On 17 September 2012, speculation about a possible release of oil from the U.S. strategic petroleum reserve had immediate impact on the oil price. Since then, the oil price has dropped 10% from $100/barrel to $90/barrel. I believe this 10% drop in the oil price is overdone and investors should take this chance to buy into this dip. Moreover, I want to put a measurable number on the effect of the release of the SPR on the oil price. This article will focus on that impact on oil prices due to a possible release of the SPR, while keeping in mind what happened to the SPR historically. Let's start with defining the SPR.
The strategic petroleum reserves or SPR are only to be used during emergencies defined as follows:
- an emergency situation exists and there is a significant reduction in supply which is of significant scope and duration;
- a severe increase in the price of petroleum products has resulted from such emergency situation; and
- such price increase is likely to cause a major adverse impact on the national economy.
The biggest reason for this release of the SPR is obviously the turmoil in the Middle East of which I talked about here. Other reasons are said to be because of the presidential election. The question is, for how long can this release of the SPR put a lid on rising oil prices?
The strategic petroleum reserves are currently standing at 695 million barrels, while the U.S. uses 20 million barrels a day according to the Department of Energy. This means that the maximum supply of emergency oil can be calculated as 695/20 = 35 days of extra emergency oil supplies. It's unlikely though that the U.S. would release all of its SPR at once. It's more likely that the U.S. will release only a small part of its total SPR. The U.S. has only released its SPR a few times in history, the first time it released its SPR was on January 1991 and the last time was on 23 June 2011. All of these releases were on average in the amount of 30 million barrels. Which is about 1.5 days of supply, too few to have any significant long-term effect on the oil price.
The first release of SPR was on January 1991 under the Bush administration due to the war in Iraq. The U.S. released 17.3 billion barrels from its oil reserves. Oil prices had spiked from an average of $25/barrel to $50/barrel due to the Gulf War. After the release of SPR, the oil price returned to its average of $25/barrel. Last year on 23 June 2011, due to the Libyan crisis, the International Energy Agency (IEA) once again released 60 million barrels of oil, of which the U.S. contributed half of it. The effect was a 10% drop in oil prices. But the oil price quickly recovered a few months later.
To summarize the effects on the release of the SPR on the oil price I would like to mention that we will likely see a decline in the oil price immediately after the announcement. The price drop won't be much more than 10%. It is very likely that this release of the SPR will occur in the months of October-November 2012 just before the November 2012 elections. The likelihood will increase if oil prices start to rise in the coming weeks. Additionally, there is speculation that before the November 6 2012 U.S. election, Israel could strike Iran. If this strike were to happen, it will put additional upward pressure to the oil price. Investors need to bear in mind though, that oil prices have already dropped 10% since the chatter about the SPR release. If the oil price were to keep falling, due to negative economic news, there will be a smaller chance of a release of the SPR.
I believe the recent 10% drop in oil prices is overdone and should be a buying opportunity for investors, especially in terms of gold (Chart 1). The reason behind this logic is found in the amount of supply of the SPR, which is probably 1.5 days if we base ourselves on historic numbers. This supply of 1.5 days is too small to have any significant long-term effect on oil prices. Additionally QE3 was announced a few weeks ago and it should be very beneficial to the price of oil going forward. Investors can bet on a rebound in the price of oil by buying iPath Crude Oil ETN (NYSEARCA:OIL) or United States Oil Fund (NYSEARCA:USO).