More than political interest behind IEA move

flovestock

Javier Blas
LONDON— Financial Times
Published Friday, Jun. 24, 2011 6:35AM EDT
Last updated Friday, Jun. 24, 2011 9:09AM EDT

Does the International Energy Agency know something that the market ignores?

The release of the strategic petroleum reserve is prompting questions in the market. True, Libya oil production is out-of-action; refineries are demanding more oil as we move into the second half of the year, and high oil prices are affecting economic growth. All of that is plainly evident to the market. Yet, it appears that there is something more.

For the critics, that something more is political interest.

The White House – and European governments – were concerned about losing votes due to high petrol prices. Other argue that the release is a response to the collapse of the meeting of the OPEC cartel earlier this month. I think factor is relevant as background, but also that there is more to it than that.

The more to it is not a secret that the IEA is keeping close to its chest and the market ignores. I just think that the agency is putting more emphasis on some evident problems it sees lying ahead: the first one is the outage in Libya, the second is the health of demand.

On Libya, the release indicates that the country’s oil production is not going to recover any time soon. The north African nation pumped around 1.6m barrels a day of high quality light, sweet oil before the start of the civil war around 100 days ago. Since then, production has fallen to just 200,000 b/d. Even if the war were to finish today, production would not recover for months. The outage has already been long enough to inflict damage on the oil wells, some of which would need to be redrilled to recover. That would take time. So the release is clearly telling the market ‘forget about Libya for the rest of the year. If not longer’. Moreover, London, Paris and other capitals involved in the conflict probably have indicated to the IEA that the chances of a military or political solution over the short term are minimal, further delaying the return of oil production.

The health of demand is another key factor. True, economic growth in the US and Europe is slowing down, and so is oil demand growth there. But at the same time consumption growth remains robust in the rest of the world. The IEA hinted at this factor during a conference call with reporters on Thursday. In particular, it noted that some of the production boost by Saudi Arabia – which has brought oil output to more than 9.5m b/d and it is on its way to a 32-year high of 10m b/d – would be necessary to meet rising domestic demand by the kingdom during the summer, when the use of air conditioning and water desalinations triggers a spike of direct crude oil burning for power generation. While some on the market expect that economic weakness would cut demand growth, I believe that the IEA is telling the market the opposite: demand growth remains strong.

Conspiracy theorist are having a field day, but I think that the release is ground of simpler facts: the loss of Libya production for longer than anticipated, the surprising robustness of oil demand growth in China, India and Saudi Arabia, and, yes, the evident impact of high oil prices on economic growth in developed countries.

Add to that a new view in Washington and at the IEA’s headquarters in Paris of the strategic reserve as a smart bomb, to be used in the event of small oil output disruptions, rather than a nuclear option, to be used only as last resort, and the release makes sense.