China is finally ready to test out its state crude oil reserves

Workers are seen near pumpjacks at a China National Petroleum Corp (CNPC) oil field in Bayingol, Xinjiang Uighur Autonomous Region, China August 7, 2019. Picture…
Workers are seen near pumpjacks at a China National Petroleum Corp (CNPC) oil field in Bayingol, Xinjiang Uighur Autonomous Region, China August 7, 2019. Picture…
Image: Reuters/Stringer
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China is selling its first ever batch of crude oil from its strategic petroleum reserve tomorrow (Sep. 24).

While unprecedented, it’ll be a small auction: just 7.38 million crude barrels, about half of what the world’s largest crude importer consumes per day. Though the Chinese government has indicated that it aims to use the sale to stabilize prices, the limited quantity up for bidding is unlikely to affect prices in any significant way. Still, the mere fact that China is releasing supplies from its strategic inventories for the first time ever is noteworthy in itself.

This is the “coming of age of China’s [strategic petroleum reserve],” said Michal Meidan, director of the China energy program at the Oxford Institute of Energy Studies in London. “What’s happening on Friday is a test, the first test, of China’s SPR mechanisms…China has never done an SPR release before.”

What is a strategic petroleum reserve?

A strategic petroleum reserve (SPR) is a stockpile of crude oil held by governments as well as private industry, designed to provide emergency fuel supplies and shore up national security in the event of an energy crisis.

With a storage capacity of 714 million barrels, the US holds the world’s largest SPR, making it “a significant deterrent to oil import cutoffs and a key tool in foreign policy,” according to the US Department of Energy. The SPR was set up in 1975, following the oil embargo when Arab producers cut off exports to the US.

China’s SPR is much younger. The first policy debates about it only began in the mid-1990s, according to research by Meidan, and it wasn’t until 2004 that China’s state-owned oil giants agreed to contribute to the newly established SPR. China is also secretive about its SPR, keeping information on the size of its reserves under wraps. However, Meidan estimates that China now has roughly 90 days worth of crude in reserve, matching the International Energy Agency’s standard for the size of emergency oil stocks.

Why is China selling oil from its strategic reserve now?

“It’s not really clear why they’re doing this SPR release now,” said Meidan. “Typically, [the SPR] is an emergency supply system,” but there’s been no physical crude shortage in China. And while Beijing has signaled that the auction is aimed at taming inflation, Meidan doesn’t buy this argument either,  since domestic product prices are set by the government anyway, and the seven million crude barrels is a mere drop in China’s consumption bucket.

Meidan hypothesizes that there may be a simpler explanation: “It might just be that they’ve reached the critical threshold [of 90 days]…and they’re saying, OK, now let’s test it.” That test involves a series of logistical questions: which refineries will sign up for the bidding, how will the pricing work, how will the crude be transported?

China may also be looking to what the US has done in recent years with its own SPR. Rather than using the crude reserves solely in cases of emergency, Washington has been drawing down its stocks and selling off oil to raise money for the national budget and possibly to finance part of the infrastructure deal.

Still, while countries may begin to draw down their SPR stockpiles as the world shifts away from fossil fuels, Meidan argues that governments have strong incentives to keep a robust reserve mechanism to hedge against the myriad uncertainties of the global energy transition. She gives a hypothetical example: Middle Eastern oil producers may suffer a drop in revenue as the world buys less of the fuel, which can spark unrest and instability in the region and cause a supply shock that ricochets worldwide. That’s exactly the kind of emergency that an SPR is designed to cope with.