The SPQR

The SPQRPosted by Izabella Kaminska on Jun 24 09:23.

Introducing the SPQR: the Special Petroleum Quantitative Reserve.

Some 36 years in the making, specifically designed to provide the US (and via that global markets) with vital oil supplies if and when an emergency strikes, tapped only twice ever in its history…

… and the reserve has overnight (arguably) been turned into a strategic tool of monetary policy authorities.

Olivier Jakob of Petromatrix commented a few weeks ago that with commodity inflation clearly undermining the Fed’s quantitative easing policy “all we need now is for Ben Bernanke and the Fed to start intervening in the oil market directly”.

So the question is, was Thursday’s release of 60m barrels of reserves by the IEA, 30m coming from the America’s strategic reserve, exactly that? Inflation-targeting via the oil markets?

Here are Jakob’s thoughts on the move on Friday:

On June 10th we had warned about the risk of an imminent stock release from the IEA and as per our note of two weeks ago it comes as a straight sale rather than an exchange for later barrels. With its declining demand the OECD was anyway carrying too high strategic stocks to demand ratios. Bulls are already making the case that 60 myn bbls is less than one day of world oil demand and is therefore a drop in the ocean. But then the total lost crude exports from Libya represent so far only 1.6 days of world oil demand.

One cannot have it both ways: either the lost supplies from Libya are significant and the stock release is significant or the lost supplies from Libya are insignificant and so is the stock release.

In our thinking and for the price impact we believe that the only thing that matters is the 30 myn bbls release from the US SPR. The other 30 myn bbls are geographically not concentrated around a price center and should have less price impact than the SPR release.

The US will release 30 myn bbls of sweet crude oil in the US Gulf. Current commercial crude oil stocks in the US Gulf are however not at all on the low side and compared to record levels there is currently only about 17 myn bbls of crude oil storage space left in the US Gulf. Maybe there will be been some crude stock draws in coming weeks, but with a SPR release of 30 myn bbls over 30 days in a market that has only 17 myn bbls of space left there is little doubt that the US Gulf should reach full capacity of stocks. And there is not much space in Padd2 to pipe crude into storage there.

The US Administration has also said that it would review the situation in 30 days and that it was ready to do more. If it succeeds in filling the US Gulf stocks to full capacity, then it can follow later with a smaller program to keep those stocks at record levels. The deliveries will start on August 1st and it will therefore be difficult to buy crude oil futures on any reported stock draws reported in the DOE weekly reports in the coming month as we now know that any stock draw will be followed by SPR supplies.

If the IEA stock release is successful in putting pressure on Brent it will comfort the central banks views that headline inflation is “transitory” and the ECB might be then in less of urgency to raise rates to combat inflation. The Euro/Dollar had a major rally late in the day (that also brought strong support to the S&P) when it was announced on Reuters that the EU/IMF had agreed with Greece on the austerity plan. All is very well, but austerity measures were already agreed a year ago (and failed) and next week we have two days of general strikes in Greece. The 200 day moving average is holding for now on the S&P500 but if oil prices come off then the other sectors will need to compensate for some weakness in the energy sector, and we maintain our view that shares of Goldman Sachs will trade at 130 before Brent trades at 130 $/bbl. JP Morgan has revised overnight its Brent price forecast for the 3Q from 130$/bbl to 100 $/bbl…

The direct impact, as Jakob notes, will not be on the US oil markets, since they have limited spare capacity to absorb the extra crude.

If anything, the move is a veiled attempt to control the Brent market. And via that, indirectly, the commercial players who are dominating that market — as was revealed by the Intercontinental Exchange’s first ever commitment of traders report this week.

The fact that volume on ICE Brent far out-passed that of WTI Nymex on Thursday is proof enough of how the IEA announcement has hit the Brent oil benchmark more than any other, says Jakob.

Indeed, time structures in the Brent forward curve (the difference in price between the varying futures months) collapsed almost immediately after the announcement, as this chart from John Kemp at Reuters shows:

The timespreads may now even transform into a contango structure — when futures further out are more expensive than immediate contracts — says Jakob.

Something which may also, he says, impact WTI-Brent spread eventually:

This also reduces the roll benefit of being in Brent versus WTI and we therefore calculate the roll benefit of Brent to WTI down to 8 $/bbl and that compares to the 16$/bbl Brent premium still being priced versus WTI. On a fundamental basis we clearly cannot see how Brent could justify its current premium to WTI when the US Gulf is about to receive 30 myn bbls of sweet crude oil. Being in Brent for the backwardation roll is now a trading theme at risk. Being long Brent has yielded a +15.3% return so far this year compared to -7.7% in WTI and with the current risk on the Brent-WTI spread we would consider bringing home some of those profits on the long Brent trade.

Which is naturally a great side-effect for the declining American WTI market as well.

So all hail the SPQR, and WTI (we guess).

Related links:
Re-inventing Opec – FT Alphaville
Goldman’s history lesson on oil releases
– FT Alphaville
El-Erian: On governments as portfolio managers – FT Alphaville

This entry was posted by Izabella Kaminska on Friday, June 24th, 2011 at 9:23 and is filed under Capital markets, Commodities. Tagged with , , , , , .

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