Oil Reserve Release: The Quickest Way to Remove Incentive
by: Dr. Stephen Leeb June 29, 2011
Last week’s decision by the IEA (International Energy Agency) to release 60 million barrels of oil, including 30 billion barrels from U.S. strategic reserves, was a remarkable and defining decision.
To my mind, it represents one of the scariest, most mindless, most desperate and worst decisions I’ve seen in more than 30 years of watching markets and economies – signaling that we are close to throwing in the towel on the very idea of developing an economy that can work in the 21st century. (If pushed to wall I might have to admit the 2009 stimulus package was just about equal.)
Yes, the implications of this decision are at least dire . . . and probably worse.
It came immediately after last week’s Federal Reserve Board meeting concluded with absolutely nothing new announced in the way of policy. The Fed said it would let QE2 expire as scheduled on June 30th, with no additional buying of Treasury securities (that is, beyond what the Fed requires to maintain its present balance sheet) to provide a monetary stimulus to the economy.
The Fed concluded that the economic data had indeed been disappointing, and on this point we wouldn’t quarrel. Unemployment insurance claims have been regularly over 400,000 per week since April – a number that virtually precludes any increases in employment growth.
These unemployment figures are not surprisingly complemented by very poor numbers regarding consumer sentiment, buying… virtually anything having to do with the U.S. consumer. Indeed, as we have noted before, the only strength in the economy appears to have come from a weakened dollar, which has been translated into high corporate profits.
Background conditions are at least as bad today, in our opinion, at they were in 2010, if for no other reason that a year of stimulus has done very little. One could argue that since monetary stimulus hasn’t worked, why continue? But in a situation like this you continue because you don’t have any other good choices. With the government set on making at least some cuts in spending (assuming they can in fact reach a deal), monetary stimulus would appear to be the best among a number of horrible choices.
But politics are politics. The emergence of Ron Paul as a forceful advocate against the Federal Reserve, along with other political elements, make a QE3 problematic as it’s not politically feasible. (We are reluctant about straying off our proper terrain by getting into political analysis here. And we have nothing against Ron Paul; although we disagree with him about the Fed, we do feel he’s one of the few honest politicians around.)
Nevertheless, for whatever reason, the Fed, when it came down to it, punted.
Following close on the heels of an economy that is now dependent on commodity prices somehow coming down (paraphrasing the Fed’s own statements), it was hard to believe that was possible in the face of China’s draw-down of inventories, along with Premier Wen’s recent statement that inflation is basically under control.
Bernanke also noted that Japan will soon get its act together, which will also boost U.S. economic growth. But trying to time the recovery in Japan (and we do believe that there will be a recovery) is getting into perilous territory; anyone betting their marbles on it occurring in a particular month or quarter or any particular time frame hasn’t studied or learned anything about Japanese history. Yes, there will be a slight uptick in auto sales, but clearly no signs in the economy point to anything that could be called a real recovery.
Again, it was shortly after Bernanke’s statements on Wednesday, June 22 that the IEA announced the release of 30 million barrels of oil from the U.S. strategic petroleum reserves (60 million barrels in total, with the addition of reserves from other IEA member nations) to make up for tightening world-wide oil supplies due to the interruption in Libyan production, among other factors.
Let’s call this “RE1,” for Resource Easing 1. Presumably this proved Bernanke right in a way: resource prices could come down and boost consumer sentiment. But he didn’t tell us this could happen, in effect, “magically” through a mechanism such as what the IEA implemented.
We should acknowledge that 30 million barrels of oil from the U.S. reserves is not a nominal amount. And this represents only the third time we have released oil from our strategic reserves. The first two times were to counteract an emergency. The first was during the first Gulf War; the second, in the wake of Hurricane Katrina, which shut down all oil and gas production coming from the Gulf of Mexico.
The amount of oil from both of these previous releases from strategic petroleum reserves was less that what’s being released this time around, which comes to 4% of the total we held.
Four percent doesn’t sound like a lot. But imagine if we had to continue doing this monthly for a year: suddenly half of our reserves for a rainy day would be gone. (We recall that former President George W. Bush elected to add a couple hundred million barrels to the Strategic Petroleum Reserve, presumably just because of the uncertainty he saw in the Middle East, a region we are so dependent on for oil.)
This release comes during the so-called Arab Spring, a time when, if anything, we should be trying to figure out how to best prepare and insure ourselves against the need for a lot of oil for an extended period of time.
The release also follows very strong statements from the Saudis, that despite what they called the worst OPEC meeting they had attended in many years, and despite no agreement to increase production, they unilaterally would make up for Libyan production short-falls from the excess supply they hold.
Of course, some argue that there are political implications behind all of these developments. We have mentioned the Fed’s inability to initiate a QE3, even though they hinted that they might go ahead with that, if conditions warranted it. But that was almost a throw-away statement by Bernanke.
Others have argued that without QE3 an action like this – an RE1 – was necessary to get the economy going, especially in view of the upcoming 2012 elections and the even closer driving season this year. Clearly this raises the issue of what Saudi production and capacity really are. We know that, after all, no one wins if the U.S. economy falls again – including the Saudis. The Saudis, remember, had already said that they would make up the more than 1 million barrels lost from Libya and go even further if needed. Now we have an extra 2 million on top of Saudi assurances.
So it remains to be seen what the implications are of this release of strategic reserves. If it suggests limits on Saudi production, it also suggests limits on U.S. growth in the face of rising commodity prices. Related, and more important, is the fact that the release virtually assures we are giving up on any plan to develop alternative/renewable energies. The best way to de-incentivize the development of any form of energy is to keep oil prices low. For example, the 2008-09 decline in crude prices set back the development of many energy projects by at least several years.
As an aside, we’re sure many of you read this week’s issue of Barron’s, whose cover story focused on China’s military buildup. China is clearly a threat on the resources front, not only because they are miles ahead of where we are in developing renewable energy, but because they continue to accumulate vital materials for developing those renewables.
The release from our Strategic Petroleum Reserves comes with world-wide oil inventories at fairly reasonable levels, certainly higher than average (which is still another reason to scratch your head in utter disbelief.). No one will be able to prove this, but our very strong guess is that a lot of the inventory that we released will go from our rainy day reserve right into China’s.
Perhaps one thing China doesn’t have enough of if they want to fully develop their renewable alternative energy capabilities is the hydrocarbons required for the development processes for those forms of energy. Needless to say, they will also need plenty of oil to run a military whose funding is increasing at double-digit rates each year.
And from this perspective, the release looks like an answer to the question Why not transfer some of the vital reserves from us to them; after all, how else will they run their military?
If this is not frightening enough, then pick up Sunday’s or Monday’s New York Times and look at the front page, where you will find articles on natural gas fracking. We’ve talked about this extraction process many times; you may recall that we haven’t liked it and think there are a lot of problems with it.
Now, to risk contradicting what we’ve been saying, we have never argued that the gas isn’t there in the shale formations. What we have maintained, as the Times has, is that the depletion rates with this method are very rapid, and the amount of energy it takes to get the gas out of the ground is enormous. (Last week we quoted the late oil expert Matt Simmons’ comment that the energy produced from fracking amounts to less than the energy it takes to bring it out of the ground).
So there are a lot of problems with gas fracking. But there’s no question that as far as natural resources we have a lot of gas in this country and probably a lot of oil, too. Continental Resources (CLR) is a strong recommendation on that basis. But the amount of oil we have here is dwarfed by the amount of gas.
The point we want to emphasize is that the last thing this country needs is to de-incentivize the development of any energy resources we have, whether it’s oil, gas, solar, wind, whatever. And the quickest way to de-incentivize something is to lower its price.
So while we’re not fans of gas fracking in its current state, we do believe that research, money and price incentives certainly wouldn’t do this technology any harm.
What will do it harm (along with all other forms of energy production) are artificially low energy prices. There’s absolutely no doubt about that – it’s Economics 101.
Then what the hell are we as a country thinking?
This takes us back to those political considerations.
If consumers have a short-term memory, shouldn’t politicians be more concerned with the price of gas during the driving season right before the elections of 2012 than 2011’s driving season?
And if somehow through this release of oil reserves and/or other means they succeeded beyond their wildest dreams and were able to light the spark that gets our economy going again, won’t that along with the growth of China and the other developing economies lead to much higher oil prices?
So come 2012, RE2 and RE3 will almost certainly be needed. The remarkable lack of foresight here is staggering. (Remember too that while the number of QE’s have no theoretical limit the number of RE’s has a hard limit of 24 before our strategic reserve runs dry.) Is this our best choice – to damage ourselves and destroy any chance we have of developing alternatives? It’s just crazy.
I hope I’ve missed something here, but I always had in the back of my mind the idea that those rainy day strategic oil reserves would be enough to buy the U.S. at least 2 years of freedom and maybe 4 or 5 years of relative dependence on outside sources for oil, a time period in which we could develop massive amounts of alternative energy if we put our minds to. After all, it only took us 3 years to win a World War. Anything is possible, I thought.
But now, unless someone can point out that there’s something I’ve missed, I can no longer make that last statement.
Instead, I would have to say, “Anything was possible.”
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