by Kevin Klombies, Senior Analyst, TradingEducation.com, LLC


Thursday, June 19, 2008

Chart Presentation: The SPR

The U.S. Strategic Petroleum Reserve was authorized by Congress in 1975 following the Arab oil embargo of 1973- 74. The reserve consists of four underground storage facilities within naturally occurring salt domes on the Gulf coast in Texas and Louisiana and has current storage capacity of 727 million barrels of oil. As of this week the reserve holds 705.7 million bbls.

Many argue that net additions or drawdowns from the SPR are too small to impact the price of crude oil but throughout the history of the reserve each and every policy change appears to be occurred at a key trend change point for commodity prices.

At right we have included a chart of the CRB Index from the start of 1994 to the present day. We are going to run through a series of policy changes with regard to the SPR so that we can see where it fit in with regard to the trend for commodity prices.

The Clinton administration suspended additional purchases of oil for the reserve after fiscal year 1994 (i.e. Sept. 30, 1994).

Between 1995 and 1998 there were a number of draw downs from the reserve including three totalling 28.1 million bbls initiated in 1996.

Following the failure of a budget request to start purchasing oil in FY 2000 the Dept. of Energy (DOE) proposed that a portion of the royalties owed to the government from oil leases in the Gulf of Mexico be accepted in the form of oil rather than cash. This oil was called Royalties in Kind or RIK.

The plan was announced in February of 1999 with the first contracts signed in March followed by a second round in June.

Following the September 11th terrorist attacks President Bush ordered- in November of 2001- that the SPR be filled to its current capacity of just over 700 billion bbls.

In August of 2005 President Bush signed into law an order to expand and fill the reserve to 1 billion bbls.

In September, 2005 in the aftermath of Hurricane Katrina 30 million bbls of crude oil were directed for release. Ultimately only 11 million bbls were actually sold.

We have included three charts today of the comparison between the U.S. 30-year T-Bond futures, the S&P 500 Index (SPX), and the sum of copper and crude oil futures. The top right chart is from 1990, the chart below right from 2006, and the chart below is from the current time period.

The argument is that the low for the SPX has on a few noteworthy occasions, been reached at the bottom for the bond market and the peak for energy and metals prices. We have shown this argument in the past using the crude oil/TBonds ratio which tends to represent a virtual mirror-image of the trend for the SPX.

Our first point would be that in both 1990 and 2006 the decision point or trend change straddled the end of a quarter. In 1990 the TBonds bottomed in late September while the equity market reached a low a few weeks later in mid-October. In 2006 the TBonds reached bottom in late June with the SPX turning back to the upside in mid-July.

The second point would be that there is a broad inverse or negative relationship between the commodity and bond markets. In other words as long as energy and metals prices are trending higher the bond market would generally be trending lower. Obviously a financial markets or banking system melt down will cause this relationship to diverge for a period of time.

The final point would be that the bond market hasn’t made a new low for a few days as the quarter draws to a close. In theory the SPX should remain under pressure into July with the final bottom occurring roughly 3 weeks after the bond market turns higher. The issue at present is whether the TBonds will manage to hold the lows through the final eight trading days of the month.

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Kevin Klombies is a prolific writer and market analyst specializing in the commodity stock market and bond commodity market trading in the energy sector. He  graduated in 1980 from the University of Saskatchewan with a Bachelor of Commerce degree (Honours) in Finance/Economics.  Click here for full bio >>