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Market Insights

Oil: what's the big picture?

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The biggest story in oil markets last week was the announcement of the huge US oil release. The move is designed to bring prices down in the short term and “to serve as a bridge until the end of the year when domestic production ramps up” per the White House.

It seemed to have the desired effect. Brent crude fell from $110 to $102 and WTI fell from the mid $106 area to lows just under $97. Prices have recovered somewhat this week.

Oil brent price daily movement

This Strategic Petroleum Reserve (SPR) release is a big deal. President Biden authorised the release of 180 million barrels at a rate of 1 million barrels per day. The US is already a powerhouse oil & gas producer. For the next 180 days, the SPR alone will become the 20th largest oil supplier in the world.

Some have called this a cynical move to solve a “pump-price” problem as the US heads for mid-term elections later in the year. The decision has also been criticised as a short-term fix to a longer-term structural problem.

Critics say that the SPR release (which is designed “to serve as a bridge until the end of the year when domestic production ramps up”) actually disincentivizes producers, because it pushes prices down in the near-term.

But the devil’s in the details…

The Strategic Petroleum Reserve will now reduce to levels not seen since the 1980’s. The oil that’s released over the course of the next six months will need to be replaced in the future.

This is also the second recent release from the SPR. In November 2021, President Biden authorised the release of 32 million barrels. This release was expected to be replaced between 2022 & 2024.

Once all’s said and done, the SPR is likely to be short 200+ million barrels of oil.

The Spanish have a great saying for this type of decision: “pan para hoy, hambre para mañana”. It literally translates as “bread for today, hunger for tomorrow” and is used as a critique when short term fixes are applied to long-term problems.

Is this the case here? The reaction in futures markets certainly suggests it could be. This chart shows oil futures prices (at quarterly intervals) between now and December 2023. It’s pretty easy to follow. The further into the future, the lower the price is expected to be:

Oil future price

But that might not always be the case. The circled areas are the immediate response to the SPR decision. Prices in the near-term fell, but longer-dated prices rose.

If the US government goal is to reduce prices now AND incentivise future production, is that exactly what they’d want to see?

All else equal, higher future prices should incentivise production. The US government will need to replenish the SPR, and there could be market share to be grabbed from Russia over time too.

International sanctions against Venezuela & Iran led to a decrease in domestic oil production. The same could be true for Russia.

If that were the case, who would plug that supply gap?

Not investment advice. Past performance does not guarantee or predict future performance.

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