It is Deja Vu All Over Again in the Energy Markets

There's been quite a bit of news on whether the government will tap the Strategic Petroleum Reserve (SPR) to combat rising gasoline prices.

I get the feeling I've been here before.

In fact, I wrote about this very topic just three weeks ago. And sure enough, we had conflicting reports on the subject yesterday.

But despite what my wife Marina may think, I don't cause events in the oil markets merely by writing or talking about them.

She remains convinced that when I go on television and discuss higher oil and gas prices, my words provide energy firms the green light to raise them.

The reality is that I just know how politicians think (and panic) when it comes to the energy markets. So please, refrain from shooting the messenger.

Yesterday we also witnessed mixed messages from both politicians and the market.

Crude oil prices initially dove more than $3 per barrel in both London and New York when the story broke that there was a joint U.S.-U.K. agreement to release volume from each country's strategic reserves.

Later in the afternoon, prices shot back up quickly in New York (by that time the market had closed in London) following a White House denial that any such deal was in the works.

Still nobody inside the Beltway is claiming the idea is now off the table.

Was yesterday a trial balloon? Some junior staff member with an itchy dialing finger?

A hasty press release?

All are certainly possibilities.

But the confusion created in the aftermath of the "leak" hides one very simple, inconvenient truth.

There are few, if any, genuine options to offset rising gasoline prices.

Everything we need to do will take a few years to work out.

And it should. But you and I need to continue this conversation.

The (Weak) Impact of Government Intervention

Releasing some of the 695 million barrels of crude contained in the SPR would prompt a very short-term reduction in prices for both crude (the immediate impact) and products like gasoline produced from it (the secondary result).

Oil costs remain the single largest overhead component in determining the price of gasoline.

But an SPR release will have no lasting effect unless it becomes a regular occurrence.

And if that happens, each subsequent release would have a declining advantage in stemming price increases - a petroleum equivalent to the principle of diminishing returns.

This results from two essential factors, both on which I commented last summer.

At the time, I addressed an abortive move to use both the SPR and the International Energy Agency (IEA) in a combined attempt to deal (much after the fact) with Libyan supply disruptions.

There are two issues here.

First, traders peg futures prices in a normal market (will we ever really see one of these again?) at the expected cost of the next available barrel.

But in a crisis, unstable or highly volatile market, that price will be set at the anticipated most expensive next available barrel.

An unusually large SPR release might push prices down for a week or so.

But this is not sustainable.

The SPR would ultimately need to be replenished. It is, after all, an emergency fund, not a surplus to manipulate prices.

This would require the government to buy crude at full market price from producers, which would be at a higher price than what they likely paid for it in the past ("just put it on the corporate card").

That would then become the focus of traders' attentions, with the higher prices commanded for that replenishment serving only to drive market prices back up anyway.

Traders would now focus on the relationship between the SPR volume and the market in setting forward prices; however, as demand increases on the other end, the SPR would have declining influence.

And of course, once it was no longer possible to sustain such an SPR-to-market balance, the whole experiment would quickly unravel.

When an element outside of (and artificially induced to) the market is introduced, such as an SPR release, traders base pricing on the relationship between the release and the market.

In short, the release becomes the trading focus. It is merely absorbed into the calculus after a few trading sessions, but it does not change the underlying dynamics of how the market determines the price.

This occurs for a very simple reason.

An SPR release will very marginally change the supply of crude. The 60 million barrels released last summer only represented less than 18 hours in global usage.

But it does nothing to offset either demand or how the market approaches it.

Fundamentally, this is not a supply side problem. An SPR release Band-Aid will have limited impact, even for the politicians who control it.

Second, coming in from the outside does nothing to change the market conditions actually prompting the price rise.

The pressures continue to build, leading to a steady rise in both oil and oil product prices. Releasing oil from the SPR does nothing to temper these developments.

A nation practicing centralized planning - for example, China, Cuba, or the old Soviet Union - could attempt to curb such factors by decree.

But open-market systems can hardly resort to such means.

Prices are not aberrations.

Like a rising body temperature, prices tell us something. Free market approaches have to deal with the causes... not the symptoms.

We are experiencing a number of causes for the current price appreciation that an SPR release cannot offset.

One of these is geopolitical.

And driving that factor is the rising tension with Iranian supply as we move closer to the July 1 date for a complete European embargo of Iranian oil.

All Eyes on Europe Once More

And something else happened yesterday, an event overshadowed in the media by the SPR debate.

The Belgium-based Society for Worldwide Interbank Financial Telecommunication (SWIFT) said it would comply with a European Union order to disconnect designated Iranian financial companies from its messaging system, effective March 17.

The SWIFT system is used by banks around the world for interbank transfers.

The move virtually cuts off Iran from processing revenues from its global oil sales and will further cripple the Iranian economy. There will certainly be a response from Tehran with the rising tension resulting further increasing oil prices.

The U.S. government can't do anything about it. And no SPR release will be able to offset what's coming in the market.

This is going to be a very bumpy ride.

Good thing we know how to profit along the way and protect ourselves from what's coming.

Editor's Note:Politicians, newspapers, and TV networks are getting it wrong when it comes to a very important question: What underlying factors are affecting oil prices?
That's why people all over the world are turning to Kent.

Kent's uncovered the biggest - and most profitable - trend in the oil markets. Seriously, it's the story of the summer. In fact, you're losing money to inflation if your cash is just sitting in the savings account at less than 1%.

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About the Author

Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.

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