Last week, western nations, through the International Energy Agency, announced the impending release of the largest amount of oil from their emergency strategic reserves since 1991.
Over the next month, the IEA will release 60 million barrels of light, sweet crude oil. The United States will lead the release by providing 30 million barrels of oil to the market.
The IEA stated that the release of oil from inventories is to make up for the loss of production in Libya.
But the real reason behind the move is a rather different one, one that shifted the landscape in the oil market permanently.
The IEA’s Decision Made By Weak Global Economy and Politics
In the past, the IEA released oil from its reserves only when a major supply disruption occurred, such as the Iraq War and Hurricane Katrina. But now they’re releasing oil when the only disruption to oil supplies is a minor one in Libya, where production has fallen from 1.6 million barrels a day to just 200,000 barrels.
This is where it gets tricky for investors. The IEA’s decision wasn’t based on supply and demand or economics, but on politics. The move is aimed at putting a ceiling on oil prices. It’s also intended to bring down the price of oil quickly and sharply, especially with increased production in Saudi Arabia.
The reason is obvious. Western economies, particularly the United States, are slowing down rapidly. They’re struggling with stubbornly high unemployment and consumers hurting from high commodity prices. It’s a very real effect. Goldman Sachs estimated that the rise in oil prices took $118 billion out of the U.S. economy in the first quarter alone.
A sharp drop in the price of oil will serve as a stimulus to the global economy. And this includes the United States, where the effects of previous fiscal and monetary stimuli have worn off. The Federal Reserve issued a downbeat outlook for the U.S. economy last week, emphasizing that growth would be lower than previously expected in 2012.
So the U.S. economy looks in need of a stimulus heading into 2012 – an election year. Especially since it looks like the Federal Reserve will hold off on launching QE3 for at least a few months.
And so what do we get? Voila – we get a stimulus – a release from the emergency oil reserves when there’s no emergency, only an upcoming election.
The stimulus should work too, at least for now. It’s estimated that for every $10 rise or fall in crude oil prices, the nation’s gross domestic product moves about 0.5 percent .
Politics entering the equation may have permanently changed the way the IEA works. The IEA, largely controlled by Washington, will intervene much more often now and enter the market with sales from its reserves any time the price of oil is deemed to be “too high.”
Who Benefits From Lower Oil Prices in the Long Term?
This change in how the IEA works will put a ceiling on oil prices over the short and medium term.
Who stands to benefit from lower oil prices? Obviously, every consumer of oil on the planet, including the United States.
But the emerging markets will benefit the most. Consumers in these countries pay a much larger portion of their incomes than Americans do for basic commodities such as food and fuel.
Even the IEA stated that the demand for oil is strongest in the emerging world, and that countries such as China, India and Saudi Arabia are the ones where demand is growing the quickest.
Emerging markets are currently suffering because their central banks are raising interest rates due to rising inflation. Much of that inflation stems directly from soaring prices for commodities, like oil.
So a drop in oil prices will likely begin a process where interest rates in the emerging world begin falling again, stimulating the already rapidly growing economies.
The current weakness in emerging market stocks presents a buying opportunity for investors.
But keep in mind that this form of stimulus cannot last for long. If the IEA keeps releasing reserves to lower oil prices, its inventories will eventually become depleted.
And as the IEA tries to restock its oil supplies, adding more demand, it will lead to much higher oil prices in the long term.