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Jul 18, 2012 ||
Justin Bozzino ||
Too often, when high prices or market inefficiencies emerge in crude oil markets, “speculative influences” are blamed. My colleagues have written many times on why these arguments are fallacies – most recently here and here. Rather than heaping blame on “speculators” for market dislocations, lawmakers might want to consider the unintended consequences of policymaking.
Take the North Sea benchmark Brent. Already suffering from a chronic production decline and unplanned North Sea outages affecting the price, the last thing it needs is a reduced incentive for explorers to explore and producers to produce. However that’s exactly what happened in last year’s budget, as the U.K. government announced a windfall tax on the North Sea oil industry. Oil and Gas UK put it bluntly:
Fiscal instability since 2002 resulted in fewer new fields coming onstream over the last few years.
The drop in BFOE barrels per day
Some of the damage was reversed by the U.K. government in this year’s budget, but the temptation to tax oil producers remains a factor discouraging exploration and production in the North Sea.
If a UK windfall tax seems unhelpful to Brent, then the EU oil subsidy to a burgeoning Asian economy is downright baffling. A year ago, the EU and South Korea signed a free trade agreement exempting the nation’s refineries from a 3 per cent tax on crude imports. Since then, North Sea oil has been flowing East, as traders take advantage of this loophole. Most of this oil is Forties Blend, which sets the price for Dated Brent, thereby providing a degree of artificial support for the North Sea banchmark – an example of policy impeding efficient markets . This “tax trade” has dislocated the benchmark to the extent that respected industry commentator Olivier Jakob recently described Brent as a “South Korean Island.” A piece this week by Reuters market analyst John Kemp agrees:
Brent’s rise is being driven by local production problems …..exacerbated by continued buying from South Korean refineries as a result of favorable tariff treatment.
These government moves have contributed to a situation where the Brent benchmark has been in backwardation for much of this year – implying a shortage of supply – while at the same time OECD stocks are at historical highs, and Saudi Arabia has announced 100 million barrels of storage. This disconnection of an important oil benchmark hurts consumers who buy Brent linked crude and products, and hinders the efficient functioning of markets.
Government intervention is not limited to the North Sea, of course. In North America, Transcanada will be forced to wait until after the US election in November before discovering whether it has approval for the long awaited Keystone pipeline – as a result, crude that could be dependably supplying American refineries remains in Canada. In the case of North America, however, a transparent price in West Texas Intermediate crude has led to increased investment in directing oil supplies from the hub at Cushing, Oklahoma to refineries in the Gulf of Mexico. The latest and most obvious example of this is the reversal of the Seaway pipeline. But even before that, companies invested in new ways to increase and improve the outflow capacity through increased rail, truck and barge transport.
The Brent dislocation serves as a reminder of the critical role that properly functioning markets play. Unimpeded by distorting tax or tariff policies, markets are allowed to accurately and transparently determine a price for a commodity, and direct resources to make that commodity available where it is needed. Lawmakers and others ought to look to the example of WTI, where properly functioning markets have helped push oil from Cushing to the Gulf Coast and, by extension, to the global energy markets.
Justin Bozzino is executive director of energy products at CME Group.
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