Commentary: Strategic Petroleum Reserve Inflating Oil Prices

Published January 1, 2005

With gasoline prices surging, American politicians are facing pressure to do something to protect consumers. Most of the suggestions offered thus far, such as imposing mandatory conservation or switching to alternative fuels, either won’t do much good or would make matters worse. With one exception, that is: The federal government could tap into the long-dormant Strategic Petroleum Reserve (SPR).

First, some perspective. Gasoline prices seem relatively high today largely because we still have rather fresh memories of 1998–the year in which records were set for the lowest inflation-adjusted fuel prices in U.S. history. However, once we adjust for the changing value of the U.S. dollar, gasoline prices are not particularly high at all if compared to the historic record. Although it’s true that prices at the pump are significantly higher now than they were last year, higher fuel prices have only set back households an average of $25 a month in 2004.

Stockpiling Drives Up Prices

Nevertheless, the federal government isn’t making the situation any better by continuing to buy oil at today’s relatively high prices and stockpile it for a potential “national emergency.” The Bush administration could do the nation much more good by halting its petroleum purchases and actually selling off much of the reserve.

As Johns Hopkins economics professor and Cato Institute senior fellow Steve Hanke observed, in an article he wrote for Cato that also appeared in the October 21, 2004 Wall Street Journal, “On November 13, 2001, President Bush ordered the government to fill the Strategic Petroleum Reserve to its capacity of 700 million barrels. Since then, the SPR fill-rate has accelerated and oil prices have gone through the roof, increasing from $21.67 to a record-setting $55.33 per barrel.

Embargoes an Unwarranted Fear

The Bush administration argues the SPR is there to protect us not against high oil prices (which, in fact, come and go) but against a catastrophic interruption in oil imports, such as an oil embargo.

But embargoes are meaningless gestures. That’s because oil producers cannot ultimately dictate where their oil goes once it leaves their shores. Hence, during the 1973 embargo, oil that was exported to Europe was simply resold to the United States or ended up displacing non-OPEC oil that was diverted to the U.S. market.

The power of the U.S. government to hoard inventory is more damaging than embargoes. Notes Hanke, “The power of inventory changes is best illustrated by revisiting the Gulf War of 1991. On Jan. 16, the first day of the war, George H.W. Bush threatened to release oil from the government’s stockpile. The results were dramatic: The spot price of oil fell from $32.25 per barrel to $21.48 in one day. More importantly, the positive spread between spot and four-month futures prices also fell, from $5.90 per barrel to $1.65, indicating a higher comfort level with the adequacy of private inventories.”

Rob Bradley, president of the Institute for Energy Research, said, “Since its founding in 1977, the federal stockpile has been a textbook case of government failure in the name of addressing ‘market failure.’ Private inventory has been discouraged. Worst of all, the massive draw-down-ready inventory is an invitation to interventionism for future politicians. For example, a future price control program could be coupled with SPR withdrawals to address ‘tight’ supply.”

Time to Redefine “Rainy Day”

We believe government shouldn’t be involved in commodity markets. We don’t need the government to tax us in order to provide insurance against high oil prices. Thus, in a perfect world we’d sell off the oil here and now, and then shut the whole thing down. Oil prices would spiral downward, gasoline prices would drop, and taxpayers would receive a windfall from the sale of 650 million barrels of oil during a time of record-high prices.

“The public policy opportunity is to privatize the reserve and let the winning bidders liquidate or manage the inventory,” said Bradley. “Taxpayers and consumers would immediately benefit, and greater discipline would be exerted on federal authorities to follow a market-oriented energy policy.”

Alas, that’s probably not going to happen. So what do we do with this 650-million-barrel rainy-day fund when the rainy day we’re saving it for is probably never going to come? Well, we could define a rainy day downward and use it for times like the present.

Wouldn’t this make the federal government a major player in the oil commodity market with all the political mischief and economic mismanagement that might entail? Not if the SPR were put on autopilot and open for business 24 hours a day, seven days a week, for as long as the government held the reserve.

Even Temporary Withdrawal Succeeded

In 2000, President Bill Clinton authorized a similar plan, but withdrawals were limited to one million barrels per day over 30 days. Hence, the program was under political management rather than market control. Even so, world crude prices dropped from $34 to $30.50 over a two-week period in late September and early October 2000.

A similar, more meaningful plan could be enacted today.

As Hanke observes, “Applying common sense, … Senators Carl Levin (D-Michigan) and Susan Collins (R-Maine) have repeatedly argued for the suspension of oil purchases for SPR. On three occasions, they have offered amendments that would have put a halt to government buying. But the amendments have not seen the light of day. The last attempt, on Sept. 14, did narrowly squeak by on a 48-47 vote, but that wasn’t enough to overcome a technical point of order raised against the amendment.

“This is unfortunate,” said Hanke. “Unless purchases are halted, we will have to live with the Bush premium until May 2005, when the SPR is scheduled to be at full capacity.”

Peter Van Doren ([email protected]) is editor of Regulation magazine, a publication of the Cato Institute ( Jerry Taylor ([email protected]) is director of natural resource studies at the Cato Institute.

For more information …

visit the Web site of the Institute for Energy Research,