Why the Strategic Petroleum Sale Was a Disaster
By Byron King | July 07, 2011 |

Today I want to dissect the latest news about the recent announcement by the U.S. Energy Department (DOE), that the U.S. will sell 30 million barrels of oil from the Strategic Petroleum Reserve (SPR). The SPR, as you know, is a national energy asset. The oil is intended for use during “strategic” events, like war or major supply dislocation.

There’s a lot to discuss here, in fact it’s highly important that you know the factors that surround this national debacle. For starters, there are plenty of politics at hand and as a resource investor you’ll want to take note. Plus there are plenty of implications for your future investments, which I’ll discuss below.

First, though, let’s look at to what happened with the release of the SPR.

Thing is there’s no true war or major supply disruption occurring that would warrant a release from the SPR. The Saudis have more than made up for the oil that’s not flowing from Libya during the current unpleasantness over there. Indeed, there hasn’t been a global (let alone U.S.) “oil shortage” in many years. World oil supplies are adequate for daily needs. No tanker ever sails away unfilled from any major loading terminal — if the buyer can pay the price. So the “strategic” motive behind the recent SPR sale announcement was not merely lacking, but was mundane.

The long and short of it is that the SPR release is overtly political. The Obama administration wants to try to moderate otherwise rising oil prices. The political calculus is to keep the price of gasoline and diesel fuel down over the summer driving season. Considering that it’s July, we’re a bit late for that — the fuel you’ll use in the next two months is mostly already in the pipelines and storage tanks.

Then again, the oil price control effort is many months in the making. I’ve heard from several contacts in Europe that the Obama administration has been badgering the International Energy Agency (IEA) since about March. The Obama advisers have been lobbying for a “coordinated” U.S.-IEA oil release into the global marketplace, to make it look like it’s not as raw a political act as it is. Now they all have their wish.

The Petro-Slush Fund?

Another (unstated) political goal for the Obama administration was/is to sell 30 million barrels of oil from the SPR and raise a quick $3 billion for the U.S. Treasury in July and August.

These funds won’t balance the national budget by any means, but may come in handy in the face of the borrowing and budgeting problems that will likely hit the U.S. by early August. It’s sort of a petro-slush fund, and who knows how that’s going to get spent?

It all sort of reminds me of that old line, “A billion here, a billion there. Eventually, it adds up to serious money.”

Of course, one key reason for rising oil prices over the past couple of years has been the declining value of the dollar. The declining dollar is something that DOE can’t control. Indeed, the Treasury Department and the Federal Reserve need to run with that particular ball — not to mention the budget cutters in Congress. But let’s not dwell on jurisdictional technicalities.

At first, the announcement about the SPR oil sale knocked U.S. oil prices down into the low $90s per barrel. That’s what supply surprises do — they make the traders trade. Although I need to add, there was some very curious oil trading the day before the DOE announcement. Where’s the Department of Justice when you need it?

Who’s Buying 30 Million Barrels?

So here’s where things stand. The DOE recently put out an offer to sell 30 million barrels of oil from the SPR. The offer attracted more than 90 distinct bidders, and was “substantially oversubscribed,” according to DOE.

At the end of last week, the bids came in. According to DOE, the “apparently successful” bids for SPR oil totaled 30.64 million barrels at an average price of $107.19 a barrel. Here’s the exact score card:

This is, as you can see, a “who’s who” of mostly domestic oil players and refiners, plus a few oil trading firms. The list includes a couple of companies in the OI portfolio.

It looks like most of the SPR oil will go to U.S. refiners (Valero, Tesoro, Hess, Sunoco, etc.) and sell into the U.S. marketplace. In fact, it’s illegal for any buyer to export SPR crude oil. All well and good. Meanwhile, I should add, the oil that these guys might’ve otherwise bought on international markets is finding eager buyers from China, Korea, India and other places.

Thing is, however, look at those prices for the SPR oil! That $107.19 “average” price is strong, by recent U.S. standards. It’s actually about $8-10 per barrel higher than the domestic price for West Texas Intermediate (WTI) oil before the DOE announcement.

Clearly, the “apparently successful” SPR bidders wanted to make sure they got their hands on that SPR oil. Thus, they bid high, by U.S. bench marks. Of course, the WTI price is unique to the U.S. It’s a “landlocked” price, controlled by the pipeline system of the American Midwest — around Cushing, Okla., to be exact. Still, the U.S. price is what affects a large part of the world’s largest single oil market.

So let’s summarize. The U.S. government surprised the oil markets by announcing it’ll sell oil from the SPR to help keep world oil prices down. As things are turning out, the sale of U.S. stockpile oil is closing at a higher WTI price than before the announcement.

The surprise SPR sale (a “surprise” unless you’re one of those front-runners from the day before the official announcement) is lifting U.S. pricing, not holding it down. Very strange, no?

The SPR Mistake — It’s “Counterproductive”

According to Peter Tertzakian, chief energy economist with Calgary-based ARC Financial Corp., any downward impact of the SPR oil sale will be short-lived on global energy prices. Mr. Tertzakian is, by the way, the author of an excellent book about world oil use published in 2006, titled A Thousand Barrels a Second: The Coming Oil Break Point and the Challenges Facing an Energy Dependent World

According to Mr. Tertzakian, the IEA-DOE release of SPR oil is “counterproductive and serves to increase, not decrease, the threat of upward oil price volatility.” Furthermore, the SPR release “introduces a surprise dimension of market uncertainty that will give decision makers at boardroom tables pause on how much capital to plough into exploration and development.”

That is, says Mr. Tertzakian, “Oil prices will rise again, and second-guessing what the IEA is going to do will only serve to push back the goal of a secure and balanced oil market.”

Then there’s that issue of replacing the 30 million barrels sold from the SPR. Will the Obama administration ask Congress for funds to buy 30 million “new” barrels? Don’t bet on it.

Yet buying oil is what has to happen if the Obama administration is planning to refill the SPR. (A big “if,” I suppose.) That is, in 2009, the Obama people terminated the former federal “royalty in kind” (RIK) system.

Under RIK, oil producers on federal leases paid their royalties in volumes of crude oil, destined for the SPR. The government received oil instead of a check for cash royalties to the Treasury. Now, however, the cash royalties flow into the bottomless pit of the federal general fund. There’s no longer a functioning method for diverting oil from federal leases into the SPR.

The SPR Card Is a Bust

In my view, this SPR oil release has overtly politicized an otherwise useful energy tool. I’d even opine that the SPR sale has turned into a strategic energy debacle.

SPR release or no, oil demand will soon clear the market. By the end of 2011, we should expect oil prices to solidify in the low triple digits, which could certainly cause a return to recession. Meanwhile, the U.S. has played the SPR card and shown the oil-producing world that it’s not effective.

This SPR sale is just another in a long series of failed efforts by the political classes, over many decades, to attempt to tweak, if not control, the global oil business. It never works.

When it comes to energy, politicians and their media Myrmidons tend not to understand how the system really functions. The politicians do cosmetic things like beat up on oil companies or stage this current stunt of the SPR oil release. It isn’t working, it won’t work and the “big” media are collectively too dumb and/or ideologically blinded to figure it out.

Does the U.S. really want to curb fuel consumption? Then the name-brand politicians need to make tough decisions like raising federal fuel taxes to curb consumption.

Does the U.S. want significant new sources of domestic oil? Then the anti-industrial, so-called “environmental” junta needs to back off and allow drilling in sacred cow pastures like the Arctic National Wildlife Refuge (ANWR) — almost right next to the underutilized Alaska Pipeline.

And don’t get me started on how hosed up is current U.S. offshore energy policy.

The bottom line is that with this SPR sale, the U.S. has just revealed itself to be an energy paper tiger — and other nations hold the paper.

This SPR episode is a national embarrassment. The U.S. has used an important energy tool and shown the world that it doesn’t work.

So what does this SPR oil issue mean for you as an investor?

It means that the U.S. government is screwing up energy policy big-time. Stand by for future price shocks. You’ll pay at the pump, when you buy airline tickets, via your utility bills and with higher costs for everything that moves by ship, rail and truck. It’s going to cost you, cost you and cost you some more.

What to do? The best of the oil companies and the oil service players will continue to do well as the world muddles along at the top of an overall Peak Oil plateau. The well-run companies that produce energy will also produce profits for their shareholders.

That’s all for now. Thanks for reading.

-- Byron KingSource: Daily Resource Hunter