IEA and the Objectives Behind Release of Strategic Oil Reserves

Dr. Walid Khadduri: IEA and the Objectives Behind Release of Strategic Oil Reserves

  • 10 July 2011

The International Energy Agency (IEA) was founded in 1974 on an initiative by former US Secretary of State Henri Kissinger in response to the 1973-74 oil embargo imposed by Arab oil-exporting countries against the US and Netherlands because of their support to Israel in the 1973 war. This led to a bitter conflict between IEA, which defends the interests of major industrialized oil-consuming countries and OPEC, which represents oil-producing countries. However, after years of intense efforts relations between the two organizations improved. They held joint meetings, exchanged information and participated in World Energy Forum (in Riyadh) to enhance transparency in energy markets for the benefit of producers as well as consumers. It is believed that both the parties built close cooperation to ensure sufficient oil supplies in times of crises and made collective efforts to avoid any disruption in the world market. Relations between OPEC and IEA have improved remarkably during the last decade.

However, IEA’s June 23 decision to release 60 million barrels from its member-states’ strategic reserves – equivalent to 2 mb/d in July 2011 – and its provocative statements against OPEC and its member-states mark a dangerous shift in the relations between the two and consequently between producers and consumers of oil. The friction is over the so-called justification for the release of these reserves. IEA’s official version is that it is to offset the loss of Libyan oil exports (1.6 mb/d) even though GCC countries (KSA, the UAE and Kuwait) have already declared that they have spare production capacity and are willing to compensate any loss of supplies from Libya. It is noteworthy that the commitments of these three countries have proved to be honest and reliable on previous occasions and they have actually compensated the loss of supplies whenever needed. They also spend billions of dollars annually to maintain this spare capacity to be utilized in times of need such as the period witnessed recently. International oil companies and their governments are aware of this fact.

Another reason cited for this was that the compensating oil is not of the same quality as the light Libyan oil even though Saudi Aramco had assured that it provides the market with oil of the same quality. The IEA even pointed out that oil being supplied as compensation by Gulf countries does not reach market in time. Doubts can been raised over all these justifications, especially when one looks at the recent IEA data, which indicates that the overall reserves of its member states amount to about 4.1 billion barrels of crude oil, of which 1.6 billion are allocated for ‘emergency contingencies’. This means that the IEA member-states have strategic reserves sufficient for 146 days (about 5 months). The IEA’s rules and resolutions, however, require its member-states to keep strategic reserves of imported crude oil for three months only. In other words, the crude oil reserves in industrialized countries are more than sufficient at present. The question hence is why has the IEA taken such a decision now?

Several assumptions have been made on the reason behind the release of strategic oil reserves. One reason given is a significant rise in the crude oil prices and its products as gasoline prices reached about $4 per gallon in the US. This happened at the beginning of the summer season when the use of vehicles goes up owing to vacations within the country. This also coincided with President Obama’s announcement to run for a second term and the nomination of Democratic candidates for the election of members for both the houses. The US administration hence started to worry about its political future and urged IEA member-states to exercise this option to enforce reduction in oil prices. Needless to add, Washington has a very strong influence inside the IEA.

Another hypothesis points to an attempt by Western countries to reduce oil prices with the objective of putting more pressure on Iran to deter the country from going ahead with its costly nuclear program. It is also said that the release of strategic oil reserves was an IEA response to the result of the OPEC ministerial meeting on June 8. OPEC could not agree on raising the production ceiling due to Iran and Venezuela’s objection to a Saudi Arabia proposal, supported by other GCC members at OPEC. Yet another assumption is that the IEA decision is meant to punish Arab oil-producing countries for supporting Palestinian Authority’s unilateral bid to get UN General Assembly’s recognition for a Palestinian state in September, in spite of the US and Israeli opposition.

Notwithstanding the real reason behind the move, most agree that the IEA is making efforts to reduce oil prices. This is also the bone of contention between IEA and OPEC because the purpose of strategic reserves is to offset supply shortages or losses in cases of disruption of supplies due to political or industrial reasons and not to influence the price of crude oil. As far as ensuring the balance between supply and demand is concerned, this is the task of commercial oil-stocks which are established and financed by international oil companies in various countries. Moreover, the recent release of oil from strategic reserves release is considered a political maneuver by the governments of industrialized nations to influence oil prices behind the scene of the free transactions in oil markets.

Some media reports even talk about the possibility of another release from strategic reserves for another month. However such a decision is unlikely because initial indications suggest that huge volume of this oil found their way to China, which doggedly seeks to build its own oil strategic reserves. China needs about 40 million barrels of additional oil during this summer season. But industrialized countries in the West are not satisfied with their reserve oil being purchased by China for relatively reduced prices (less than $115 per barrel).

The important question that comes up now is: are oil prices going to drop in the medium to long term due to the release of strategic reserves? Even though prices decreased to about $100 per barrel as a response to this release and remained so until the end of June, they went up again to about $114 during the first week of July, which is almost the same price level registered before the release. Data indicates that the demand for oil is constantly increasing and that is proved by the current level of demand, which is estimated to be 89 mb/d compared to 85 mb/d in 2005. This demand rise has occurred despite the global financial crisis of 2008-09, which means that this release only had a temporary impact on prices and will not affect it in the medium to long term.

The IEA’s decision to release oil from its strategic reserves is a significant turning point in the relations between producers and consumers of the commodity. Hence, in order to limit the damages and consequences of this decision, it has become imperative to review the reasons and motives behind the decision.