Story By David Uberti |The Wall Street Journal| The U.S. government’s attempt to refill the skyscraper-sized caverns that hold the country’s emergency oil reserves is coming with a crash course in energy markets: How to think more like a trader.
President Biden last year authorized an emergency sale of more than 180 million barrels from the U.S. Strategic Petroleum Reserve to ease gasoline prices that skyrocketed after Russia’s invasion of Ukraine. The Energy Department sold high, averaging roughly $95 a barrel.
After authorizing the largest release ever from the U.S. emergency Strategic Petroleum Reserve, the Biden administration is signaling it will soon try to refill the stockpile. WSJ explains how this strategy can lower gas prices, and why some are skeptical that it will work. Illustration: Ali Larkin
Now the agency is learning that replenishing those stockpiles at the lower rate it wants—between $67 to $72—is more difficult, despite prices sliding near those levels at various points this year. On Monday, benchmark U.S. crude closed at $71.99 a barrel, within Washington’s window to buy.
Biden has deployed the SPR more aggressively than his predecessors, forcing Wall Street to pay attention to moves that could affect oil markets. As crude sputtered in recent months amid a cooling U.S. economy and a gusher of global supplies, some investors have looked to Washington’s proposed purchases as a potential support for prices.
The Energy Department’s first attempt at buying oil this year—and beginning a potential billion-dollar trade—failed. That prompted the agency to revamp its approach to bids in a way some analysts say is more reflective of how crude is traded. The tweaked pricing approach underscores the government’s steep learning curve on how oil companies weigh volatility and risk in a market that can unexpectedly turn on natural disasters, geopolitical tensions or production changes by the Organization of the Petroleum Exporting Countries.
The four reserve sites near the Gulf Coast have about 358 million barrels of crude, down from about 593 million at the beginning of last year, according to the Energy Information Administration. Many analysts say the stockpile is more than enough to weather supply shocks, particularly since drilling output in fast-growing shale regions of Texas and New Mexico has propelled near-record domestic production.
The SPR periodically loans oil to refiners and receives additional supplies in return. But outright purchases have been rare in recent decades.
The Biden administration, which previously said it aims to buy 60 million barrels, has suggested it is in no hurry to refill the SPR without maximizing taxpayer returns. If successful, the new request for proposals could offer a blueprint for additional purchases.
Strategic Petroleum Reserve storage in Texas. The U.S.’s second effort to buy oil for the SPR is based on price differentials. PHOTO: BRANDON BELL/GETTY IMAGES
The Energy Department’s attempt to buy domestically produced sour crude earlier this year sought fixed-price proposals for up to 3 million barrels. But bids came in with higher prices than the agency expected or otherwise missed its specifications.
The fixed price meant companies would have to swallow the risk of the market sliding over a 13-day window as the agency evaluated proposals, said Ilia Bouchouev, managing partner at Pentathlon Investments. Producers likely bumped up their prices to account for the costs of hedging against the risk of oil prices swinging by several dollars a barrel.
“That’s a lot of risks to hold a fixed price for two weeks,” Bouchouev said. “Nobody trades [on a] flat price.”
Instead, the market moves based largely on price differentials between types of crude or locations where they are produced, bought and sold. Those spreads allow traders to account for costs such as transportation and give producers the opportunity to limit the threat of volatility by buying financial instruments such as futures or options contracts.
The Energy Department’s second try at buying up to 3 million barrels of sour crude, with proposals due May 31 and contracts expected to be awarded June 9, swaps its previous pricing approach for one based on differentials. That could help suppliers more accurately forecast costs and help limit potential losses.
Government officials asked companies to propose offers on sour-crude differentials. That figure factors in the average spread between West Texas Intermediate, the U.S. crude benchmark, and an American sour crude gauge known as Mars in the three days after notice of the award.
Those benchmarks were separated by 98 cents as of Friday, according to price-reporting agency Argus Media, meaning companies’ financial risk in the event of market choppiness could be in cents, rather than dollars, per barrel.
“In theory, the same problem still remains because dealers have to hold this differential for two weeks while waiting for the decision,” said Bouchouev, a longtime trader. “However, the differential is significantly less volatile than the oil price.”
For now, the more pressing question for Biden’s potential oil trade may be whether prices stay within the Energy Department’s target range.
Wall Street was bullish on oil late last year, but many analysts more recently slashed forecasts as Western economies slowed, Russia continued pumping out crude and China’s appetite for energy failed to push prices higher.
Write to David Uberti at david.uberti@wsj.com
