Don’t Fill the Strategic Petroleum Reserve: Drain It

President Bush recently announced that he has directed the Department of Energy to completely fill the nation’s Strategic Petroleum Reserve (SPR) for the first time in history. The feds are saving up oil for a rainy day, the administration said, to blunt any future use of the oil weapon against the U.S. economy. Politicians and pundits of all stripes applauded the idea — so you know there has to be something wrong with it. And there is: America does not need a Strategic Petroleum Reserve.

If having the feds buy oil when prices are low and sell it later when prices are high is a good idea, why doesn’t anyone in the private sector do it? After all, if it makes economic sense for the taxpayer to pay for this, it ought to make sense for a private investor as well.

Unfortunately, it doesn’t. Holding oil inventories is so expensive that companies rarely get the opportunity to cash those reserves in at a profit. And when they do get that rare opportunity to make a profit by buying low and selling high, pitchfork populists and their political henchmen will, like clockwork, scream bloody murder about “price gouging” and threaten to confiscate profits if the company insists on recouping its investment.

This is underscored by back-of-the-envelope calculations that, once you factor-in inflation and overhead, the oil in the SPR has cost the American taxpayer over $60 a barrel. The SPR is no “bargain” for the taxpayer or the economy. It’s like buying an insurance policy that has a premium that’s higher than the expected payout.

Moreover, private inventory holders have to worry that, just when prices get high enough to allow them to unload those petroleum stockpiles at a profit, the feds will dump oil onto the market, driving down prices and taking away the profit opportunity before it can be realized. So even when there are incentives to build oil inventories, the SPR crowds out and deters such private investments.

If the SPR makes so little economic sense, why this near-universal support for the program? The obvious answer is that few people in Washington understand energy economics but almost everyone understands (wrongly) that there’s an “oil weapon” out there pointed at our heads. The SPR would appear at first blush to make sense — until you do the math.

The less obvious answer is that it’s a backdoor bailout for the domestic oil industry. That’s because, due to the recession, demand for oil is dropping which, in turn, drops oil prices and thus profit margins for oil producers. Having the feds step in with massive purchase orders for oil artificially boosts demand and thus raises oil prices and, accordingly, oil profits. Prices may in fact continue to slide, but they would have slid a lot faster and a lot steeper had the president not stepped in with this federal “buy” order.

Now, before you get your dander up about “Big Oil,” it’s worth noting that the SPR is far more important to the small, independent producers that dot Texas and Oklahoma (the so-called “Little Oil” crowd that used to include President Bush) than it is to their larger corporate brethren. Higher prices help them too, of course, but not as much. “Little Oil” is living closer to the economic edge than, say, ExxonMobil. “Big Oil” lobbyists support the SPR but do so without a lot of enthusiasm. “Little Oil” looks at the SPR the same way the corn lobby looks at ethanol programs.

There is a reasonable case for the SPR - it’s just not one that you’ve probably heard much about. Oil economists know that it’s not so much production cutbacks or supply interruptions that spike oil prices as it is fear of future supply interruptions. The SPR, some economists maintain, is an important institutional break against panic buying, ensuring investors that, if oil supplies ever did run dangerously low, the feds would step in and flood the market. If the only thing we have to fear about oil markets is fear itself, then taking away that fear with the SPR serves a valuable economic and political purpose.

Well, maybe. But investors aren’t stupid. Most of them take the SPR into account when they walk in to the spot or futures market. That’s one reason why President Clinton’s release of oil before last year’s presidential elections didn’t affect oil prices as much as many analysts thought it would. The chance of intervention was already factored into oil prices.

Let’s just drain the reserve and call it a day. The oil therein would return about $13 billion to the treasury. We’d be better off spending that money on the war against terrorism than on the war against sliding oil prices.

Jerry Taylor is director of natural resource studies at the Cato Institute. Peter VanDoren is editor of Regulation, the Cato Review of Business and Government, published by the Cato Institute.