Is this consistent enough Joe?
President Joe Biden’s administration outlined a new rule in October whereby the Department of Energy could buy oil for future delivery — most likely 2024 — at fixed prices to refill the Strategic Petroleum Reserve. The mooted price range is $67 to $72 per barrel. Then, earlier this month, Biden’s energy security adviser Amos Hochstein appeared to set a new condition by saying the DoE would solicit for those barrels when oil prices were trading “consistently” around $70.
Attention tends to focus on the front-month oil futures contract; that’s what people generally mean when they say “the oil price.” But in this case, the more relevant benchmarks are contracts in 2024 and 2025, where prices are now firmly in the refill range. Indeed, as of Monday morning, the entire futures curve has sunk below $72. The time to make good on Biden’s plan is now.
There is skepticism about it in the oil industry, in part because of the adversarial relationship firms have with this White House. Chevron Corp. Chief Executive Mike Wirth recently dismissed the plan as not offering a “meaningful” incentive for oil companies to drill more. Hochstein’s comments unhelpfully added further uncertainty.
Making good on the proposal now would at least put the onus on oil producers to either accept or reject it. They have justifiable reasons to be cautious, such as the risk of cost inflation eating into their return on oil delivered two years out. On the other hand, oil’s slide over the past week, bucking the Keystone pipeline leak and Russian President Vladimir Putin’s threat to cut supply, suggests bearish economic forces are overwhelming the bullish narrative that held for much of this year. While oil majors like Chevron set multi-year budgets and tend not to hedge anyway, smaller producers may take the opportunity of a refill solicitation to defray risks and lock in prices on some production, especially as liquidity in the futures curve thins sharply beyond the first 12 months.
It would also be a clear win for Biden. At a recent hearing of the Senate Committee on Energy and Natural Resources, Doug McIntyre, the deputy director for the Office of Petroleum Reserves, suggested replacing the 180 million barrels so far drained from the SPR by emergency sales with 60 million purchased from the market, and then by holding off selling roughly 140 million barrels, which were mandated for sale by Congress. (By way of background, a series of legislation passed in recent years — including the tax cuts of 2018 and last year’s bipartisan infrastructure act — have contained provisions for selling off bits of the SPR to raise cash (remember that the next time you hear representatives rail against the risks of draining our national oil tank).) In this way, 200 million barrels would be effectively bought back to replenish the SPR: 60 million from the market and 140 million from Congress.
There is more than enough to pay for this at the mooted price band. This year’s SPR sales were done at an average price of $96.25 per barrel, raising $17.3 billion. Even at the top end of the refill range, $72, that’s enough to buy back 240 million barrels, a third more than were sold. In theory, DoE could solicit for $4.3 billion worth of oil in the market, hand over $10.1 billion to the Treasury Department to negate the Congressionally-mandated sales — provided Congress played ball, of course — and still have $2.9 billion left over. In pure trading terms, that would be a home run.
In political terms, it would also show Biden’s willingness to help set a price floor, encouraging domestic oil production. Opponents of this on environmental grounds should bear in mind that US onshore oil has less “lock in” than say, deepwater fields or petro-states, because shale wells are relatively quick to develop, require little in the way of new infrastructure and produce most of their output within a few years. Plus, this year’s geopolitical mayhem has unavoidably raised the security premium in energy markets; in political terms, western democracies won’t reach net-zero if its proponents are voted out by citizens fearful or angry about high living costs. As I wrote here, a Biden put at $70 offers the possibility of stability that could benefit both oil producers and the transition.
Looking at oil’s slide last week, there will be a temptation within the DoE to say, as ClearView Energy Partners put it in a recent report, “if $70 [per barrel] is good, wouldn’t $60 [per barrel] or $50 [per barrel] be even better?” This would be an egregious mistake, not least because it would expose the October announcement as the shallowest of politicking over a strategic sector. Moreover, the lesson to take from 2022 isn’t that we managed to dodge a bullet on energy costs but that we remain subject to volatile forces that mock the notion of “consistency.” In oil trading, you take your wins when they present themselves and move on.
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