From The Streetwise Professor:
The IEA and the United States have announced plans to release over the next month 60 million barrels of crude oil from strategic stockpiles, including the US’s Strategic Petroleum Reserve. Oil prices plunged, by about $5/barrel. Initially, I was reluctant to attribute most of the price drop to the announcement, because the stock market and virtually all other commodities were down hard too, and the dollar rallied. These broad changes were plausibly due to bad US job numbers and continued angst about Greece, and given the recent correlations between oil and stocks and the dollar, it was likely that a good part of the oil sell-off was related to these factors. But when the stock market rebounded later in the day, recovering about 3/4ths of its previous losses, and oil only recovered slightly, it was evident that the oil stockpile release had caused a substantial drop in prices.
To understand the implications of the release, assume initially that the release is considered a one-off, with no implications for the future. In that case, it is like a sudden increase in initial availability of oil. Here is a figure based on a dynamic model of a storage economy that relates the amount of inventory carried out (on the vertical axis) to the amount of the commodity initially available (on the horizontal axis).*HT: FT Alphaville
A surprise increase in initial availability is a move along the horizontal axis. Since carry-out is an increasing function of initial availability, some of that new supply released from the reserve is added to private inventories. This would tend to dampen the effect of the release on prices, but some of the increased supply would be consumed, prices would fall. Here is a figure of price as a function of initial availability, which shows that as availability rises price falls. But this curve is flatter–more elastic–than the flow demand curve, because of the fact that some increases of initial supply are put into inventory which buffers the impact on price....MUCH MORE ending with:
It is especially ironic that this move came during the same week that the Federal Trade Commission announced that it was launching the most recent in a continuing series of investigations of manipulation by oil companies. This happens every time prices are high, with the same result: the FTC finds nothing. It’s one of the longest running farces in Washington.
If it wants to find manipulation, it should restrict its investigation to the 202 area code.
This is not the first time, certainly, that the US government has attempted to intervene in commodity markets to control prices in order to achieve a political objective. The Hoover administration–you know, that laissez faire bunch (not!)–did so with abandon in the grain markets with the onset of the Depression. That turned out badly. I don’t expect this to turn out much better.
