Finance

Don’t Tap The Strategic Petroleum Reserve!

With oil prices at $80/barrel, and OPEC+ refusing to accelerate its relaxing of production quotas, some have called on President Biden to release oil from the Strategic Petroleum Reserve. Indeed, over the years, oil price volatility has been a concern for producers and consumers, although to be honest, consumers usually complain about volatile prices only when they are high and producers tend to complain about volatility when prices collapse.

And stable prices have often been described as a goal, usually by those attempting to sell expensive fuels. Enron promoted fixed price natural gas contracts, arguing higher prices were beneficial because stability avoided uncertainty. Ethanol advocates have made the odd claim that ethanol was more expensive but reduced fuel cost volatility because supposedly corn prices don’t fluctuate much (or something). Renewable advocates point to long-term contracts at fixed prices as preferable to relying on spot prices for conventional power that occasionally rise above competing wind and solar costs.

Oil prices have been stable in the past, first with Rockefeller’s Standard Oil monopoly, later the Texas Railroad Commission and the Seven Sisters’ (multinational oil companies’) agreement to avoid competition). Although prices were lower than before OPEC achieved market dominance, they were actually above competitive price levels. The main difference was that taxes paid to producers, especially in the Middle East, were very low, making delivered prices low.

So, would it make sense to release oil from the SPR in an effort to moderate prices? Well, that depends on whether you think that the government is capable of knowing what the ‘correct’ price should be. This always reminds me of the Soviet era joke: Joseph Stalin wakes up in a hospital, surrounded by officials who explain that Communist medicine has enabled them to resurrect him, and that all the world is Communist now except for New Zealand. Why isn’t New Zealand Communist? He asks. Well, they shrug, somebody has to tell us what prices are.

In case you are not skeptical about the ability of governments to understand what the oil price should be, the figure below shows the U.S. government’s purchases of oil for the Strategic Petroleum Reserve and the oil price over time. The first 500 million barrels were purchased when the oil price was an average of $85/barrel (2020$), which might seem reasonable considering the price is now $80, but the average price since the SPR was created has been $63/barrel. Indeed, when the price collapsed in 1986, SPR purchases were all but ended.

In fact, a number of OECD countries made similar purchases, pushing up strategic reserves in the years immediately after the Iranian Oil Crisis when prices were high and reducing them subsequently, after prices had fallen. Some governments avoided losses by requiring their oil companies to hold minimum stocks, the level of which rose and fell with prices. Again, cyclical rather than countercyclical behavior and there were losses—but the industry’s and consumers, not the government.

What’s worse is the irrepressible urge that official forecasters have to predict ever-higher prices. The IEA does have scenarios where climate change policies result in lower oil prices, but their standard expectation, given stated policies or announced plans, is for prices to be flat or increase over the longer term, as the figure below shows. (I have interpolated forecast points.) The EIA is in rough agreement as are many other forecasters.

But this is based on the fallacious notion that depletion of the resource means ever-higher prices. As M. A. Adelman said in 1986, “Diminishing returns are opposed by increasing knowledge, both of the earth’s crust and of methods of extraction and use. The price of oil, like that of any mineral, is the uncertain fluctuating result of the conflict.” And, as I have written before, many economists followed the lead of a Nobel prize winner who argued that economic law demonstrated that mineral prices should rise exponentially—even though they have not done so historically.

Over time, the psychology driving oil price forecasts (and you thought it was economics) has changed repeatedly, with the figure below highlighting the evolution of IEA price forecasts/scenarios. They are generally representative of the consensus at any given time, which demonstrates that the consensus tells us more about the desire of forecasters to cluster together than about the accuracy of their forecasts.

Finally, the use of strategic reserves for short-term political gain is certainly inadvisable. As my colleague Larry Goldstein wrote recently, it is rather like tapping into your retirement fund to pay for a vacation. To which I would add, it might feel good in the short-term, but in the long run you will usually regret it.


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