Avi Salzman, Barron’s

NEW YORK
Energiesnet.com 12 08 2023

Oil and war have long been linked. Russia’s deep oil reserves gave President Vladimir Putin a tactical advantage when he invaded Ukraine in February. He struck at a moment when global oil producers were struggling to keep up with demand, and prices were rising. Given that Russia is the world’s third-largest producer, close behind the U.S. and Saudi Arabia, he was betting that Europe couldn’t afford to shun his supplies in retaliation for the invasion.

For the first few weeks, his calculations appeared to be correct. The chaos…

Oil and war have long been linked. Russia’s deep oil reserves gave President Vladimir Putin a tactical advantage when he invaded Ukraine in February. He struck at a moment when global oil producers were struggling to keep up with demand, and prices were rising. Given that Russia is the world’s third-largest producer, close behind the U.S. and Saudi Arabia, he was betting that Europe couldn’t afford to shun his supplies in retaliation for the invasion.

For the first few weeks, his calculations appeared to be correct. The chaos within the energy industry strengthened Putin’s hand and filled his coffers with oil money as prices spiked. But the shock wasn’t nearly as destabilizing as it would have been had an alliance of energy consumers not joined together to oppose him. By releasing oil from strategic reserves, and mobilizing key players in oil transportation to cap prices of Russian oil shipments, countries dependent on imports blunted the oil shock.

“I don’t think there’s any precedent for this,” says Daniel Yergin, vice chairman at S&P Global and author of The Prize, a Pulitzer Prize–winning history of oil. “It certainly sends a message that consumers have a say here, too.”

While there are clear limits to how far these actions can go, and questions about whether they will be used after the war, “it does show a shifting of the balance of power in the world oil market,” he says.

Ukraine’s success at repelling a much better-armed invader will be studied by military historians for years. But energy historians are taking note of the response by the West and some Asian countries to Russia’s militarization of energy supplies, which marks a sea change in energy power politics. After decades of paying deference to the Organization of the Petroleum Exporting Countries and other large oil producers, oil consumers developed a kind of buyer’s cartel.

“Out of desperation, consumers and especially the U.S. have discovered in 2022 that there are paths to oil market intervention beyond pleading with OPEC,” writes Karim Fawaz, who leads the energy advisory service at S&P Global Commodity Insights.

In an email to Barron’s, Fawaz writes that the “newfound interventionism” from oil importers adds a “new tier of relief valves for prices that did not exist (or were not used) in the past.”

All else being equal, a united group of oil buyers could serve as an anchor on oil prices, and potentially curb gains for oil stocks. A persistent and united buyer’s cartel could eventually become a factor in a long-term investment thesis.

The show of force by consuming nations began last March and April, when the 31 members of the International Energy Agency agreed to release oil from their strategic reserves to force oil prices lower. The IEA, a Paris-based multilateral organization that largely represents oil consumers, had activated emergency measures before, but nowhere on the scale of 2022’s actions. Through late December, developed countries had sold 281 million barrels of oil from strategic reserves, or about 800,000 barrels a day since the start of that year. That amounts to less than 1% of the oil market, but it probably shaved $20 or more off oil prices in the spring and summer, because oil tends to trade at the margins of supply and demand. Brent crude, the international oil benchmark, hit its peak settlement value of $127.98 per barrel in March, but had fallen below $100 by July. Recently it has been trading around $80.

How much of that decline, which has also led to a sharp drop in gasoline prices, was caused by reserve releases? Part was clearly driven by a fall in demand, but research shows that releasing reserves also tends to have major price impacts. Past U.S. releases have shaved 15% to 20% off prices, according to a 2017 study by nonprofit research organization Resources for the Future, or RFF. And those prior releases were much smaller—during the Libya conflict in 2011, the U.S. sold 60 million barrels. President Joe Biden’s emergency release was 180 million barrels, though stretched out over a longer period of time. Richard Newell, an author of the paper and the president of RFF, says it’s difficult to pinpoint the exact financial impact of this year’s SPR release, but that it was almost certainly more than the prior releases he studied.

Republicans have criticized Biden’s aggressive use of the SPR, claiming that it weakens U.S. preparedness by bringing reserves below 400 million barrels, the lowest level in decades. House Republicans launched an inquiry into the sales in October, writing to the Department of Energy that Biden had “emptied more of our vital stockpiles than all previous presidents combined.” U.S. government reserves hold less than 50 days worth of U.S. consumption, should imports cease, they said. Indeed, the reserve isn’t bottomless. Some barrels in the reserve are already spoken for, because congressional bills to fund items like highways have been partially paid for through future sales of reserve oil.

Aggressive reserve releases aren’t the only tool buyers are using, however. The Group of Seven nations, the European Union, and Australia imposed a price cap on Russian crude on Dec. 5 to go along with a ban on oil shipments to Europe. Western shipping companies and insurers, who dominate the industry, were forced to attest that any Russian crude they transported sold for less than $60 a barrel, thereby depriving Russia of oil revenues. Russian barrels can still flow to India and China, but they can’t rely on most shippers without adhering to the cap. Russia has said it won’t sell to countries abiding by the cap, but the cap’s existence at least strengthens the hand of oil buyers in negotiations with Russia. And analysts say that the cap worries OPEC, because its members could one day become a target of this kind of action.

The Treasury Department, which played an influential role in imposing the cap, has said it’s a solution for one particular problem. “This is not about a global buyer’s cartel for all oil,” said Ben Harris, Treasury’s assistant secretary for economic policy, in a December session at Harvard University. “This is about oil that is coming out of Russian soil and nothing else.”

Some market experts agree. “I don’t see this kind of price cap playing a big role in a normal oil market situation,” Newell says, calling it a “targeted mechanism.”

But others expect the price cap idea to last.

“Having gotten a taste of it, there’s no sign of going back,” Fawaz writes. “The more tools consumers have in their oil market intervention toolbox—the harder it becomes for OPEC to maintain price and political leverage.”

The newfound aggressiveness of oil consumers comes as OPEC has lost some of its market power. The cartel produced 29.95 million barrels a day in September, before agreeing in October to cut two million barrels a day to attempt to force prices higher. Several countries in OPEC have been unable to hit their quotas, however, and at times its production has fallen as much as three million barrels below expectations. Production is well below the 2016 peak of 34 million barrels a day.

Still, talk of a buyer’s cartel needs to be put into the context of other colossal shifts in the energy market, not all of which benefit buyers. OPEC’s capacity may have fallen, but it has deepened its alliance with Russia and a handful of other producers, a group known as OPEC+. Together, they control over 40% of the oil market and remain a formidable force. In addition, the world’s oil consumers are not exactly unified, given that top oil importer China has not joined efforts to hold prices down. Chinese demand will do more to determine the path of prices than almost any other factor for the next few years.

The U.S. also plays a more complicated role than when then–Secretary of State Henry Kissinger first pushed for an alliance of buyers 50 years ago, leading to the creation of the IEA. Back then, the U.S. imported most of its oil and depended heavily on the Middle East. Today, the U.S. is the world’s largest oil producer and exports more petroleum than ever. The strength of the U.S. shale revolution, which has caused production to grow from five million barrels a day to 12 million, is a key reason that buyers have more options. The price cap wouldn’t be nearly as effective without the tacit understanding that the U.S. can supply oil to its allies. “I think without the shale revolution, the U.S. wouldn’t have this leverage,” Yergin says.

The Biden administration’s latest oil market intervention illustrates just how special a role the U.S. plays. With oil futures flirting with the $70 level in early December, the Department of Energy announced that it was taking bids for three million barrels of crude to be delivered at fixed-price contracts in February. Biden has said that when oil falls to about $70 or below, the U.S. will consider buying more for the strategic reserve. His hope isn’t just to refill the reserve, but also to “encourage firms to invest in production right now.”

A buyer’s cartel is an appealing thought, particularly as oil consumers shift to renewable energy and lower overall demand. For now, oil consumers will benefit the most when independent producers invest steadily in production. The most powerful countries will be ones, like the U.S., that can flex muscle on both sides of the market.

Write to Avi Salzman at avi.salzman@barrons.com

barrons.com 12 08 2023