The G7 is pushing on an oily string

NEW YORK: It is a problem familiar to central bankers: Under certain weak economic conditions the tools available to policymakers become ineffective, hence the expression “pushing on a string.”
Western governments wishing to undo this summer’s geopolitically-induced oil rally (incidentally, one of their making) face a conundrum similar to central bankers’ puzzles.
The tools available to those seeking to drive the oil price lower are for the most part strategic crude oil reserves located in the US.
Yet a combination of circumstances in the global oil market has robbed these reserves of some of their power.
In other words, another release of US crude oil reserves, even in coordination with other partners, may not have the desired impact on crude prices.
This helps to explain the mixed signals coming out of the G7 nations and the International Energy Agency.
On the one hand the Group of Seven most industrialized nations warned late last month governments were ready to tap strategic reserves to offset rising prices.
On the other, the IEA, even after modifying its language in its most recent pronouncements, has still highlighted the fact that in its view “crude markets are reasonably well supplied.”
The problem facing policymakers is twofold. For the most part the global oil market is not short of crude oil but it does face logistical issues that have been worsened by the enhanced Western sanctions against Iran.
At the same time, even though crude oil is in relative abundance in most parts of the world and refining margins are attractive, there is a genuine reluctance on the part of market participants to hold refined products inventory, a dangerous situation recently exposed by Hurricane Isaac.
Thus, an coordinated release of strategic stocks by Western governments faces considerable hurdles to achieving the goal of lower oil prices.
Even before considering the possible reaction of major oil exporters to a release of strategic stocks, there are factors that present serious difficulties.
First, most of the oil is in the United States, while the logistical issues hampering refiners such as North Sea production outputs and curtailed Russian exports are most concentrated in Europe, meaning the impact on global markets will take weeks or months to be felt.
Second, a release of refined product stocks in Europe may only depress regional prompt refined product prices, thereby acting as a disincentive to oil refiners.
Third, it is far from clear that a one-off release of strategic stocks will be sufficient to blunt geopolitical fears of a catastrophe in the Middle East.
Nor is it given that a big release would provide enough of a lift to refining margins that refiners would tip refined products markets into oversupply and start meaningfully building fuel stocks.
The risk is that any release, particularly one that in hindsight was “too small,” will simply transfers wealth to oil refiners without providing consumers with meaningful price relief.
These factors underlie in part some of the calls for the United States to shift its strategic stockpiling strategy away from holding crude oil stocks to a more balanced approach that includes a component of refined products.
Yet in the absence of meaningful refined product stocks, the big hammer of the US Strategic Petroleum Reserve is really all that the G7 has.
European strategic stocks are after all relatively small. Moreover, Europe tends to replace stocks released to the market, which lessens the long term impact of their release.
While the US President Barack Obama has shown no sign he plans to replace the barrels released last year during the Libyan civil war, European stocks agencies have so far been oil buyers this year.
At root, the fundamental issue is one of market confidence.
Oil product markets are in backwardation not so much because there is a generalized scramble for a scarce commodity but rather because there is a generalized fear that the economy, and hence oil demand, could again fall into recession.
Who wants to buy up expensive inventory only to have to sell it at a loss months later?
Until market players see more risk in relying on the spot market to cover short term supply shortages than from holding inventories, Western policymakers may struggle to gain much influence over the market with strategic stocks.

— Robert Campbell is a Reuters market analyst. The views expressed are his own.