A Contrarian View On The Strategic Petroleum Reserve Release Decision
Last week, many, Zero Hedge among them, blasted the decision by the IEA to released 60 million barrels of crude in what was perceived as a last ditch effort to lower the price of gas in exchange for brownie points, while ignoring the fact that the crude would have to repurchased at some point in the future almost certainly at a higher price, and that it puts OPEC in a position of potential retaliation that could have far more adverse price repercussions than the IEA's opening salvo. Then again perhaps the move was not as misguided as the skeptics believe. Below we present the view from Emad Mostaque of Religare Capital Markets who provides a different spin on things: "Market consensus following the IEA release of strategic reserves last week has been quite negative on fears of OPEC/Saudi retaliation, erosion of the all-important buffer and accusations of political pandering. We are more positive and see this as positive for market transparency and function. GCC and IEA objectives are aligned: Neither the GCC or IEA want oil prices over $100 or market distortions. The remainder of OPEC has no room to retaliate and we are likely to see more cooperation to reduce volatility. IEA targeting shortages, GCC price: This is essentially an oil swap agreement addressing the lack of light, sweet Libyan crude in the European market and the ridiculous Brent-WTI spread. The GCC will continue to pump heavier crude at market value and will defend prices in the $85-100 range. As a result, we do not believe reserves will fall to dangerous levels. Fundamentals and Libya: While we have been negative on the short-term oil price since the start of May and have been looking at the lower end of our $90-100 range for the summer, we are still constructive long-term and believe consensus estimates are reasonable. We also see a potential resolution in Libya as increasingly likely, with no increase in MENA violence."
Yet the punchline from Mostaque's line of thinking revolves around the possibility of OPEC retaliation:
OPEC unlikely to intervene: While there have been fears of production cut in reprisal from OPEC, we do not believe this will be the case as highlighted in our previous note on June 23rd “MENA Strategy - From OPEC to OPIC”. With the previous meeting having broken down on disagreement over production increases, we find it highly unlikely that the GCC nations of OPEC will agree to a production cut as long as the oil price remains within their comfort zone. Most of the non-GCC members are producing at capacity given inefficient economies and high budget breakevens and it would be a brave move to unilaterally cut production and pit themselves against the spare capacity of the GCC. It should be noted that while Iran currently heads up OPEC, this is a rotational position and does not indicate that they have taken control.
Needless to say, our opinion does not quite mesh with that of Religare, because if it all boiled down along rational decision making, OPEC would not have broken apart during the Vienna summit two weeks ago. Of course when it comes to irrational players, a rational decision is precisely one of the unexpected possible outcomes. Which is why we could very well be wrong. Although, much more than marginal supply and demand issues, the key driver of oil prices over the past decade has been central bank liquidity. Which is why the world should probably be far more concerned with what Bernanke will do than what the OPEC may or may not.
And finally, lest they be blamed for spreading optimism, Religare does note that despite all of the above (or below, where we have placed the full note), the likelihood of $200 oil has actually increased:
Feeding the bear: Finally, we would highlight that the chances of our bear case scenario of $200 oil outlined in our February 27th note, “Global Strategy – Resilience or Ignorance”, have increased given the shift in the political and economic situation in the MENA region, with the probability of an attack on Iran rising to 15% from 5% on a 12 month view
Much more in the full note:
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