London, 18 July 2011

The International Energy Agency's decision to order the release of 60 million barrels from emergency oil stocks remains fiercely controversial, but on balance it should be considered a success. Many of the agency's harshest critics argue the release failed to achieve a lasting price reduction (economist Albert Hirschman's futility thesis) undermined its future credibility (the jeopardy thesis) and blunted price signals (the perversity thesis).

But critics are judging the release against the wrong criteria. In its own terms, the release successfully provided liquidity over the summer when the supply of sweet crude was severely disrupted by North Sea maintenance programmes and the conflict in Libya.

It almost certainly averted a panic about the shortage of benchmark grades that would have risked a severe price spike at a time when the global economy appears unusually fragile. Central bankers and investors have good reason to offer thanks to the agency for averting a much worse outcome.

COUNTERFACTUALS

Critics charge the IEA release was futile because spot prices quickly returned to levels observed before the announcement. But this is the wrong comparison. The correct comparison is not between prices before and after the stock release but between prices after the release and what they would have been if the release had not happened.

"Ultimately, the IEA release will have to be judged subjectively in the answer to the impossible question of how different prices prove to be relative to the unobservable counterfactual case in which there was no release," as analysts from Barclays Capital explain in a recent note.

The fact the counterfactual is unobservable does not make it any less relevant. There are plenty of reasons to think the market would have become exceptionally tight over the late summer. Without the comfort provided by the stock release, fears about the availability of light sweet crudes would probably have triggered a panic-driven price surge.

As my colleague Robert Campbell has noted, natural field declines coupled with an unusually heavy summer maintenance programme will cut output from the four streams on which Brent futures are priced (Brent, Forties, Oseberg and Ekofisk) to less than 900,000 barrels per day in August, the lowest level since 2007.

Reduced output from the North Sea together with the ongoing loss of Libyan exports and the expected rise in refinery throughput to meet summer driving demand pushed prices for August Brent futures to a steep premium of more than $2 per barrel over September when the August futures contract expired on Thursday

http://graphics.thomsonreuters.com/ce/BRENT-SPREADS1.pdf

If the market was that concerned about the shortage of sweet crudes with the stock release, most of which will become available in August, imagine how severe concerns would have been if the IEA had not released stocks.

In the absence of a release, prices for August crudes would almost certainly have risen much higher, with attendant risks to the recovery.

TEMPORARY LIQUIDITY

The IEA's release may not have been able to prevent tightness in the market at the end of the summer completely, but it does seem to have contained the fears, and convinced participants shortfalls will be confined to a few weeks in August, not leave the market persistently short into the autumn and the winter heating season.

While the Aug/Sep timespread flared out to more than $2, up from 45 cents prior to the IEA announcement, other timespreads fell sharply and have stayed low. The Sep/Oct spread has fallen from 32 cents before the announcement to around zero in recent days.

Spreads had been softening since Saudi Arabia indicated it would boost supplies by up to 1 million barrels per day following the breakdown of the OPEC meeting on June 8. But more than half of the reduction came after the IEA announcement, implying market participants believe the stock release will play a crucial role in preventing tightness in the supply-demand balance lasting through the end of the year.

In fact the IEA release coupled with Saudi Arabia's agreement to increase output has taken the spreads back to levels recorded at the start of the year before the loss of Libyan production.

Like commercial inventories, the IEA's emergency stocks are not a substitute for production. They exist to dampen damaging short-term volatility. The stock release appears to have performed that role admirably well.

Market participants remain concerned about the shortage of North Sea crude production in August. But the release combined with higher Saudi output has convinced most the shortfall will be confined to a single month and not cause a legacy of tightness in September and beyond.

It is hard to see how the stock release could have achieved much more.

Ends --

By John Kemp, Reuters market analyst – for Commodities Now.

The views expressed here are his own.