War in Iraq threatens to deprive world oil markets of 2 mn bpd. Strikes in Venezuela may add a further 1 mn bpd to the shortfall. Other members of OPEC have said they will make up the deficit, but they may not be able to produce the extra oil quickly enough to prevent a shortage. In any case, whatever OPEC does produce will take several weeks to arrive in key markets like the USA and Japan. This leaves the oil industry dependent on its inventories; but these are close to record lows in many areas. One source of oil, however, is both at a high level in many cases and readily available: and that is the oil held in strategic stockpiles by governments in the industrialized countries. The only trouble is that governments do not want to use their stockpiles even though they were established to meet such emergencies as the present one.
Iraq’s oil production exceeded 2.5 mn bpd in February, of which just over 1.7 mn bpd was exported under the UN’s oil-for-food programme. A further 0.3 mn bpd was supplied outside the UN’s auspices to Syria and Jordan. Around 0.9 mn bpd was supplied to the USA. Venezuela managed to push its output up to 1.5 mn bpd in February, some 0.8 mn bpd above January’s level, giving exports in February of about 1.0 mn bpd (see Table A).
Table A |
|
Iraqi and Venezuelan supplies, February 2003 |
|
| (mn bpd) | |
| Iraq | |
| Production | 2.5 |
| Consumption | 0.5 |
| Exports | 2.0 |
| UN | 1.7 |
| Non-UN | 0.3 |
| Venezuela | |
| Production | 1.5 |
| Consumption | 0.5 |
| Exports | 1.0 |
The fall in Venezuelan exports since November has easily been made up by the rest of OPEC. Output from the group as a whole has risen from 26.7 mn bpd last November to 27.6 mn bpd in February. Much of the extra output has come from Saudi Arabia, where crude oil output is running close to 9.0 mn bpd, compared with 7.9 mn bpd in November. Nigeria has raised output by 0.3 mn bpd over the same period, whilst United Arab Emirates (UAE) and Algeria have put on a further 0.2 mn bpd each. There is therefore little problem as far as production is concerned: the issue is more one of the oil’s not being where it is needed. Much of the oil produced in February is still on the high seas en route to the USA, Europe, and East Asia, where the main consumers are and where also the main shortages are to be found. Refiners are having to draw down stocks of both crude oil and refined products to meet winter demand and, in some cases, to cut runs, which depletes refined product stocks still further. US stocks of middle distillate and heavy fuel oil are near to record lows. European refinery inventories are showing a similar trend, and the situation in Asia is little better.
The oil industry is thus running short of oil, but industry stocks are by no means the only form of inventory. There are five main types of stocks:
Stocks held by refiners come under the category of ‘operational stocks’, which also include stocks held by wholesalers and retailers. They may also be described as ‘commercial stocks’. Their main function is to allow refining, wholesaling and marketing to be carried on efficiently and without interruption during temporary shortages or periods of high demand. Stocking and de-stocking often takes place in seasonal cycles. Refiners and wholesalers, for example usually build up stocks of middle distillate in advance of the winter heating season, after which they start to stock up with gasoline in readiness for the summer driving season.
In the early 1980s, oil companies would aim to provide themselves with a cushion of stocks sufficient to cover all but the most extreme circumstances. Carrying stocks, however, is expensive, and pressure from stockholders to improve returns forced oil companies to take a hard look at their costs. Stock levels were gradually reduced and companies began to operate much more on a hand-to-mouth basis. They were aided considerably in this policy by changes in the oil markets. The growth of spot markets enabled refiners who suddenly found themselves short of crude or products to cover their requirements quickly, whilst derivatives markets enabled them to hedge the higher costs of their emergency purchases.
The system worked well as long as there was spare capacity in the refining, transport, and storage networks. By the late 1990s, however, all three were coming under strain, most notably in the world’s largest oil market, the USA. Environmental pressures made it very difficult for oil companies to build new facilities. This has left the industry with old and even hazardous pipelines. In June 1999, a product pipeline serving the Seattle area was shut down for 18 months following a fire. Refiners have been able to expand only on existing sites: no new refineries have been built for over 20 years. The US refinery system frequently has to operate at 100% of capacity during times of peak demand: for example, during the gasoline season.
The policy of operating at high capacity and minimum inventory levels means that refiners cannot quickly obtain extra crude or products in the event of an emergency. Price spikes are common as Atlantic Coast consumers try to obtain fuel oil form the Mid-West or Gulf Coast during cold snaps in winter, or as Mid-Western refiners try to import crude oil via a congested pipeline system to raise throughputs during the gasoline season.
For several weeks in the run-up to an Iraqi war and during a period of cold weather in the North-East, US refiners have been operating close to minimum operational inventory levels. These are normally reckoned to be 270 mn bbl for the USA as a whole. Early in February, the US Department of Energy’s Energy Information Administration reported in its weekly survey of US stocks that commercial crude inventories had fallen below 270 mn bbl. By the end of the month they were only 274 mn bbl, some 53 mn bbl below the level a year earlier.
Product stocks are well down too. Total product stocks at the beginning of March were within 2% of their record lows. Fuel oil stocks were close to 50-year lows thanks both to cold weather and the loss of Venezuelan crudes with their higher than average yields of heavy fuel oil.
Discretionary stocks include those kept by oil traders as a speculation in rising markets and stocks kept by end-users over and above their immediate needs. German householders, for example, tend to fill their heating oil tanks in summer when prices are low.
Levels of discretionary stocks are not reported to the same extent as commercial or operational stocks. They nevertheless amount to considerable volumes in total. Germany’s household heating oil stocks, for example, can amount to more than 100 mn bbl: roughly the same as US commercial inventories of middle distillate. Part of the reason for the recent falls in US commercial middle distillate stock levels is a build-up of discretionary stocks by consumers in the USA.
At any one time some 500 mn bbl of oil can be in tankers on the high seas on their way to market. The actual amount varies over the year. In December it was estimated by Oil Movements at 430 mn bbl: some 24 mn bbl below year-earlier levels as the effects of the Venezuelan strike began to be noticed. January’s figure rose to an estimated 441 mn bbl, of which 310 mn bbl were en route from the Middle East. On long-haul routes such oil can take several weeks to arrive at its destination. The picture can be complicated, for example, during periods of rising prices when tanker captains are instructed to reduce speed in order to delay the arrival of the oil and so maximize the price on arrival.
About 105 mn bbl of crude oil is held in floating storage. Around 93 mn bbl of this is oil stored at offshore oil fields for direct loading into tankers. It is thus operational storage and remains more or less constant throughout the year, being drawn down and replenished as tankers arrive and depart.
The remainder of the oil held in floating storage is mainly oil held by oil producers in locations close to the main consuming centres. The purpose of such inventories is to enable long-haul suppliers, such as Iran, to supply markets more quickly. Such storage is normally short term and tends to fall when freight rates are high, as they have recently been.
Floating storage was once popular with several Persian Gulf exporters, but is now much less common owing to the risk of oil spills. Many countries prohibit floating storage in their territorial waters. Saudi Arabia has abandoned floating storage for permanent sites on shore, for example in the Caribbean and the Bahamas. Jordan, however, has just bought a tanker to store some 650,000 bbl of crude and a smaller amount of products as a precaution against the interruption of supplies from Iraq. Iraq supplies all of Jordan’s crude—some 80,000 bpd—and 20,000 bpd of refined products.
Strategic stocks are acquired under the auspices of governments or, in the case of the OECD, the International Energy Agency (IEA). In their present form, they date largely from the Arab oil embargo of 1973. They consist of stockpiles held directly by governments or by oil companies on behalf of governments through regulations requiring companies to carry a certain level of strategic stocks. They are meant as a supply of last resort and, for this reason, governments are reluctant to use them, even during a crisis. There are about 1.3 bn bbl of strategic stocks in the OECD, of which nearly 1.1 bn bbl are crude oil (see Table B). Stocks held by the oil industry are roughly double this level (see Table C), though this latter figure includes stocks that companies are required by governments to carry for non-commercial (i.e. strategic) reasons. The strategic portion of these industry-held stocks is subject to government controls and for use only in designated emergencies.
Table B |
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OECD government-controlled stocks, end-2002 v. end-2001 |
|||
| End-2002 | End-2001 | Change | |
| (mn bbl) | |||
| North America | |||
| Crude | 600.0 | 550.2 | 49.8 |
| Products | 2.0 | 2.0 | unch |
| Europe | |||
| Crude | 154.9 | 141.1 | 13.8 |
| Products | 190.8 | 211.2 | (20.4) |
| Pacific | |||
| Crude | 317.9 | 316.0 | 1.9 |
| Total OECD | |||
| Crude | 1 072.8 | 1 007.4 | 65.4 |
| Products | 192.8 | 213.2 | (20.4) |
| Total | 1 266.6 | 1 221.6 | 45.0 |
| NB: totals rounded | |||
| Souce: IEA Monthly Oil Report | |||
The largest strategic stockpile is the US Strategic Petroleum reserve (SPR), which consists primarily of a series of underground salt caverns on the US Gulf Coast in which crude oil is stored. The SPR was established in 1975 with the aim of reducing the USA’s vulnerability to supply disruptions. It currently consists of 600 mn bbl of crude, and 2 mn bbl of heating oil in a separate reserve. The size of the SPR has been increased by 9% since the end of 2001 (see Table B) as part of a longer term plan to raise crude oil stock levels to 700 mn bbl.
The problem with the SPR and most strategic stockpiles is that there is no automatic mechanism to trigger the release of stocks. Some general rules exist, but it is not clear how these apply in any particular circumstances. The SPR has only been used once in an emergency: in 1991 during the last Iraqi war; but the draw-down then amounted to an almost insignificant 17 mn bbl. Under the Clinton administration, oil was released from the SPR to curb politically sensitive price rises for gasoline and heating oil. A further sale was authorized in order to raise money to cut the federal budget deficit. Sales for political and fiscal reasons have occurred elsewhere. Germany, Italy, and Sweden have sold stocks to raise government revenues. Last year, the European Commission proposed that EU stocks should be used to keep oil prices down, regardless of whether there was disruption to supplies. In some Asian countries, including the Republic of Korea, oil companies in financial difficulties have been allowed to reduce the strategic stockpiles they were obliged to hold on behalf of the government.
Strategic stockpiles in the OECD are supposed to be drawn down in a coordinated manner rather than unilaterally. The coordination is meant to come from the IEA but the manner in which any release of stocks might take place is far from clear. The IEA’s policy is governed by a set of procedures known as the Coordinated Emergency Response Measures (CERM). These are not a set of clear guidelines, however, so much as a process of consultation between IEA member-countries.
Different members, however, have different priorities. Some are concerned to keep prices down, whilst others are more concerned with replacing lost supplies. There is no standard definition across the IEA of what constitutes a crisis, let alone what the response should be. The original policy of the IEA was to permit a stockdraw when one or more members sustained a reduction in supplies equivalent to 7% or more of their daily consumption. This was considered too restrictive and the CERM were established to allow the consideration of other, less drastic scenarios.
Even if IEA members can agree on the need for a stockdraw, there is no automatic process to determine when and by how much stocks shall be released. The size of the release depends partly on the availability of alternative supplies. In the case of war in Iraq, these would primarily come from other OPEC members. Any stockdraw would also be offset against the amount of oil forecast to be saved in the OECD as a result of conservation and fuel switching. Any draw-down of strategic stocks is likely to err on the side of caution, ensuring that oil prices remain higher than they would otherwise have been.
Table C |
|
OECD industry stocks, end-2002 |
|
| (mn bbl) | |
| Crude | 857.4 |
| Products | |
| Gasoline | 386.9 |
| Middle distillate | 517.8 |
| Fuel oil | 140.5 |
| Others | 326.2 |
| Total | 1 371.4 |
| Total* | 2 515.6 |
| * includes NGLs, feedstocks, and other products not listed separately | |
| Source: IEA Oil Monthly Report | |
© Blackwell Publishing Ltd, 2003