COMMODITIES RESEARCH 8 March 2012

ENERGY FLASH
High-wire act: Obama's Iran and SPR policies
„ President Obama tried to quiet the war talk this week. During a press conference Helima Croft
on Tuesday, he insisted that diplomacy and economic sanctions can still resolve +1 212 526 0764
the Iranian nuclear impasse and lashed out at critics who have accused his helima.croft@barcap.com
administration of passivity.
Amrita Sen
„ Obama’s press conference came one day after Israeli Prime Minister Benjamin +44 (0)20 3134 2266
Netanyahu visited the White House amidst growing speculation that the Israeli amrita.sen@barcap.com
government is preparing to launch a unilateral military strike on Iran. Netanyahu
has expressed scepticism that diplomacy and sanctions alone could stop Tehran www.barcap.com
from building a bomb.

„ Iran agreed this week to resume direct negotiations over its nuclear program
with the P5+1. The Iranian government has repeatedly expressed a willingness to
engage in a dialogue over its nuclear program over the past couple of years, only
to balk at making the concessions sought by the P5+1 interlocutors.

„ In our view, a military confrontation is unlikely in the middle of formal nuclear

negotiations, especially given Obama’s recent remarks. However, if the talks are
judged to be a resounding failure, the war drums will likely beat louder.

„ With geopolitical tensions in the Middle East continuing to drive oil prices higher,
speculation is mounting about whether the Obama administration will tap the
Strategic Petroleum Reserve (SPR). In the event of an outright confrontation
between Iran and Israel, when oil prices would likely react sharply irrespective of
actual supply disruption, the use of IEA strategic reserves is easier and
governments may well overcompensate to calm markets.

„ The difficulty arises if the escalation of the situation continues to manifest itself
in a series of proxy wars, encompassing but not limited to Syria and Iraq. The
timing of the SPR release in this context is extremely challenging, as is the actual
design of how many barrels to put in the market and in what frequency.

„ Further, the fundamental backdrop of the oil market is extremely tight, with
OECD inventories 60 mb below the five-year average and spare capacity a thin
1.7 mb/d. In this case, a strategic release would provide a temporary relief at
best, much like the release last June, and as the market yearns for more crude,
the headache for the governments would soon be to decide when to stop the
release before they effectively make a severe dent in their reserves and before it
severely reduces the credibility and market effectiveness of future releases.

„ The Obama administration is more likely than not to use the SPR, especially given
that 2012 is an election year. However, if the release is purely politically
motivated, it would do little to alleviate tight short-term market balances and
simply make longer-term oil prices even more expensive.

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 6
Barclays Capital | Energy Flash: High-wire act: Obama's Iran and SPR policies

Iran and Israel: Obama seeks more time for diplomacy

Obama tries to buy more time
for diplomacy and sanctions…
With the war drums growing ever louder and oil prices moving higher on fears of another
Middle East conflict, President Obama launched a full court press this week to quiet the talk
of an imminent strike on Iranian nuclear facilities. During his press conference on Tuesday,
he once again stated that his administration will not allow Iran to acquire nuclear weapons
and specifically ruled out a containment strategy, similar to the one the US employed with
the USSR during the cold war. However, he insisted that diplomacy and economic sanctions
can still resolve the Iranian nuclear impasse and lashed out at critics who have accused his
administration of passivity. He reiterated that the US intelligence community believes that
Iran has still not made the decision to pursue a nuclear weapons program; hence, “a
window of opportunity” remains open to alter Tehran’s nuclear calculus. He added that
“this notion that somehow we have a choice to make in the next week or two weeks or a
month is not borne out by the facts.” Obama also called on his opponents to clearly spell
out to the American public the costs and benefits of military action. Last month, the
Director of National Intelligence, James Clapper, told the Senate Intelligence Committee that
Iran is keeping the option open to developing nuclear weapons but we do not know “if Iran
will eventually decide to build nuclear weapons.” Clapper added, “We continue to judge
Iran’s nuclear decision making is guided by a cost-benefit approach, which offers the
international community opportunities to influence Iran” (Statement for the Record on the
Worldwide Threat Assessment of the US Intelligence Community fir the Senate Select
Committee on Intelligence, February 16, 2011).

…but Netanyahu Obama’s press conference came one day after Israeli Prime Minister Benjamin Netanyahu
remains skeptical visited the White House amidst growing speculation that the Israeli government is preparing
to launch a unilateral military strike on Iran. While Netanyahu praised Obama for leading
international efforts to impose crippling sanctions on Iran and for publicly stating that he
would not allow it to develop nuclear weapons, he expressed scepticism that diplomacy and
sanctions alone could stop Tehran from building a bomb. During his speech before the
American Israel Public Affairs Committee (AIPAC) he stated, “Israel has waited, patiently
waited, for the international community to resolve this issue. We have waited for diplomacy
to work. We have waited for sanctions to work. None of us can afford to wait much longer.”

Coinciding with Obama’s appeal for more time for diplomacy and sanctions to run their
course was the announcement that Iran will shortly resume talks with the permanent
members of the UN Security Council plus Germany (P5+1). It is the first time in over a year
that Iran will participate in direct negotiations with the P5+1. Catherine Ashton, the EU
foreign affairs chief who leads the negotiations, welcomed the decision, stating, “We hope
Iran will now enter into a sustained process of constructive dialogue which will deliver real
progress.” As we noted in Iran: Double Talk, February 3, 2011, the Iranian government has
repeatedly expressed a willingness to engage in a dialogue over its nuclear program over
the past couple of years, only to balk at making the concessions sought by the P5+1
interlocutors. However, by offering to negotiate, the Iranians have been able bolster Russian
and Chinese opposition to additional UN Security Council sanctions. The Israelis are unlikely
to be reassured by the Iranians’ willingness to restart talks and remain at loggerheads with
the United States and the EU over whether Tehran should be allowed to enrich any uranium.
The Israeli government insists that Iran should immediately halt all uranium enrichment and
that the suspension be verified by UN inspectors before the negotiations resume. The White
House has rejected this demand and previously signalled a willingness to live with Iran
continuing some enrichment activities as long as it submits to a rigorous inspection regime.
Secretary of State Hillary Clinton recently noted that the United States seeks “a negotiated
solution that restores confidence in the exclusively peaceful nature of Iran’s nuclear

8 March 2012 2
Barclays Capital | Energy Flash: High-wire act: Obama's Iran and SPR policies
Attention turns to Obama’s
SPR release policy
The use of the SPR will ultimately
be motivated by price levels
The mechanics of an SPR release
in a world of proxy wars is
extremely challenging
8 March 2012
program while respecting Iran’s right to its peaceful use of nuclear energy consistent with
its obligations under the Non-Proliferation Treaty.” The Iranian government, for its part,
maintains that it has the legal right to enrich uranium under the NPT treaty and shows no
signs of being willing to halt this activity. The latest IAEA report, released last month,
showed that Iran has tripled its monthly production of higher grade enriched uranium,
largely at its previously undisclosed, underground Fordow sight. While it is not enriching at
the 90+ percent levels required for nuclear weapons, its current 20 percent enrichment
levels are beyond what is generally seen as required for civilian nuclear power plants. On
Monday, the IAEA head, Yukiya Amano, stated that his agency continues to “have very
serious concerns regarding possible military dimensions to Iran’s nuclear program.” In our
view, a military confrontation is unlikely in the middle of formal nuclear negotiations,
especially given Obama’s recent remarks on Iran. However, if the talks are judged to be a
resounding failure, the war drums will likely beat even louder.
Obama and the SPR: Will he, won’t he?
With geopolitical tensions in the Middle East continuing to drive oil prices higher,
speculation is mounting about whether the Obama administration will tap the Strategic
Petroleum Reserve (SPR). In late February, Treasury Secretary Tim Geithner indicated in a
CNBC interview that the White House continues to weigh the circumstances that would
warrant doing so, stating “There is a case for the use of the reserve in some circumstances,
and we will continue to look at those and evaluate that carefully.” However, he noted that
there was “no quick fix.” Several well-placed policy experts contend that the Obama
administration is more willing than previous administrations to tap the SPR to deal with
higher oil prices, rather than wait for an actual physical supply disruption to US refineries
before releasing strategic stockpiles. Some Congressional Democrats are already calling for
a more proactive SPR policy to contain prices. Last month, Representatives Ed Markey, D-
Massachusetts, Rosa DeLauro, D-Connecticut, and Pete Welch, D-Vermont, sent a letter to
Obama calling for “an aggressive strategy” for releasing oil from the SPR. They insist that
such a policy would in the near term “send a strong signal to oil markets responding to the
unrest in the Middle East.”
While specific price levels have never really been used as a rationale for the release of the
reserves, we believe that a release, much like its predecessor, would ultimately be motivated
by a desire to reduce them, even if there is no specific target in mind. In the event of an
outright confrontation between Iran and Israel, when prices would likely react sharply
irrespective of actual supply disruption, providing the first extra tranche of oil should help at
least to the extent of bringing the initial ferver of prices down. If the confrontation takes the
form of a blockade of the Strait of Hormuz or military action, underlying oil production may
not even be disrupted. But oil trade flows would have to be re-routed and the general
escalation in tensions in that area would constrict crude flows from the Middle East to
Europe and Asia. In this context, a release from the strategic reserve would be beneficial, at
least to the European markets, which over time can free up some of the African barrels to
move to non-OECD Asia (who are yet to benefit from full-fledged government SPRs).
Indeed, we suspect that a highly likely response from the IEA/US government would be to
overcompensate in that first tranche, simply to calm nerves and indicate to the market pro-
activeness. Despite issues of remapping potential trade routes, the net effect might well be
for prices to come down sharply first, before settling back at a higher equilibrium level.
A more likely outcome, in our view, would be a scenario whereby the escalation of the
situation continues to manifest itself in a series of proxy wars, encompassing but not
necessarily limited to Syria and Iraq. Against a backdrop of extremely thin spare capacity and
3
Barclays Capital | Energy Flash: High-wire act: Obama's Iran and SPR policies
Given the fundamental
backdrop, prices are likely to pay
little attention to an SPR release
Today, global spare
capacity is less than 2%
of world oil demand
8 March 2012
low inventories, oil would likely grind higher in line with the gradual escalation and non-
resolution of the situation. While far from a worst-case scenario from a political standpoint,
this is in reality an immensely difficult one for policymakers to deal with in terms of the oil
market implications. Such a situation could last the rest of this year, into 2013 and even
beyond. Under those circumstances, strategic stock releases would be extremely difficult. In
the absence of an event-driven supply shock, how does a government take a decision to
release oil from the strategic reserve? Far worse, when does it start placing oil in the market
and when does it stop? In the 1991 Gulf War, the release of the strategic reserve was simple –
it would simply be the day after the pre-determined US strikes began. Similarly, in 2003, all
events leading up to the US invasion of Iraq signalled exactly that – war. Decisions to release
reserves under these circumstances are far more transparent and easily justifiable. In the
current set of events, there may not be a decisive end game; thus, timing the stock release
could become a real bother for the governments.
Equally, if the sanctions continue to take Iranian barrels off the market but at the same time
eat into the existing thin wedge of spare capacity, oil prices could continue rising, even after
absorbing an SPR release. Indeed, much like in Q3 11, the market is likely simply to absorb
the oil, take a breather from moving higher, but ultimately resume its upward trajectory.
Unless higher oil prices start choking off demand to the extent that it starts falling more
than supply, the fundamental issue for governments remains that there are very few natural
buffers in the market today to meet the marginal gap between the two. In this case, a
strategic release would provide a temporary relief at best, and as the market yearns for
more crude, the headache for governments would soon be to decide when to stop the
release before they effectively make a severe dent in their reserves and before it severely
reduces the credibility and market effectiveness of future releases. There is a huge
difference between a stock and a flow, and any indication to the market that withdrawals
from stocks are going to be used to replace OPEC flows would simply have the contrary
effect on prices.
Prior to the last IEA strategic release, for most of the previous nine months, oil prices had
moved steadily higher, due largely to the scale of 2010's demand shock, the erosion of
inventory and spare capacity buffers, and the inability of the supply side to catch up
smoothly. Geopolitical turbulence in the Middle East, particularly the loss of Libyan barrels,
and its intensification provided further support to a market that was already in tightening
mode. While the IEA’s release was intended, belatedly, to address that lost supply and lower
prices, after an initial fall, prices rallied. The day before the release was announced, August
Brent settled at $114.21 per barrel. Having lost $8.22 across the next two days and having
spent four days below $110, prices rose steadily over the next week and added over $13
since the lows of 24 June over the course of nine days. Exactly two weeks on, prices settled
at $118.33 per barrel. The fundamental backdrop against which the oil market is operating
is perhaps even tighter. An unusually large number of significant supply-side concerns at
the moment, not limited to Iran, but also encompassing Sudan, Syria, Yemen, Iraq, North
Sea, Nigeria and a tail of other producers continues to haunt the market. At the same time,
non-US oil demand is holding up rather robustly, and the combination is likely to result in a
small stock draw in Q1, despite the extremely warm Northern Hemisphere winter, making
this the ninth straight quarter of stock draw. Combine that lack of inventory cover with an
upstream system that is running rather hot at more than 98% of sustainable capacity, and
the result is that supply-side fluctuations are felt faster and have larger effects on physical
differentials. What was global spare sustainable capacity of over 5.5 mb/d at the start of
2010 is not much higher than 1.5 mb/d today. Within that, Saudi Arabia sits on almost 65%
of it, the UAE has a sliver of about 200 thousand b/d and Qatar the remaining share. Even
4
Barclays Capital | Energy Flash: High-wire act: Obama's Iran and SPR policies
The timing of an SPR
release, if purely politically
motivated, does little to
ease tight market balances
Quality issues may
become an impediment
8 March 2012
including the full extent of Saudi estimates (for example, Oil Minister Ali Naimi has stated
that Saudi output could quickly be taken to about 11.8 mb/d), it would be extremely hard to
produce a figure for global spare capacity much above 2.5 mb/d. At the same time, the
spectre of geopolitical risks now concerns far larger supply-side players of Iran (3.5 mb/d of
oil output), Iraq (2.9 mb/d) and Nigeria (2 mb/d). Thus, the probability that a release similar
to last June’s goes completely unnoticed in terms of price action remains very high indeed.
Further, government intervention to correct a market mechanism always has its side effects.
For instance, the IEA’s clearest mandate is to cover for supply losses. The appropriate time
to start covering for Libya was in March, rather than wait three months and then state that
it is being covered with a release that is one-third of the size of its loss up until then (June).
The release came under significant criticism in that many saw the action as a potential
source of distortion, rather than one of correction. We noted back then that "Qualifying
when a significant supply interruption needs a response according to the subjective and
imprecise use of perceived market context is simply not the way to go, in our view. The
decision to act should have been transparent, bold and decisive. It should not have had a
rationale that has had to back out of some very volatile market balance projections and on
something as ethereal as the perception of market context." Indeed, it gave rise to the
danger that the market perception was that the IEA had started to see itself as a price
regulator, and in the event that strategic reserves are used at some point during the current
stand-off in the Middle East (in the absence of a confrontation), that will simply gain
traction. For example, if the idea is that if prices are considered too high then more oil will
come, then in effect there would be an IEA government target price. The more benign
interpretation is that releases depend on market balances and the effect of any outage
arising from sanctions against Iran and commensurate volume lost from the market. Then
the quantity released will have to be enough to offset all the losses up to the point of the
release and presumably provide for a roadmap for the IEA to come back with more as
supply outages compound. Those represent a rather challenging set of targets to meet all at
once, and if the last coordinated strategic stock release is anything to go by, the IEA/US
government is most likely to fail to address any of these issues with particular finesse,
rendering it rather meaningless. Much like last time, we suspect that once the initial shock
wears off, the cumulative oil market response to the IEA release is likely to show some level
of scepticism.
It is not just the last strategic release that fell short of market needs (or expectations).
Rewind to the time of Hurricane Katrina, when initial crude loans were made to refineries
followed by a potential 30 mb offered for sale, and the effective result was a significant
disconnect between crude and gasoline markets. The loans helped a number of refiners in
the Gulf that faced logistical problems in getting crude after the hurricane and that are
sufficiently close to links to the facilities to have easy delivery. For all other refiners, getting
the crude was not the problem. Equally, of the 30 mb offered from the SPR subsequently,
only 11 mb was accepted, highlighting that the problem was oil product availability, rather
than crude oil availability. Additionally, of the 11 mb which was accepted, 10.8 mb was
sweet crude, while only 0.2 mb of the 15 mb of sour crude offered received adequate bids.
Back then, light, sweet crude was in demand; thus, the heavy barrels were shunned. While
the situation may not be as polarised today, quality differences still exist. Iranian crude is
primarily medium, while the existing spare capacity is almost all heavy. While Asia will be
able to absorb those barrels, once again, trade flows will have to adjust. The quality of the
crude in the strategic reserves is primarily light, sweet or some heavy, sour. The medium
grades may get dear should the sanctions keep the Iranian barrels off the market for long,
although these nuances may be lost in market interpretation of the release.
5
Barclays Capital | Energy Flash: High-wire act: Obama's Iran and SPR policies
An SPR release is bullish
for long-dated oil prices
8 March 2012
In our view, as discussed above, the current administration is highly likely to use the SPR as
a political tool, at least to be seen to be tackling higher gasoline prices, especially in an
election year. While the SPR release may or may not be a part of a larger IEA strategic
reserve release, the effect on short-term prices is likely to be fairly minimal in the context of
current market fundamentals. If the release is purely politically motivated, the timing of the
release may well be closer to the peak driving season in the US (ie, August), making it neatly
placed closer to the elections. The reasons can be found in many potential shortfalls – eg,
the combination of Syria, Sudan and Yemen has curtailed almost 1 mb/d of output and
could be accounted for as a supply shock. Equally, the growing problems in Nigeria and any
negative effect on oil production there should probably be given particular attention in that
it directly serves US refineries and can very easily be used as a bait for an SPR release. The
problem in doing that is that the lukewarm proxy wars and sanctions would have taken a
heavy toll on market balances by then and by most measures, any SPR release will fall short
in replacing the actual volumes lost. Further, the oil taken out of physical government-held
stocks is likely to be replaced, and the reduction in the minimum days of holding of private
stocks that increases availability in some countries will be reversed at some point. Thus, in
the long term, the oil would go back, and the release is essentially borrowing oil from the
future. Even the 60 mb release in June 2011 is yet to be replaced, making the eventual hole
at the back even more gaping. In a market where a potential capacity crunch over the next
3-5 years from the complete reshaping of the Middle East looms, additional demand to refill
the SPR is not necessarily going to be price neutral. If the short-term effect is simply lower
prices for a day or two, then that trade-off becomes even worse.
6
Analyst Certification(s)
We, Helima L. Croft and Amrita Sen, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of
the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the
specific recommendations or views expressed in this research report.

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