Farewell, SPR Release

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The Biden Administration announced a number of items relating to the Strategic Petroleum Reserve, making it topical yet againThe U.S. has released oil from the SPR for 58 consecutive weeks through mandatory or emergency salesThe final 15 million barrels from the 2022 emergency release will be delivered throughout DecemberThe Department of Energy appears to be targeting fixed price swaps in the $70 range with delivery beginning in late 2024 and beyond, but will buy near-month oil if prices allowWe provide some thoughts

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One Last Bite At the Apple

First things first.  Before we dive into the SPR news cycle, let's look at the true ailment in the global oil markets.  

Tight diesel markets, low diesel supplies and high diesel crack spreads have offset a material amount of the partially SPR-induced oil price drop.  Diesel crack spreads exceeded the price of oil this week, something that has almost never happened in the U.S. oil markets.

2022 total commercial and SPR oil and product stocks are literally falling off the chart in 2022, largely due to the SPR release.

SPR

We've admittedly discussed the United States 2022 Emergency Strategic Petroleum Reserve release at length recently, including here, here, here, and here so we won't rehash any of the prior work.  The logic, sustainability and impact of the SPR release has been hotly debated, with intended or unintended impacts on oil markets, the macro environment and geopolitics analyzed often through a political bias.

With three new SPR news items this week we got roped back into reporting on what appear to be the final releases from the prior 180 million barrel emergency sale.

1. White House announcement and press conference on new actions aimed at keeping oil prices lower.

2. Department of Energy Final Rule, allowing fixed-priced futures contracts  

3.  FY23 Emergency Drawdown No. 3D NOS

Some thoughts

• The amounts and timing comport with what we have discussed previously, although we had anticipated some releases sneaking into early 2023.

• The Biden Administration jawbones additional SPR releases but implicitly acknowledges something would need to occur to create a catalyst to give them the additional drawdown authority.

• We continue to be in the camp that a 700 million barrel SPR is too large, but remain sympathetic to the idea the SPR shouldn't be politicized.  As noted earlier, with 58 consecutive weeks of drawdowns, the releases hardly just happened right before midterm elections, but clearly a primary goal was to reduce the cost of gas at the pump for Americans at a time when inflation is creating a significant financial burden.

• We are conflicted.  Surely the releases may be 'political' in that they were used to help Americans.  But it worked.  Isn't that what DC politicians are there for?

• We also believe unspoken but implied reasoning for the SPR and IEA releases included reducing the financial windfall - if any - Russia received from economic and oil trading sanctions.  The SPR was built to help reduce the impact of oil being used as a weapon.  Russia likely believed its energy exports were too valuable to be turned away from and that prices would rise if the world tried.  Emergency releases or price caps, world leaders don't want Russia to benefit from its nefarious and gruesome actions.

• Targeting $70 is a little odd in that most traders of size don't show their hand, but we believe the Administration may have targeted U.S. E&P profitability levels.

• The DOE Final Rule is a little unclear but we believe it has been published in the Federal Register and is thus live currently.

• DOE appears set to target oil repurchases in 2024 and beyond.  At the time of the announcement second half 2024, 2025 and additional out years had futures prices listed in the $70 buy zone.

• We think the Administration boxed itself in by promising a profit for the American people.  If prices rise, they will be forced to buy further out the curve.

• In effect, the DOE has a short-term bid if prices drop and a dynamic theta (time) put.  Although it will take time to sort out, it appears the DOE is set on creating a long-term hedge market, with liquidity far in excess of what exists today.

• Changing the skew of oil prices should incentivize more drilling, should extend the cycle of profitability of U.S. producers and it should reduce volatility.

• If the entire 180 million emergency release was repurchased at $70, the DOE could buy 250-260 million with the proceeds from the 180 million barrels sold.  By no means is the SPR a trading vehicle, but selling front-end and buying the back-end could be used occasionally to reduce oil market volatility.

• There remains a chance oil prices run away from the Administration, but recessionary fears make that unlikely.

• We applaud the efforts to incentivize drilling today by providing out-year support.  But we increasingly are coming around to the view that American Energy Independence is a nice slogan but doesn't mean much if we export our energy advantage to the world or get negatively impacted by energy policy elsewhere in the world after tying U.S. energy products to global pricing.