Europe must wean IEA from dependence on US

September 6, 2012 | 00:00

Europe must wean IEA from dependence on US

European countries should firmly resist any move made by the US and G7 to release strategic oil reserves in the current situation. Such blatant interference in the market, which would clearly be made only for political (US electoral) purposes, would hurt the credibility of the International Energy Agency (IEA) and make a mockery of the IEA's ambition to become a truly global (rather than 'Western') organisation by extending its reach to China and India. In view of the US' renewed striving for ‘energy independence’, Europe has a vital interest in making the IEA’s global ambition work: the only way for Europe to reduce its dependence on Russia is to connect with China.

British Prime Minister David Cameron and President Obama shake hands: Britain has so far backed the US in its strategic oil reserve policy  (c) Time
Storm clouds are gathering for a release of the strategic petroleum reserve to coincide with US presidential elections. Not because any release could currently be justified relative to fundamentals, but because Washington needs to make it to polling day (6 November) delivering two contradictory political imperatives: cheap ‘American oil’ and sanctions pressure on Iran. Understandable stuff for the White House, but as far as the IEA is concerned, any release would not only have highly uncertain market impacts, the Paris-based agency could never be taken seriously as a global energy proposition.

Although missed by most analysts, the strategic reserve has been put on political standby at least since May 2012 when G7 ministers issued a communiqué that said they “stand ready to call upon the International Energy Agency to take appropriate action to ensure that the market is fully and timely supplied”. Iran was the clear issue to hand; the IEA was directly enlisted as a geopolitical foot-soldier to help fight the sanctions war. What made the communiqué even more politically telling was that oil prices had already dropped back to $90/b at the time due to deep seated demand side concerns. Some commentators said the G7 "misread" the market, but this had nothing to do with misreading fundamentals: Washington was laying the political foundations to make entirely clear that it would use IEA reserves whenever deemed politically fit. President Obama has cleverly used the G7 to normalise the strategic reserve as a rational (and indeed logical) option to use whenever he wants to cool benchmark prices.

So wind the clock forward to the latest G7 meetings in late August (not to mention oil prices back above $115/b), and it comes as no surprise that the threat to use the reserve has not only been repeated, but heavily briefed to journalists to get the message out: We’re on the verge of a September release: Right here, right now.

That will probably prove to be a bluff as far as September is concerned. Provided Saudi Arabia maintains notional control of the market, September is merely the final round of Obama’s bluster to trick the market into lower prices, October will be the ‘play’ where action is taken. If nothing else, Washington will want to get far closer to polling day before orchestrating a release, precisely because the IEA only has one shot at this. Go too early, and Iran will make President Obama sweat all the way to the ballot box. The release must be seen as an effective counter balance to Iran, not another ‘tried and failed’ sanctions strategy on the US electoral trail.

In order to claim some kind of political success from a release, the US needs tangible trigger points to measure their actions against, not just ad hoc actions. Squeezing Brent prices below $120/b would be one measure (particularly if prices continue to rise on the back of anticipated US and Chinese stimulus measures); making sure petrol prices in the US remain below the magical $4 a gallon is another. Both would give Washington something to point towards for electoral purposes, and especially so if a release tops 60 million barrels to significantly pull down prices.

Market jitters

Good for America, very bad for the IEA. To say this is not what the reserve was supposed to be for would be the understatement of the energy decade. As much as the US are taking a strategic release as a political given over Iran, the economic case is far (far) less compelling.

In no way has Iran created an actual or imminent supply disruption to fulfil official IEA criteria for a release. This was confirmed by none other than Executive Director of the IEA, Maria Van der Hoeven, who said on 28th August that “the market is sufficiently well supplied and when there is the collective action needed as there was last year, it can only be when we are talking about a serious disruption of supply.” Point taken.

If anything, the market has been supplied with some of the largest excess OPEC spreads since 1998: 2.1 million barrels per day (mb/d) above projected demand. But what sanctions have done, is create a

By morphing into an explicit political instrument through misuse of the reserve, the IEA's market credibility would be dead in the water
sustained political risk premium in the market that’s played well for Tehran. Whatever the Iranians have failed to sell in volume (down to 2.9mb/d against its usual 3.5mb/d) they’ve been able to make up for through elevated prices. A short term release would do nothing to fix this underlying volume vs. price problem against Iran in the medium to long term, nor would it put Tehran on a revised nuclear track. If anything, Iran is increasing market outlets through revised (sovereign) shipping insurance with South Korea, Japan and elsewhere.

Sanctions are both the cause and the problem of oil market jitters. The reserve is a very short term tool, incapable of solving a structural sanctions problem. If you release IEA stocks now, then why not in two days, two weeks or two months or two years’ time? The political fundamentals on nuclear enrichment will be exactly the same for Tehran, irrespective of whoever wins the June 2013 Presidential elections.

Hard-liners

But there are other major problems with using the strategic reserve for political purposes. First, even if a release momentarily brought down prices (traders would merely hedge the margins to pocket a handsome return, exactly as they did over Libya), it would imply that Saudi Arabia is no longer capable of setting benchmark prices. That’s a worrying development in its own right, plus it’s also entirely possible that a release would send the wrong message to Israel. Many hard-liners in Tel Aviv would be more than happy to use the window of opportunity provided by a release of the petroleum reserve to launch an attack on Iran. Forget dampening oil prices, you wouldn’t be able to put a price on oil if Israel went down that track. The collateral implications for Iranian blockage of the Strait of Hormuz and long term regional meddling across key Gulf producer states would be disastrous for oil markets. ‘Policy own-goal’ somehow wouldn’t quite capture the scale of the IEA blunder if things played out that way.

This points us towards the second major problem, namely the long term standing of the IEA. The fact that the US (G7) has never made clear what ‘a serious supply disruption’ looks like, or what price band would supposedly justify a release makes any decision inherently political. Is it $120/b, $130/b or $150/b? Or is this purely an issue of politically expedient timing? Any decision will be seen purely as a political call rather than an economic one. In earlier cases, over Iraq, Katrina and most recently Libya, there was at least some economic justification, if not always a convincing one. That is not true now.

It also remains unclear whether a decision to release strategic oil reserves would be made by the US

Europe will soon be left without any serious consumer cover to counteract producer pressures once America goes back to its native roots
unilaterally, or by those sharing G7 and IEA memberships or whether the IEA as a whole would be involved. Either way would not be good for the IEA. If done on a unilateral US basis - or indeed through bilateral US, UK, and French arrangements - the IEA would take a reputational hit by standing idle; if they are involved, they will be shown to be an instrument of US foreign policy.

But it really is the long term position the Paris based agency needs to think about most. By morphing into an explicit political instrument through misuse of the reserve, its secular market credibility would be dead in the water. Increased volatility will be the inevitable result. Not just over Iran, but over a whole range of geopolitical factors where the reserve now politically comes into view.

The IEA’s own ambitions would also take a hit. The OECD organisation is trying to extend its reach towards emerging economies, particularly China and India, and become a truly global organisation. But Asian consumers will have no truck with ‘global’ energy blueprints proposed by the IEA (or indeed co-operative ventures) if the OECD is this closely linked to US foreign policy issues. Western club, Western rules, Western foreign policy baggage. It’s as blunt as that. The IEA’s global ambitions if not moribund, will certainly be in abeyance until it can prove it has an international agenda, rather than pandering to narrow foreign policy interests.

Super-excited

With these stakes involved, the IEA (and by implication G7) has a binary choice to make. It can accept its fate as an implicit instrument of US foreign policy, and follow through on a release, or take a stand, and refuse to delve into reserves around the American elections (barring any real supply emergency of course). That means highlighting some awkward truths for the US over Iranian sanctions. Everyone knew that sanctions were never going to work unless Asian consumers were onboard to bring serious economic pressures to bear on Tehran. The twin goals of cheap US oil and Iranian pressure remain an impossible circle to square, the IEA should refuse to be the collateral damage involved papering over US electoral cracks.

But if it makes a stand, the IEA would need to rapidly step up efforts to bring in new Asian members to counterbalance US political pressures. That would mean drawing up some new market rules that everybody can live with, and giving Asian consumers a key stake in the management and running of the IEA. European politicians had their chance to stand up to US political pressures, so far, they’ve failed. Asian counterparts would hopefully do considerably better.

An ‘Asian tilt’ makes all the more sense for European IEA members when you consider what US energy independence will eventually mean for American international engagement. Europe will soon be left without any serious consumer cover to counteract producer pressures once America goes back to its

The rest of the world needs a serious strategy to safeguard their own energy security, which is exactly what the IEA should being doing
native roots. Despite drilling a staggering 58,350 wells since 2009 (pumping US oil production to a 14 year high), the Obama administration is bright enough not to believe the entire energy independence story, at least not as far as vested US international interests are concerned. But compare that to super-excited Republicans (and especially Mitt Romney), and North American energy independence is supposedly a done deal by 2020. Combine US, Canadian and Mexico production, and the rest of the world (read the IEA) can go whistle. Mitt’s even got Citigroup’s Global Head of Commodities Research Ed Morse telling him it’s a smart idea. US energy independence has become an article of political faith in Washington. Republicans and Democrats are all brought into it; it's merely a question of how far and how fast US disengagement should play out.

If that’s not sufficient food for thought for European figures within the IEA to ponder, they also need to consider the upside of having China sitting at the same consumer tables. It would have enormous strategic value against Russian pressures at both ends of the Eurasian pipeline, act as a useful hedge in Central Asia, and a positive contribution towards sustainable production from the Middle East. As recent Chinese investments in the North Sea attest, Beijing also has a vital interest in the smooth functioning of Brent markets setting global prices. It has no problem investing heavily in physical assets to do so.

Contrast that with the American mantra of ‘US energy, for US consumers, at US prices’, and it’s clear the rest of the world needs a serious strategy to safeguard their own energy security, which is exactly what the IEA should being doing. Stop being used as a pawn in US elections, and become a far larger global player by catching the biggest and most interesting fish in Asia. It’s the only way the IEA will find safer political waters in future, and retain a serious energy role.

 

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