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A Crude Reserve

The government has a Strategic Petroleum Reserve. But they have no idea how to use it.

11:00 PM, Feb 24, 2003 • By IRWIN M. STELZER
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GASOLINE PRICES are up by over 50 cents per gallon, have passed $2 in some places, and show no signs of moderating. Venezuela, one of our major suppliers, is in an uproar, with unions curtailing oil production. Never mind: We have a reliable supplier to fill the supply gap--Iraq. Our imports from that charter member of the axis of evil rose 24 percent last month, to 1.2 million barrels per day, representing one-third of that country's exports under the U.N. oil-for-food program (or, more aptly, oil-for-Johnnie Walker and aluminum tubes).

Not a good situation. So bad, indeed, that Hollywood types, feeling guilty about the share of the earth's resources that they consume and the pollution that they create (from driving Hummers, not from appearing on television), want us all to give up our safe SUVs and cruise Beverly Hills in prototype vehicles that don't use gasoline.

Meanwhile, we have some 600 million barrels entombed in our Strategic Petroleum Reserve, and are planning to up that to 700 million by 2005. Since we import about 10 million barrels per day, that comes to about a two month supply if all imports are cut off (or four months if we assume that Mexico, Canada, and other non-OPEC suppliers keep the oil flowing).

Unlike the biblical Joseph, who had a plan for the use of his stored-up surpluses when the fat years ended, we only have a plan for putting oil into the SPR, not for getting it out. Just last week Spencer Abraham, our secretary of energy--and no fool--informed us that the Reserve "has nothing to do with price; it's all about meeting shortages." A variation on this theme is the oft-repeated statement that "we shouldn't use the reserve unless we really need it."

This may rankle some economists, but it seems to make sense to Washington policy types whose ability to handle complex economic theories, such as "supply and demand determine price," is minimal. They are after all, too busy studying a stimulus package, formulating an energy policy, and considering how to save Social Security to have time to deal with economic issues!

The cost of our inability to devise a draw-down strategy is far from trivial. The 1991 Gulf war saw crude prices top $40 per barrel, and the economy was in turmoil. But we refused to use the Reserve: After all, it's not about price or, it seems, about recession either. More recently, with prices rising to around $35, and the economy weak, the guardians of our economy and of our energy policy have decided to hold onto every drop of oil in the Reserve. After all, we might "need" it some day.

Unless we get over the notion that the SPR sits in those holes in the ground to cope only with "physical shortages"--a concept too vague to be used as a guide, and one that anyhow gets reflected in the price of crude--we will continue to face costly--and in part unavoidable--price volatility. The SPR should be used as a tool to damp down such volatility, whether that volatility results from a war in the Middle East, an uproar in Venezuela, or any other cause. We have, after all, had periods of volatility without supply disruptions, and it is volatility that imposes huge costs on the macroeconomy.

The problem is that we don't want to turn bureaucrats in the Department of Energy into oil traders, guessing whether an upward movement in price is merely a spike or instead a change induced by durable underlying changes in the supply and/or demand for crude oil. So we might explore the possibility of selling options to buy the oil we have stored, so as to (a) convert the SPR into an earning asset, with the proceeds used to maintain it at the desired level; and (b) let the market signal when withdrawals are indicated--which would be when the options "come into the money."

Is all of this feasible? I'm not certain. But I am certain that we need a rational policy to decide when to use our Strategic Petroleum Reserve, when to add to it, and how large it should be. For when the desert dust settles in Iraq, we will still be heavily dependent on that unstable area of the world for our oil supplies. Russia, Africa, and other regions may be increasing their role in supplying the world with oil, but the Middle East still contains the low-cost supplies and excess capacity that allow it to dominate world oil trade.

Irwin M. Stelzer is director of regulatory studies at the Hudson Institute, a columnist for the Sunday Times (London), a contributing editor to The Weekly Standard, and a contributing writer to The Daily Standard.