China and Saudi Arabia: interesting SPR team up?
China may tap Saudis to fill its oil reserve, a move likely to influence prices
By Myra P. Saefong, MarketWatch
Last Update: 12:04 PM ET Jun 23, 2006
SAN FRANCISCO (MarketWatch) -- A deal between the globe's most populous nation and the biggest oil producer in the world may hold significant consequences for oil prices, but experts disagree on exactly what that outcome might be.
China and Saudi Arabia are reportedly discussing an agreement to import oil from Saudi Arabia to fill China's strategic oil reserves.
The goal was to have about 800 million barrels in the reserve, said Phil Flynn, a senior analyst at Alaron Trading, who cited comments from China's Finance Minister Jin Renqing last year.
That would be larger than the strategic petroleum reserve in the United States, the biggest stockpile of government-owned emergency crude, which peaked at an all-time high of 700.7 million barrels of oil in August 2005 and can hold as much as 727 million barrels. Its current inventory stands at 688.6 million. Read more.
When the U.S. started its strategic petroleum reserve in 1977, imported crude-oil prices remained fairly steady for nearly two years, according to data from WTRG Economics.
Then prices climbed past $15 a barrel despite a steady climb in the SPR level to more than 70 million barrels.
Imported oil prices didn't fall back to the $12 level until 1986 though by then, the SPR level had reached 500 million barrels, the data showed.
That could provide a hint for China's SPR. Filling it may cause a climb in oil prices because it'll draw from market inventories. At the same time, it could prompt a price decline since a reserve would also offer a cushion in case of supply disruptions.
Either way, it may take time for an SPR in China to influence prices, given that the first of the oil reserve facilities isn't expected to start operation until at least the end of this year.
"All of the above are correct -- or can be," said James Williams, an economist at WTRG Economics.
Prepping for storage
China's first strategic petroleum reserve base will be completed in August in Zhenhai, in the eastern Zhejiang Province, according to a June 17 report from the Xinhua News Agency. The government had announced the building of reserve bases back in 2004, it said.
Another three bases are scheduled for completion in the next two years, according to the China News Service.
China's energy policy bureau has said no imported oil will be purchased for the bases as long as international prices remained high, according to the Xinhua report.
But earlier this week, the Chinese government said it's in talks with Saudi Arabia on importing oil to fill its strategic reserves, according to Dow Jones Newswires. The deal would involve large volumes of Saudi crude, with the first shipments unlikely to come before year's end.
"This is probably a first step toward building a very big reserve in China," said Flynn, pointing out that China stated about a year ago its desire to have a strategic reserve larger than that of the United States. And "this obviously is a very bullish development."
That means "China is really going to be a competitor with the U.S. for oil supplies," he said.
Reserving influence
But which direction the possible collaboration between China and Saudi Arabia may drive crude prices remains in question.
While a reserve is being filled, it is the same as an increase in consumption," said Williams, pointing out that it "takes crude from the market, which can have the affect of raising prices."
Indeed, "the amount of oil that eventually could be diverted to the reserve should keep supply tight," said Alaron's Flynn.
Once filled, the "existence of additional spare barrels makes the market more comfortable in times of supply interruptions," said Williams.
That would limit the price increase that comes will any inventory disruptions -- and the more crude there is in SPRs, the greater the cushion, he said.
Industry and government-controlled petroleum supplies in industrialized countries which are members of the Organization for Economic Cooperation and Development totaled 4.1 billion barrels as of February of this year, with 1.5 billion of that pegged as available for emergency use, according to data from the Energy Department.
With worldwide oil use at around 84 million barrels per day and 1.5 billion barrels available for emergencies, the world has about 18 days worth of emergency oil at its disposal.
If the China/Saudi deal pans out, "more reserves would be fundamentally price bearish - or at least dampening," said Jason Schenker, an economist at Wachovia Corp.
Then again, "no one wants -- except in [a] dire emergency -- to dip into SPRs and the commercial petroleum in OECD countries is not really all usable in a practical sense," Williams said.
For example, say 20% to 30% of the U.S. industry's supply of 1.04 billion commercial barrels is in pipelines right now, and 870 million barrels is considered minimum inventory to just operate the system, he said. "On the commercial side, that only leaves about 130 million barrels of wiggle room, or about 6-7 days of U.S. consumption."
"The [U.S.] SPR gives an additional 30 days but if you use it, it is gone," he said.
China approach
There are actually two different ways China can approach a potential agreement with Saudi Arabia, said Williams.
It can develop storage facilities and fill them with crude purchased from Saudi Arabia or elsewhere, he said. Or, with Saudi cooperation, fill it with Saudi oil that is still owned by Saudi Arabia.
The latter would give Saudi Arabia a place outside the kingdom to store oil and give the Saudis "some flexibility if there were an event that interrupted their production or shipments," said Williams.
In that case, Saudi Arabia would have oil to put on the market, and it would be a "ready" market, he said, implying that the location of the oil in China -- the world second-largest consumer of oil -- would be a definite advantage.
And if the Saudis kept their "title" to the oil, "it would not count against their quota as they filled the reserve," he said.
But Williams doubted that Saudi Arabia would do anything that would increase the price of oil, which is what shipping oil to an SPR -- when it's needed on the market -- would do.
"They are doing all they can to add capacity and provide enough spare capacity to take some of the speculative air out of oil prices," he said. "I don't see them doing anything to change that policy."
China and Saudi Arabia: interesting SPR team up?
Author