Suddenly the global oil market looks a lot less loose….

What a difference a few months makes!  Today’s monthly update from the Energy Information Administration again slashed estimated OPEC spare capacity by roughly 30%, by a whopping 1.5 mb/d less than foreseen in May (chart below).  At 2 mb/d, the world’s current extra-supply buffer is well below the roughly 4-5 mb/d level most analysts would describe as adequate to cushion unexpected supply outages and stabilize crude oil (and therefore pump) prices.  OPECSpareCapRevsSep13

Spare capacity may be an unfamiliar term to many but it matters a lot to anyone interested in understanding what is moving global crude oil and therefore domestic pump prices.  More so than any other fundamental metric, it gauges the fundamental tightness and looseness of the global oil supply/demand balance.  Low spare capacity indicates a tight global oil supply-demand balance and upward price pressure.  Low spare capacity also triggers panic buying and higher prices when supply disruptions or even threats of disruptions appear, as seen recently with regard to Syria and Egypt.

How can the global supply buffer be so low when US oil production is soaring?

Robust oil demand here and especially abroad in developing countries played a role but the main reason for the big drop is unexpected supply outages in Libya and other OPEC and non-OPEC countries.  These disruptions force Saudi Arabia to produce more to make up for the loss.  Since Saudi Arabia is the only producer that holds spare capacity, as Saudi production goes up the world’s spare capacity cushion goes down.

Despite the huge cut in OPEC spare capacity near term, EIA still projects a weakening starting later this year and continuing through the end of 2014.  This projected increase  is due to forecasted production capacity growth in North America, Iraq, and other producers as well as restrained demand growth.  EIA’s rosy forecast is reassuring especially given turmoil in the Middle East.  It may be one reason why officials haven’t been scrambling to prepare a strategic stocks during the recent oil price run-up over Syria.

I am skeptical that the 2.5 mb/d increase in OPEC spare capacity EIA projects by end-2014 will take place.  As long as economic growth hangs in there, the oil market is likely to keep “surprising” to the tight side relative to official forecasts due to continual supply disruptions and stronger than expected oil demand in fast-growing countries.

But if I’m wrong and surging supply growth swamps tepid demand growth, I doubt OPEC Saudi Arabia will cheerfully cut production by over 2 mb/d, effectively handing over market share to its rivals in Iraq, North Dakota, and Texas.  More likely (and consistent with analogous historical experience), Riyadh would keep production high and watch prices fall, threatening investment in North American oil production capacity.

Tight or loose, I would not bet such a big increase in OPEC spare capacity anytime soon.

Turning to Congress and Iran sanctions, EIA’s much tighter revisions and the recent run up in oil prices underscores the hazard of selling new sanctions on the view that the oil market is “loose and getting looser” due to booming US production.  We can safely drive Iran’s oil off the market, so the argument went, without driving pump prices up here at home. This view overlooks the fact that pump prices at home are set in a global oil market and outside the US that global market is far from hunky-dory.

But it would be unfortunate if after being mugged by the reality of a tighter-than-hoped-for oil market, Congress shirked from tightening oil sanctions at this late stage in the diplomatic effort to prevent Iran from acquiring a nuclear weapons capability.  Despite the tight oil market balance and real risk of higher pump prices, quarantining all of Iran’s oil exports still makes sense because the consequences of failing to convince Iran to halt its drive toward nuclear weapons capability are more destabilizing for global peace and gasoline prices than coercive sanctions aimed at preventing it.  But let’s do it with our eyes open to the reality of a today’s tight and fearful global oil market, and be prepared to offset the lost supply not only with higher Saudi production if available but also strategic stock releases.


High time to fix the broken Renewable Fuel Standard

My successor on the Obama White House energy staff Jason Bordoff and I call for fixing the broken Renewable Fuel Standard before it leads to higher gasoline prices.


Congress should not allow a tight oil market to stop tougher Iran sanctions

This past week demonstrated that bipartisanship is not dead with regard to one of the most critical geopolitical challenges we face – Iran’s unrelenting and nearly complete defiance world’s demand to stop its illegal and dangerous pursuit of a nuclear weapons capability.

The Senate voted 99-0 to support Israel if it is compelled to act preemptively against the Iranian nuclear threat.  And the House Foreign Affairs Committee passed a bill with 338 co-sponsors that aims to cut roughly two thirds of Iran’s remaining oil exports, Tehran’s main source of earnings.  Congressional action is deservedly strong and timely:  The window for second to last resorts to work is fast closing and the President has repeatedly threatened to use military force if diplomacy fails.

Recognizing that sanctions so far have imposed a cost but not stopped Iran’s nuclear drive, the House sanctions bill would remove 1.0 mb/d of Iranian oil exports over one year, cutting Iran’s oil exports to 0.5 mb/d or less.  This is a non-trivial amount for Iran, but also for the global oil market…which is where the risk comes in.  EIA’s latest estimate of total OPEC spare capacity is 2.7 mb/d and private estimates tend to be lower.  While EIA forecasts spare capacity will rise to 3.5 mb/d by end-year, that level if reached would still leave a global safety cushion that is far from ample, especially considering ongoing geopolitical oil supply disruptions and disruption threats.  With the world’s safety cushion relatively low, losing Iran’s oil exports could put upward pressure on oil prices.

As noted in earlier posts, some in Congress are selling tough sanctions on the view that the oil market is loosening up this year, implying Iran’s oil can be lost without putting upward pressure on gasoline prices here at home.  But this rosy view is not shared by oil experts and overlooks cautionary nuances by those who believe loosening oil market conditions this year may offer a window of opportunity to cut off Iran’s oil at lower cost and risk.  The authors of a recent, widely circulated analysis by Securing America’s Future Energy backing big cuts to Iran’s oil exports in 2013 partly on some official forecasts of a loosening oil market appropriately warned that “any action that removes further Iranian supplies from the global oil market has the potential to generate oil-price volatility.”  The authors emphasized that higher Saudi and Gulf production as well as readiness to “swiftly utilize public stocks if needed” is an essential component of a successful strategy. 

While professional barrel counters debate current and future spare capacity, few would argue that it is or soon will be ample or that driving most or all of Iran’s oil anytime soon would be risk-free.

So as Congress puts final touches on new sanctions legislation, it should make one change to protect the economy while ensuring the tough oil sanction takes force regardless of future oil market conditions or oil prices.

The current version of the House bill leaves unchanged a safeguard provision in current sanctions law whereby the President must first certify that global oil supply is adequate before he imposes sanctions.   So far the President has certified oil market supply has been adequate to allow sanctions to take force.  But with oil hovering around $100 per barrel and considering the aforementioned caution from analysts, the Administration – which is decidedly less enthusiastic about oil sanctions than Congress – may well decide that another 1.0 mb/d of supply loss would cause economically harmful oil price increases.  

While Congress and the Administration are understandably concerned about high oil prices that hurt growth and upset consumers, at this stage in the contest a tight oil market must not become an excuse to avoid cutting Iran’s oil exports.  As Matt Kroenig and I recently argued in The American Interest [subscription required], the consequences for oil price stability and economic growth of a nuclear Iran are greater than those of efforts aimed at stopping it. 

Fortunately, the US and other oil consuming countries have a tool to offset the loss of Iran’s oil:  Strategic petroleum reserves held in the United States and other major oil consuming countries that coordinate their use under the auspices of the International Energy Agency.  IEA countries collectively hold roughly 1.5 billion barrels in strategic reserves.  A 1.0mb/d release from strategic stocks could offset lost oil from Iran for over four years, though such a lengthy, total drawdown would be neither necessary nor prudent.

Strategic stocks are intended to offset geopolitical supply disruptions of an emergency nature.  They should never be used as just a price control mechanism.  But this case is different:  Strategic stock releases are an appropriate tool to protect the global economy while maximizing pressure on Iran in an effort to prevent the worst outcomes for global growth and peace.   While normally considered a reactive option to respond to embargoes or conflict disruptions, in this case strategic stocks should be proactive component of coercive diplomacy.

Therefore, Congress should amend the safeguard provision to authorize if not direct the President to draw down strategic stocks, coordinated with IEA countries, if he determines that the loss of Iran’s remaining oil supplies would cause economically harmful oil price increases. 

With time short and the alternatives to successful sanctions fraught with danger and risk, a tight oil market or high oil prices need not and should not be an excuse to duck the strongest remaining measures to stop Iran’s drive for a nuclear weapons capability.


Squeezing Iran’s oil exports is the right thing to do, but not because the oil market is “loose”

Picking up on the subject of my last post, I fully support ratcheting up sanctions to cut off Iran’s oil exports.  Sanctions do-date have not stopped Iran’s march toward nuclear weapons.  Before resorting to military options we should give coercive diplomacy a final, maximum-effort try.  An oil quarantine of Iran offset by new supplies from Saudi Arabia and strategic stocks (“Quarantine-and-Release”) would eviscerate its economy, get Tehran’s attention, and is overdue.  I have been publicly advocating it since last year.

It is good to see support building in the Senate for this step this week.  But it would be  misguided at best and counter-productive at worst to think we can block Iran’s oil exports without raising global oil prices (and therefore gasoline prices at the pump) on perceptions that oil market “loose” due to slack caused in part by the US supply boom. As noted earlier, this is the argument some advocates of tough oil sanctions, including now Senate Foreign Relations Committee Chairman Menendez, are making.  At a hearing this week on sanctions Chairman Menendez said:  “Oil markets are now and predicted to be loose for the coming year… it would seem that this is the time to press our allies to further reduce crude purchase from Iran.”

Understandably, Congress does not want to do anything that would raise gasoline prices.  If there is a true red line in American politics, driving gasoline prices up is it.  Last year, Congress and the Administration were rudely surprised that financial sanctions caused Iran’s oil exports to drop precipitously, tightening the market and putting upward pressure on oil prices.  They had assumed or hoped Tehran would keep producing and exporting while being forced to heavily discount its sales.  That did not turn out so well.

As Iran gets closer to a nuclear weapons capability, willingness to target oil supplies is going up.  That is a good thing in my view.  But the oil market is not as loose as some interpret from leading oil market forecasts, and even if it were it could tighten later this year before new sanctions went into effect.  If after selling oil sanctions to the public on a forecast that gasoline prices would not rise and they did because the forecast proved wrong or was misunderstood, would that mean we should drop the quarantine option?

A quarantine is called for whether the market is loose or tight because the costs and risks of a nuclear Iran outweigh any risk of near term oil price increases associate with steps to stop it.  We have the tools to mitigate those short term oil price risks – Saudi spare capacity and strategic stocks – and should be prepared to use them.

Below is a wonky note my firm distributed to clients on the subject.  The take-away is that while we should quarantine Iran’s oil exports as a second to last resort before only the worst options are left, we not sell it as cost-free for consumers.  Despite the tremendously welcome US oil supply boom, the global oil market remains tight and fearful, hardly loose.  Forecasts for loosening in the future are just that – forecasts – that depend on many debatable supply and demand trends in the global oil market.

For now and the time being, let’s keep perspective and be realistic about the potential costs of the right policy:  The loss of Iran’s oil is probably the only sanction severe enough to convince Iran’s regime to cease defying the world regarding its nuclear ambitions.  But if implemented this year or next, a quarantine would likely put upward pressure on pump prices.  Instead of pretending otherwise, we can and we should protect our economy by offsetting the loss with higher Saudi production and strategic stock releases.

The Global Oil Market is not ‘Loose’ TRG 130517


Quarantining Iran’s Oil Exports Makes Sense No Matter How Loose the Global Oil Market Is

Bravo to these distinguished folks who recently called for sanctions that would cut Iran’s oil exports.  In a similar vein, last June I wrote an FT opinion editorial calling for a quarantine of Iran’s oil exports offset by higher OPEC production and an IEA strategic stock draw.  Officials are afraid cutting Iran’s oil exports (as opposed to squeezing the money it earns from them) will push up global oil prices and hurt fragile growth at home.  The concern is understandable, but short-sighted.  Time is running out, and as Matt Kroenig and I recently wrote the only thing worse for oil markets and prices, and therefore global growth not to mention peace, than coercive steps to prevent a nuclear Iran is a nuclear Iran.

However I disagree with the authors’ basing the timing of a halt to Iran’s oil exports on IEA forecasts that the global oil market will be soft in the first part of 2013,  Their logic is reasonable:  A temporarily loose oil market means the world could get by without Iran’s barrels without upward price pressures.  This should reassure nervous politicians with an eye on pump prices.  But there are a couple of problems with conditioning the quarantine strategy on a short term time window based on IEA oil market forecasts:

First, the IEA’s forecast could be wrong and the market may be tighter than it now estimates.  It’s happened before.  Basing critical geopolitical policies on IEA forecasts – or anyone’s forecast – is not sound policy generally and would be a critical mistake in the case of Iran’s nuclear program.

Second, even if the IEA is right that the market is loose now but will tighten up later this year, exhausting sanctions and diplomacy could last well through the summer, possibly after the June 14 Iranian elections.  If the world dawdles while the markets tighten up later this year, would that mean the option of quarantining Iran should not be considered this fall?  I think not….the larger point we agree on still stands:  A nuclear Iran is the worst of all outcomes, for peace, growth and oil prices. As a second-to-last resort before President Obama needs to consider acting on his pledge to use military force, Iran’s oil exports can and should be replaced by higher Saudi production and an IEA strategic stock draw.

Bottom line, quarantining Iran’s oil exports mitigated by higher Saudi production and IEA stock draw makes sense no matter how loose the oil market is.  And while the sooner the better, it should not be discarded later this year if the oil market tightens up.



Kampuchea MD, my home

When the Washington Post calls a state out for veering far to the left, that’s saying something.




Preventing Iran could be bad for oil prices, but a nuclear Iran would be worse

Matthew Kroenig and I wrote an essay in the new issue of The American Interest examining the overlooked consequences for oil markets, economic growth and political stability should Tehran acquire a nuclear capability.  We concluded they range from “severely jarring to systemically catastrophic.”  First few paragraphs are below and a link to the article is here (subscription required).

Kroenig-McNally_1Iran’s rapidly advancing nuclear program is one of the most acute national security challenges facing the United States, for reasons that are not entirely well appreciated. Whatever else it would portend, an Iranian nuclear breakout would pose first-order challenges to the stability of the entire global economic order via its impact on energy prices, a concern with obvious broad strategic implications.

As policymakers formulate strategies to curb Iran’s nuclear ambitions, the oil market has loomed large, and with good reason. Iran is the third-largest producer in the Organization of the Petroleum Exporting Countries (OPEC), and its location and military capabilities enable it to disrupt up to 17 million barrels of oil per day (mb/d) produced in and exported from the Persian Gulf—roughly 30 percent of the global oil trade. Iran holds a knife across the jugular of the world economy.1

The Obama Administration’s dual track pressure-and-negotiate strategy has been crafted with the risk of oil price spikes in mind. But its calculations pull up short by considering only the relatively short term. Administration analysts know that a complete embargo on Iranian oil would take 4.6 percent of traded oil off the market at a time when OPEC’s spare capacity is tight, contributing to a bias toward rising oil prices. Washington thus designed oil sanctions so as to keep Iran’s oil flowing into the tight global market while at the same time reducing Iran’s revenues. The plan called on some importers of Iranian oil to reduce or stop Iranian imports and others to demand large discounts as the list of Iran’s customers diminished. Unfortunately, the plan has not worked as intended. Instead of dropping prices, Iran dropped production. The unexpected production drop is due partly to unforeseen constraints on exports arising from problems with tanker insurance, a reduction in foreign investment in Iran’s oil fields, and a policy decision by Tehran to choose lower output over big discounts as the lesser of evils. The U.S. Energy Information Administration has noted that unexpected loss of Iranian supply, among other factors, has contributed to the recent upward pressure on global crude prices. Some of the lost Iranian supply may take many years to return to production, if ever, due to the nature of Iran’s fields. This unexpected loss of supply has made Washington skittish about taking additional steps that could cut Iranian exports still further.

Nevertheless, Iran’s nuclear program remains an important foreign policy challenge, and if diplomacy and sanctions fail to convince Iran to limit its nuclear…


Chatham House note on US energy policy and my (Republican side) response

Chatham House is doing a series on post-election US policies and its energy note went out last week.  They asked me to write a Republican response.  Both are here.  The Democratic response should appear next week.


Time to Tighten the Noose on Iran (FT)

My piece in the Financial Times is here.


Never did, never will

Today’s In the Pipeline email described me as supporting an “explicit price on carbon.”


Let me clarify for the record:  I have not, do not now, and will not support an explicit price on carbon.  Those who know me, know this.

I do favor SWAPPING our regressive payroll tax for an energy consumption tax as part of a sweeping tax reform and restructuring of our insolvent entitlement programs.

But I would not base the energy tax on carbon, partly because the term “carbon” suggests combating global warming would be the rationale for the tax swap.  In my view the rationale for swapping regressive taxes would not be to combat global warming, but instead to reform our tax code and entitlement programs so we can recover confidence that our children will inherit a solvent, prosperous country.  The swap would also partially insulate consumers from crude oil price volatility.

For this reason, I  would explicitly base the energy tax, again which would go up as payroll taxes went down, on any other unit of measure but carbon.

Substantively and semantically, there’s a big distinction and a big difference.

I realize my tax swap view is controversial and open to legitimate criticism.  But it’s factually untrue and grossly misleading to suggest I favor an explicit price on carbon.  I have asked Inside the Pipeline to correct the record.