Should We Use the Strategic Petroleum Reserve?

March 21, 2011 • Commentary
This article appeared on Forbes​.com on March 21, 2011.

With regular gasoline prices averaging $3.62 per gallon last week, the political bat‐​signal has been fired to summon the Strategic Petroleum Reserve (SPR) to remedy the situation. Rep. Ed Markey, D‐​Mass., is at the legislative forefront of this effort with a bill directing the Department of Energy to sell 30 million barrels of crude — about 4% of the stockpile — over the next six months. White House chief of Staff Bill Daley recently suggested the Obama administration might well do just that if soaring fuel prices jeopardize the economic recovery.

Unfortunately, Markey’s proposed release would likely fail to accomplish much. Oil economist Timothy Considine examined a similar 30 million barrel release of crude from the SPR prior to the 2000 election. He concluded that the release reduced prices by only 3.5%, largely because oil producers (the Saudis in particular) responded to the new crude by cutting back on production.

It’s unlikely we could even do that well today given that the 2000 release was executed over two months whereas Markey would have us play out that release over a full 180 days. Regardless, even if we compressed Markey’s proposed release, Considine’s calculations suggest that global crude oil prices would only drop from $97 (where they were last week) to $93.60 and, correspondingly, U.S. gasoline prices from $3.62 to $3.49.

Accordingly, opponents of an SPR release argue that the reserve should be shut‐​in until a true supply disruption hits the market. But that argument is hard to accept. After all, the world did lose over 1 million barrels Libyan production — no small thing — and most of the price increases we’ve experienced over the past several months can be explained by that event.

The argument to hold on to SPR’s crude until a much larger supply disruption hits would seem compelling, but there’s so much oil in the SPR at present, we don’t need to be miserly. Considine examines a scenario in which the world experiences a 5 million barrel per day loss of non‐​Saudi crude and responds with an SPR release of 90 million barrels per month for the first three months, 60 million barrels per month for the next two months, and 30 million barrels during the sixth month. He concludes that slightly more than two‐​thirds of the price increase would be avoided. But this scenario would drain only 58% of the SPR, so smaller releases here and there do not seriously jeopardize our ability to respond to “the big one.”

But does the federal government really need to be in the commodities business? Most people forget that the SPR was not established in order to stabilize prices during supply disruptions. Instead, it was established in response to the Saudi oil embargo in the fall of 1973 (to punish us for our support of Israel in the Yom Kippur War), an embargo that was blamed for fuel shortages and gas lines. But subsequent analysis by economists demonstrated that Saudi oil found its way onto the world oil market; albeit indirectly.

The Saudis and some other OPEC countries did indeed reduce production in the Fall of 1973, but the cutback was less than the inventory buildup in early 1973. As a consequence, overall supply in 1973 actually increased relative to consumption. Moreover, the shortages in the U.S. had nothing to do with the embargo; they were the result of an elaborate system of price controls instituted by President Nixon that eliminated the incentive of major oil companies to import crude oil into the U.S.

Thus the entire narrative about the embargo and the need to protect ourselves against foreign policy blackmail was never true. Nor is it true today. The development of an oil futures market, which did not exist in 1973, allows consumers and firms to insure against the financial consequences of oil shocks through contracting.

Where then is the market failure that would invite federal maintenance of a stockpile? That is, what makes Congress think that market actors will not “hedge enough” and that they — the vote maximizing pols who haven’t spent a day of their lives in anything remotely resembling the world oil market — know what the “right” hedging strategies might be? To ask the question is to answer it.

Hence, we’re with Markey, but we’ll see him one better. Let’s release all the oil from the SPR in whatever manner maximizes returns for taxpayers. Let’s use the tens of billions that are earned from sales to reduce the deficit. And then let’s shut the thing down.

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