Reserve Time

September 26, 2000 • Commentary

With oil prices continuing to shoot skyward, a squabble has broken out between Vice President Al Gore and Texas governor George Bush about the president’s decision to open up the strategic petroleum reserve, a 582 million barrel stockpile of unrefined crude oil large enough to replace 37 percent of oil imports for 90 days. It kills me to say it, but the administration’s right; it’s time to put that oil into the marketplace.

Bush’s objection is that the reserve should be held back in case of an embargo or other supply disruption. A common objection, but a bad one nonetheless.

First, let’s quit scaring the public about an embargo. Once OPEC puts oil into the world market, it can’t control what happens to it. All that happened during the 1973 embargo was a reshuffling of supply lines. The resulting price spike was almost entirely caused by inflationary expectations and fear of future cutbacks, not by the lack of supply. Years later, Sheik Yamani, the Saudi oil minister during the embargo, conceded that it “did not imply that we could reduce imports to the United States … the world is really just one market. So the embargo was more symbolic than anything else.”

Nor should the Texas governor worry about what an oil shortage might mean for our military during some future crisis. The Pentagon maintains that the military could fight two major regional wars simultaneously while using only one‐​eighth of America’s current domestic oil production.

Republican fear that Iraq might shut down production to punish U.S. consumers is hardly any more substantial. Sadaam Hussein wants to sell oil on the world market — it’s the only source of revenue for the Iraqi economy and, thus, the Iraqi military. The only threat to the availability of Iraqi oil is a U.N. embargo on Iraqi oil exports, an embargo strongly supported, ironically enough, by the United States government.

The nightmare scenario — a complete shutdown of OPEC production capacity — would indeed be serious, but then again, removing 40 percent of the world oil supply in one fell swoop would so rock the global economy that SPR’s relatively tiny reserves could scarcely contain the damage.

If Bush really wants to tear into the Gore plan, he should lambaste Gore for proposing a massive handout to the very industry that sits to the right hand of Satan in the standard Democratic political playbook. Read carefully: Under Gore’s swap proposal, oil firms would be loaned crude from the reserve which they could then sell in the open market. They are then told to replace the borrowed oil at a later date when prices fall. They sell high now, buy low later, and face little or no downside risk. All in all, a pretty good’s day’s work thanks to Pitchfork Al.

Since there’s no national security rationale for the SPR, we might as well put those 582 million barrels to productive use. Opening up the SPR might well break inflationary expectations regarding future price (expectations that seem to be responsible for at least $5 of the present cost of a barrel of oil) and add enough new oil to the market, thereby dropping the world price a bit for the time being.

But we can’t be sure. In both currency and oil markets, government reserves are so small in relation to the size of the market that market manipulation is difficult to pull off.

Moreover, crude oil prices are only one cause of high gasoline and home heating oil prices. The other factor is tight refining capacity. Even if we flooded the market with SPR reserves, there’s nothing we could do with it for now because domestic refineries are already operating at full capacity. Importing consumer‐​ready gasoline and home heating oil is possible, but shipping capacity is also tight and there are few refineries outside the United States that are presently tooled to make heating oil (a product used hardly anywhere but in New England) or the unique blend of gasoline mandated by the federal government. It will thus take quite some time before a drop in crude oil prices translates into a drop in oil or gas prices.

Treasury secretary Larry Summers, however, is right to point out that using the SPR to manipulate domestic prices sets a dangerous precedent. The idea that government should be in the business of wholesale retailing for important commodities is the path to economic ruin. That’s why we should open up the reserves, drain them as fast as possible, and shut the reserve down permanently.

The SPR is a bad economic investment. It costs a tremendous amount of money to maintain a physical reserve of oil. A back‐​of‐​the‐​envelope calculation finds that, after adjusting for inflation, the oil in the SPR has cost taxpayers about $60 a barrel to stash away for a rainy day. Rainy days can and do occur, but even at today’s prices, the SPR represents an insurance policy that’s more costly than the disaster being insured against.

Let’s sell it all off while oil prices are high and cut our losses. Hopefully, we’ll moderate prices along the way and buy some time until new production and refining capacity comes back on line. As long as we don’t do something stupid in the meantime like impose windfall profit taxes, the “crisis” will disappear in due course. Or have we all forgotten the lessons of the 1970s?

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