Four Reasons Why Washington’s SPR Plan Won’t Work
With oil prices showing no signs of retreat during the final months of the U.S. presidential campaign, beltway insiders are turning to one misguided solution to combat rising oil prices.
Releasing oil from the Strategic Petroleum Reserve (SPR).
Trial balloons floated all over Washington during the past few days. The only reason politicians didn’t move on this sooner (say a few months ago) was the price level. Until the last month or so, both oil and gasoline prices were heading in the other direction.
Near-month futures contracts for West Texas Intermediate (WTI), the crude oil benchmark traded on the NYMEX, were below $78 a barrel in intraday trade toward the end of June, while the same futures for RBOB (the NYMEX traded gasoline contract) were at $2.55 a gallon.
At the time, all the sage pundits predicted that oil would fall below $60 a barrel; some even suggested that prices could approach $40. On the gasoline side, these same wise guys were proclaiming we may see prices at the pump breach $3.
Well, everything has changed quickly.
This morning, markets opened with WTI 23% higher than then were in late June and RBOB up by more than 20%. Oil stands at more than $96 a barrel in New York, while Brent has exceeded $116 a barrel in London. And retail gas prices are once again approaching $4 a gallon.
Recently, I discussed why oil pricesare moving up. But for some politicians, including the fellow running for reelection at 1600 Pennsylvania Avenue, those prices are becoming a job liability.
So it’s back to hitting the SPR.
But there are four reasons why tapping the SPR won’t make oil prices any cheaper in the end.
Maybe you should let your Congressman know about them…
Untapping a Political Convenience
The reserve contains some 700 million barrels of oil. The initial rationale for the SPR was the Arab oil embargo of 1973-74, an attempt to prevent a recurrence of short-term price spikes due to our dependence on imported crude.
But the market has changed since then.
There will never again be an embargo of sales to the U.S. The SPR is now regarded as an offset to national disasters or other short-term national need. And it is also a protection against market imbalances. On 18 occasions since the creation of the SPR, oil has been drawn to offset shortfalls domestically, respond to a natural disasters (Hurricane Katrina), overcome international trade problems, or level off cross-border consignments.
And after each of these occurrences, the U.S. replenished the SPR.
In 2011 during the Arab Spring, however, 30 million barrels were drawn down to combat the loss of Libyan oil and a spike in global crude prices. Then, the 30 million was matched by a similar commitment from the International Energy Agency (IEA) – provided via member states.
As I wrote in OEI at the time, the attempt was destined to fail from the beginning. And it did. The experiment ended after one month. The entire six million barrels were not even used because there were insufficient buyers.
Tapping the SPR Won’t Work
Washington is attempting to use the reserves for political purposes with hopes of artificially affecting crude prices.
But this won’t decrease prices over the long run for four reasons:
- First, an SPR is not designed to work this way. Such draw downs will not have the intended effect because they are not in response to a genuine market lack of supply. The availability of excess oil, in itself, will not determine prices.
- Second, the amount necessary to affect prices over any extended time period is well beyond the ability of a political manipulation. Take last year’s unsuccessful exercise, for example. The total amount of 60 million barrels was the commitment for an entire month. However, that translated into about 18 hours of global oil consumption.
- Third, the market compensates for the additional supply rather quickly. Unless policy makers are prepared to continue the draw downs, there is no effect. This is always the problem with policy moves that are not in response to genuine causes.
- Finally, should the use of SPR barrels continue for any length of time, the reserves would need to be replaced. That requires purchases directly from oil companies. The market then draws its attention away from the draw downs and toward the buying of oil for replenishment as the base point for determining price. The attempt then would fail anyway and priced would move back up, based this time on what was actually paid for the oil moving back into the SPR – rendering the entire approach a grand waste of time.
All of this merely points toward a simple reality when it comes to oil prices. Presidents cannot influence them very much. It makes no difference what party the president represents or how much of a supporting majority that party provides on Capitol Hill.
There are no political solutions to higher oil prices.
What has been showing up in these trial balloons is a bit of “oil jawboning.” Reminding the futures contract traders of a possible government fiat may subdue rises now and then. But draw downs from the SPR cannot restrain prices that are moving up because of market factors.
Whether or not there is an election looming.