Any hopes that volatile global oil markets would settle has been dispelled by events over the past two weeks: With OPEC unable to agree on a price target at its latest meeting, the International Energy Agency (IEA) decided to release 60 million barrels of strategic reserves. As a result, markets have little idea how to set prices. A 7 percent price drop following the IEA's actions suggests that the market is trending downward. But while lower prices will be welcome news to consuming countries, the IEA is playing a dangerous game in seeking to influence short-term sentiment by putting more oil on the market when supplies are not tight enough to justify such a move. The reserve is designed to cover supply gaps, not influence the basic price of crude.
The IEA's move could prove costly, particularly if consuming countries fail to take medium-term steps to moderate prices. Cheaper oil will help prolong the Western economic recovery, but the IEA's game of looking at price instead of physical supply is deeply problematic, not least because a continued release of reserves is unsustainable. As a result, the IEA's credibility will suffer.
The IEA's official justification for the release cites Libya, a claim that, although controversial, has some merit. Around 132 million barrels of light-grade, low-sulphurous production has been lost since the onset of the Libyan civil war. IEA stocks are one of the few ways of boosting such production beyond enhancing sweet crude supplies from Algeria and West Africa, neither a dependable alternative. The real question is whether 60 million barrels will be sufficient to boost longer-term sweet output, particularly if Algiers gets drawn into the turmoil of the Arab Spring. To date, Europe has taken up the bulk of sweet supplies, while Asia settles for heavy crude, but continuing that split would significantly affect benchmark prices.