Rystad Energy: A Deep Dive into the Coordinated SPR Release and its Effect on Oil Balances and Prices
A new and unchartered type of price war is brewing in the oil market. The world’s biggest consumers of oil have pledged an unprecedented and relatively sizeable release of strategic reserves onto the market to quell high oil prices amid pandemic recovery.
The orchestrated release of what we estimate will be 71.5 million barrels from the US, China, India, Japan, South Korea, and the UK comes as a last-ditch effort after OPEC+ repeatedly rebuffed calls to increase supply and ease prices.
If the release is rolled out starting as early as mid-December, crude supply to the commercial market (production plus government stock release) could potentially outpace crude demand for December 2021, instead of our previous projection that the crude balance shifts into surplus into February 2022.
This begs the question of just how strategic the timing is from Biden, Xi and others if fundamental reprieve is already just around the corner in 1Q22. The release may be a case of too much, too late, as the oil market was tightest and needed supply relief in September.
Traders also seem unconvinced by the impact of the release on the market. Prompt time spreads strengthened, suggesting increased expectations in the market for OPEC+ to counteract today’s SPR release announcement at its next meeting on 2 December 2021.
Instead of patching up a tight oil market and easing prices, the announcement unleashes more uncertainty on how OPEC+ will react and creates a tug-of-war between producers for higher prices and consumers for lower prices, which can only lead to a very volatile 2022.
The intended outcome of the US SPR release to lower domestic gasoline prices also remains dubious, as the release of crude supply from governments does not lead to higher gasoline supply from refiners immediately, or in the worst case, at all.
The total volume of the volumes to be released is still in flux, but on top of the 50 million barrels from the US. Rystad Energy assumes that China will at least match the 7.38-million-barrel release from September, and that Japan, South Korea, and India will contribute possibly 5 million barrels each, or more.
The UK urged companies to release their own emergency reserves voluntarily, to the tune of 1.5 million barrels. Altogether, this brings the grand total release to an estimated 71.5 million barrels.
If released in mid-December and lasting for a 60-day period, this would imply an average supply “addition” of 1.2 million bpd over a 2-month period, which is not immaterial in an 80 million bpd global crude market.
The biggest impact will depend on how the US decides to proceed with its sales. The White House announced that 32 million of the 50 million barrels are being “swapped” rather than sold, meaning that the extra supply on the market is temporary and the release is simply shifting the timing of the market dynamics further down the road.
The intention is to refill these volumes during 2022, 2023, and 2024 at lower spot prices. The remaining 18 million barrels will be sold outright and after 17 December 2021.
The Department of Energy has said that both dispatches will be sour crude volumes, which are less sought after than normal by the market currently, fetching deeper discounts to sweet barrels due to high natural gas prices.
Thus, the type of crude released is not necessarily the best for any immediate relief for domestic gasoline prices in the US, and some of the barrels may also end up in Asia.
There is historical precedence of tapping into strategic petroleum reserves, but of smaller magnitude. President Bush released 11 million barrels from the SPR in the aftermath of Hurricane Katrina in 2004 and President Obama released 30 million in 2011 when Libya’s supply went offline due to civil war.
The Clinton administration attempted (and ultimately failed) to quell high prices in 2000 with a 30-million-barrel sale of SPRs.
The technical maximum drawdown rate of the US SPR is according to the official DOE website is 4.4 million bpd, but in the last two decades, the maximum observed drawdown rate has been less than 1 million bpd (6 million barrels for one week).
If the US were to release 50 million barrels in a 60-day period, that would require quite a rapid pace of leased 5.86 million barrels per week, which is not out of the capability range, but certainly a brisk pace.
In our analysis, we estimate the releases on a monthly basis to benchmark against our monthly crude balance fundamentals. But in reality, these barrels will hit the physical market in larger, sporadic batches and potentially frontloaded, as sales from smaller countries may be executed all at once before the end of the year.
If the coordinated release totals 71.5 million barrels and is conducted over a 60-day period beginning mid-December, this could already theoretically flip the market into a surplus in December 2021 versus our previous assumption this would happen in February 2022.
The release of SPRs at the end of the day make supply to the commercial market looser, but we cannot count the releases as “supply” in the same way as extracted upstream production. Instead, the release from SPR is in fact a stock draw from government stocks.
The stock draw is then added as a potential “stock build for the Industry”, all else equal assuming crude runs/demand in the market is not affected. Lastly, the SPR release increases the supply to the commercial market on top of upstream production.
The all-else-equal release impact on industry stocks would push the implied stock change for the market into bearish territory, with a build of 0.3 million bpd in Dec-21 versus our previous assumption of a draw of 0.4 million bpd, if demand and crude production stays the same.
The biggest impact could be concentrated in Jan-22, when market crude stocks could build by 0.7 million bpd instead of the previously projected draw of 0.5 million bpd, assuming no change in government stocks in the balances forecast previously.
However, in practice, there is news flow suggesting that OPEC+ may not allow such a supply imbalance to materialize, and may act to erase the bearish builds threatened by the SPR release.
Just because the volumes are released doesn’t mean that refineries will jump to increase utilization rates and churn out more gasoline, especially given the shaky demand recovery on the backdrop of resurging pandemic scares, as well as general macro and inflation risk sentiment.
We will be monitoring refinery runs and utilization in key consuming economies in the weeks to come as SPR volumes are released.
The bold move from the oil importers has opened the door wide open for OPEC+ to adjust its supply policy downwards at its next 2 December 2021.
Previously, the group has said it would increase supply by 400,000 bpd on a monthly basis, but can easily hold back on this in reaction to the SPR release.
For December 2021, the group was set to ramp up production to 38.4 million bpd, though we expect the actual volumes will fall slightly short at 38.3 million bpd, due to persistent production weakness in West Africa.
Looking to 1Q22, the alliance may stay even more cautious on supply in light of not only the SPR maneuver but also downside demand pressure as Europe is already exhibiting risks to oil demand as mobility restrictions loom amid rising Covid-19 caseloads and governmental reaction.
In short, the market seems to believe in OPEC+ to keep oil balances tight more than it believes in the transitory nature of an SPR release, that seems to have underwhelmed in both size and speed.
Although WTI time spreads reacted expectedly weaker (more prompt market supply), Brent flat price actually rose while prompt time spreads strengthened, suggesting increased expectations in the market for OPEC+ to counteract the SPR release announcement at its next meeting on 2 December 2021.
In addition, the cold weather snap in Europe also lends upward support to natural gas and the commodity complex across the board as a prolonged winter energy crisis again takes center stage.
But the market shouldn’t underestimate the will of China and the US, which appear to be aligned in their aim to steer the market into bearish territory to support the economic recovery and to address the increasingly risky inflationary macro environment.
The US, while hesitant, could add support to the dollar and downward price pressure on oil via an earlier than expected interest rate hike. China has already been adding several bearish traps to the market including lower crude imports, fuel rationing, and other macro tools intended to slow down growth to prevent the economy from overheating.
If it turns out that the SPR release fails to, as it seemingly might, significantly impact the price of gasoline and oil, we would not be surprised to see further action by the top two economies towards both OPEC+ and/or the market.
We also expect a flattening of the curve, as parts of the SPR release will need to be replenished again down the line, although spread out over time.
The spot price premiums versus deferred prices are what may be most impacted, but not necessarily the price level in the market itself, both of which also depend on what approach OPEC+ takes at its meeting next week.
