Oil Market Report June, 2011

How do the EU’s various financial leaders feel at the moment? Anyone who in their youth has fought with their elder brother and ended up sitting on his head will know the answer. As context, the fight has developed in such a way that the younger brother finds himself on top of his elder brother, pinning the latter’s head down and immobilising the rest of his body. The victory of course is pyrrhic and the dawning realisation now strikes the younger brother that this situation can only get much, much worse. As long as the elder brother is pinned down, the younger brother is safe. But the longer this situation continues, the more devastating the consequences will be when the elder brother finally escapes – which of course he will.

The parallel with the Greek crisis is that Greece WILL default on its debts. The amount of money that has to be repaid would be ruinous to any country, let alone one with such a weak and chaotic economy. And the austerity measures being proposed are so draconian relative to where the country currently sits, that the thought that they can be achieved with less than 50% of the population “onside” is fanciful to say the least.

So the question the EU leaders have been grappling with is this; let the default happen now and maybe see the European banks crash or sit on its head for another 2-3 years and hope to come up with another solution? Like the immobilised brother, this situation will not go away and can only get worse. But maybe, just maybe, staving off the crisis for another couple of years will enable the rest of the EU to recover sufficiently, so that they can weather the inevitable default and subsequent losses of up to $485bn (Greece’s total sovereign debt – a staggering figure).

But where politicians can cover up, markets will brutally expose and the oil market dropped steadily throughout the month. Nobody was convinced that the bail-out was anything other than papering over the cracks of a dire situation and the real possibility of mortal fissure within the EU and the crumbling of the currency. So oil prices fell heavily and only significant drops in the value of the £ prevented the 3ppl drop over the month from being much, much greater.

Just as things could not get more interesting (for Portland at least), the International Energy Agency (IEA) quite remarkably stepped in and released 60m barrels of oil onto the market (circa 2% of world production – equivalent to the recently lost Libyan production). For those unaware, the IEA manages the world’s emergency oil reserves, of which the EU and USA are the main contributing members. Every member country must hold at all times, between 60 and 120 days of their annual oil consumption, ready for times of emergency.

Since its inception 40 years ago, IEA stock releases have been incredibly rare, so much so that this latest release was only the 3rd time in the history of the system that such an event had occurred. Big news indeed and news that Portland saw as almost entirely politically driven. Traditionally, the IEA has only ever released product when prices are surging upwards, with the intent of cooling down over-heating markets. So where was the justification for releasing stock onto a market that had already dropped by $20 per barrel in the space of 4 weeks?

Portland believes that both US and EU leaders saw a real opportunity to “put the boot in” and hit the oil price just when the downward momentum was at its strongest. The aim perhaps to drive the oil price below $100 per barrel and thus deal a crippling blow to that resurgent enemy of the West, otherwise known as rising inflation. So pressure was put on the IEA to make the release and prices did indeed immediately respond downwards, with a huge $7 / barrel drop on the 23rd June.

Tampering with markets in this way is a risky game, particularly the oil markets where so many vested interests are at play. But be in no doubt that this is a bold move and the next few months will tell us whether the IEA’s silver bullet has truly hit the target.