The views expressed in this column are solely those of the
author and do not reflect the views of SVB Financial Group, or Silicon Valley
Bank, or any of its affiliates.
Last week the administration decided to release 30 million
barrels of oil from the Strategic Petroleum Reserve (SPR). For the first time,
the move was coordinated with other reserve releases around the world bringing
the total to about 60 million barrels. With a daily consumption of 89 million
barrels, world governments put an additional 16 hours of supply on the market.
The price impact was immediate and surprisingly large: about a 5 percent
decline. It seems the move took a little wind out of the sails of the
speculative long positions. The decision was also cleverly timed to drop prices
at the pump just as Americans load up their gas-guzzling SUVs and head out for
their summer driving holidays.
The move was publicized as an offset to the disruption of
supply from Libya due to the civil war there. Assorted administrations have used
the reserves, but not often have they sought to offset disruption in oil
producing countries, which tend to be politically chaotic and unpredictable. So
that explanation is a bit thin. We do hope that the administration is thinking
about the impact it had and how the oil market operates considering the role of
producers, refiners and those "evil" speculators. This last group adds a lot of
value in terms of price discovery and liquidity. Speculators must constantly
assess correctly a myriad of economic and political factors which might affect
supply and demand.
If economic growth declines, so will demand, putting downward
pressure on prices. If supply is constrained — be it for weather (Katrina), or
economics (the oil crash of the 1980s and 1990s), or politics (the embargoes of
the 1970s) — prices will rise. We would hope that one conclusion drawn by the
administration's economists is that the marginal speculative price, which
ultimately drives the price at the pump, can be easily influenced by simply
changing the expectations of the future. You don't actually need to add to
supply to affect prices as in the case of the SPR release, but simply create the
expectation that supply is going up.
With that notion in mind, we offer up the chart nearby. On July
14, 2008, President Bush announced that he was lifting the ban on offshore
drilling, sending a message to the market that the U.S. government was in favor
of lower oil prices.
Bush's opponents reacted with derision. In particular Nancy
Pelosi, speaker of the house at the time, said, "Once again, the oilman in the
White House is echoing the demands of Big Oil. The Bush plan is a hoax. It will
neither reduce gas prices nor increase energy independence." Prices began
dropping immediately and eventually bottomed out 70 percent below the level at
the time of the Bush speech. We're not sure how a 70 percent decline in prices
helps out "Big Oil," but we are willing to listen to any and all arguments from
the former speaker or her staff.
What is perhaps more interesting is the apparent market impact
of the Obama administration's decision in February of 2009 to once again ban
offshore drilling, essentially putting the world on notice that the largest
consumer of petroleum products was comfortable with higher prices. Prices have
been on a saw-tooth rise ever since. Now, as we stated before, there are
hundreds of factors involved in oil price movements. So despite our little
chart, it is impossible to infer that 100 percent of the price move is related
to the U.S. government's view on domestic oil production. But if we turn that
question on its head and ask, all other things being equal, what would
happen to prices if one of the world's largest sources of supply decided to move
aggressively to constrain future production? Economics, common sense and
experience tell us prices must rise.
We know there is a great tendency in Washington to think that
there is some oil cabal that manipulates prices and decides from on high what
they will be. This view is understandable because that is how many in our
nation's capital see the world and their place in it: a few really smart people
deciding all the important things for the rest of us. Our hope is that one day
our leaders in Washington accept that some laws of economics are not up for
amendment or repeal. They just need to live with them. The reality is that for
every price move there are winners and losers in the oil market. As they say, it
takes two to tango or contango, as the case may be.