that owning US oil assets in the ground is a safe way to sleep at night. Horizontal drilling in the Bakken shale in North Dakota is producing a new domestic boom. My favorites are Continental Resources (NYSE: CLR) and Whiting Petroleum (NYSE: WLL).

Politicians play political games by definition. Actions like what we saw yesterday may give you chance to pick up domestic assets at a sale price. The Saudi bluff has been called. If they fold and Peak Oil happens, you'll be riding scooters a few years from now. Think about hedging yourself, unless you like the open air...

To read the rest, head on over to Minyanville.