SPR Drawdown: Unnecessary; Counterproductive?
I wrote back in March about the Strategic Petroleum Reserve (SPR) and proposals to release oil from it in an effort to ‘stabilize’ fuel prices. I stated then that the SPR serves a very specific, important national security and economic purpose and it has only been used beyond those specific purposes one time (in a debt-reduction sale under President Bill Clinton [D]).
What is the SPR for? It’s for stabilizing supply of oil in an emergency, like foreign embargoes or serious supply interruptions like Hurricane Katrina. This has an impact on oil prices, which are set by the laws of supply and demand (though artificially manipulated in normal times by the OPEC cartel). The price impact, however, is just a side effect. The purpose of the SPR is to make sure oil is available for security (i.e., military) use and, secondarily, for public use. If SPR draw-downs make oil products affordable, that is just a nice bonus.
It is unsurprising that President Barack Obama (D) has decided to release oil from the SPR—in concert with other countries making similar releases—in an effort to lower gas prices. He promised as much in his 2008 campaign, but that it is a promise-kept does not mean it is a smart move.
Despite claims to the contrary in our government’s statements about the oil release, oil supply is not seriously constrained at the moment. Libyan oil output has dropped due to the fighting there, but Libya supplied virtually no oil at all to the United States and supplied less than 2 percent of the world’s total consumption. The countries exporting the other 98 percent of the world’s oil can pick up Libya’s slack, especially since they produce on a fixed schedule (defined by OPEC) well below their total capability. Of course, OPEC is interested in artificially forcing prices higher and likely won’t do this . . . but that’s nothing unique to today’s situation. That’s been happening for decades.
Because supply is not constrained, draw-downs on the SPR are inappropriate and unnecessary. Of course, it may seem economically (and politically) expedient, but that’s a separate matter. Things aren’t always as they seem anyway. It would be economically and politically expedient to return all 2010 taxes to the taxpayers, but the other consequences of that would be dire. Thinking in the short-term is only good politics in the short term. Eventually it comes back to bite you.
So, SPR draw downs increase oil supply, and increased supply forces prices lower. Sounds great, right? I could see a lot of people nodding along with my histories of the SPR and coming to the conclusion at the end that they don’t care if it’s technically a misuse of the resource. Lowering fuel costs is good for us, directly and indirectly: we pay less at the pump, we pay less on shipping, and we pay less for products themselves (which have their supply and retail delivery costs baked-in).
These are all good things, and they have a broad, positive economic benefits . . . in the short term. The problem is that the draw-down is a one-time influx of oil, not a sustained change in worldwide oil production. Yeah, it’ll force prices a bit lower (probably), but then they’ll bounce right back up. The supply curve hasn’t actually moved and, as such, the price won’t actually move. In fact, even the short-term increase in supply runs the risk of causing a short-term increase in demand, completely wiping out (or at least limiting) even that benefit.
Also, SPR draw-downs reduce the available oil supply in the SPR and harms its strategic usefulness. One would hope that the SPR will be resupplied as quickly as possible so as to not lose its potency when a real supply constraint occurs, but the administration has been predictably coy on this point. This increases market uncertainty, which could also cause upward pressure on oil prices. This particular release is only about 2-days worth of U.S. oil consumption, a fraction of the 34-day total in reserve, but these price-oriented draw-downs could easily become a habit. OPEC is not going to be voluntarily lowering prices any time soon.
So, all-in-all, this draw-down is a purely political move orchestrated by the president and his allies in the International Energy Agency. Treasury Secretary Tim Geithner claims this was a non-political decision, but provides no explanation except for repeating the specious claim that there are supply constraints. Indeed, if this is a non-political move, then why is our Treasury Secretary telling us so? Geithner is in charge of the administration’s economic policy. Oil supply is a matter of energy policy. The Energy Department’s silence and the Treasury Department’s loudness is all the proof you need you that this isn’t really about supply at all; this is about trying to shore up the economy by any means necessary—long-term consequences be damned—for short-term political gain.
Do we need to get oil prices under control? Of course we do. But an SPR band-aid won’t actually help anything for any serious length of time. If anything, it will do exactly what the Clinton draw-downs did.
In an effort to reach a balanced budget sooner than it would have happened otherwise, Clinton authorized the sale of oil from the SPR to temporarily increase government revenue before the benefits of his tax cuts kicked in (revenue benefits from tax cuts lag about 2-3 years, on average). The Clinton sales did force gas prices down, as anybody who remembers paying $0.89/gal in the late 1990’s can attest. As soon as the draw-downs stopped, prices jumped up $0.20-$0.30/gal almost immediately. The price shock of such a large change so fast was a contributor to the early-2000’s recession, which hit hard in the third fiscal quarter of 2000 (when Clinton was still in office, although that recession is often pinned by revisionists on President George W. Bush [R] who wouldn’t take office for another six months).
So, what is the long-term solution? I’ll repeat what I said in March, when SPR draw-downs were being discussed but hadn’t yet been implemented:
More importantly, it is time to stop playing games with our energy independence. For both economic and national security reasons, it is time to begin exploiting our domestic oil resources to the fullest. The companies that benefit from the newly-opened fields, both on- and off-shore, should be levied a reasonable tax on their oil profits, and every cent from those taxes (and every cent saved from reduction in our dependence on the OPEC cartel) must be re-invested in domestic nuclear power plants, electric battery and motor research, and fuel cell research. Smart public policy can end our reliance on foreign oil without increasing the federal deficit, but it won’t happen if we keep thinking in terms of short-term band-aid solutions.