How QE2 is forcing the West to release emergency oil reserves

Money printing by the Federal Reserve is driving up commodity prices. Now oil is being released from the world's emergency reserves to counteract the effect. Will it work? Or will it do more harm than good? Merryn Somerset Webb investigates.

Did it make sense for the International Energy Agency to release 60m barrels of oil from its emergency reserves last week?

On the face of it, not really. This is only the third time it has done so and both other occasions came with pretty obvious emergencies. One was the first Gulf War and the other the hideous weeks after Hurricane Katrina.

This doesn't. But that doesn't mean it doesn't make some sense. QE2 was designed to stop the free fall in US property prices. We don't know if it has had much of an effect or not, in that we don't know how much worse things would have been in the US without it (in this sense QE is a little like aspirin for most people).

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

But what we do know is that it has had a thoroughly unpleasant side effect the huge rise in commodity prices that has come with it. Again we can't say for sure exactly how the cash from QE has leached into the commodity markets (is it money playing hot potato round the markets? Or has the fear of inflation forced investors into hard assets?). But a quick look at the charts shows us that it has.

This leaves the politicians of the West with a problem. QE2 is coming to an end but that doesn't mean that any cash is being removed from the markets, just that more isn't being added. So while it is possible that we will see commodity prices fall in the near future, it isn't a given and even if it was its timing would be uncertain. At the same time it is beginning to look like global growth, such as it is, is slowing. Europe (and even Germany) is losing momentum; the UK is a mess; the US is more of a mess; and China has been forced into a series of interest rate hikes in an attempt to control its (probably uncontrollable) inflation.

It is the kind of picture the Federal Reserve looks at in dismay. Like the Bank of England, it can't raise interest rates to deal with inflation (that would hit property prices and the banks) and it can't yet introduce any new QE to try and boost growth (this would push commodity prices higher and make things even worse).

So releasing oil to bring down the oil price looks like a stroke of brilliance: it has the effect of a rate cut but without a rate cut. Better still, by bringing down oil prices should make the inflation numbers look rather better than they do at the moment.

The problem? While releasing IEA oil may work as a temporary response to a shortage of supply from Libya (the excuse given for it), it is no more a sustainable solution to the financial crisis than anything else. GFC Economics notes that the release "reflects an implicit belief" that higher oil prices have been primarily responsible for the recent slowdown in growth in the US. That seems unlikely given the head winds offered by the credit crisis (US banks are in just as crappy shape as ours) and the housing market the thing that really needs fixing.

But it is also worth noting that you can't release oil very often. First the market knows released oil has to be replaced so it delays demand morethan anything else. It is also the case that the more oil you release from emergency reserves, the less you will have to play with should you have a genuine emergency. Note, for example, that while there is a general perception that the US is stuffed to the gills with its Strategic Petroleum Reserves (kept in salt domes on the Gulf of Mexico) there is in fact only 726.5 millionbarrels. That's 36 days worth for the US and less than 10 days worth for the world. Not much really.

Ben Bernanke appeared to rule out QE3 when he spoke last week. I suspect he'll end up changing his mind as the global economy tanks regardless of what it does to commodity prices. He can't make more oil. But, as he has already proved, he can make more money.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.