...against fictions and other tall tales

Thursday, 10 March 2011

The US should use its oil reserves to stabilize oil prices

How is the world's largest economy and oil consumer to cope with the current oil supply disruptions resulting from the turmoil in the Middle East? This question is especially important to consider given the significant amount of uncertainty surrounding OPEC's current spare oil production capacity. As a result, reporters and commentators are asking whether the US should tap into its oil reserves to supplement the global supply of crude oil and mitigate the risks associated with unknown oil prices and supplies moving forward.

Would it be a good idea for the US government to use some of its strategic oil reserves? Given the uncertainty regarding the additional spare capacity and the substantial risks associated with higher oil prices moving forward, it would indeed be wise for the US to sell in the market some of the oil it has accumulated in its strategic petroleum reserve (SPR). Not doing so could jeopardize the recently revitalized recovery. More precisely, tapping into the SPR would reduce the risk that the global economy derails into another recession, and it would ensure that the price of oil and its derivatives remain stable until the events in the Middle East subside.

In his book The Keynes Solution (New York: Palgrave, 2009), post-keynesian economist Paul Davidson explains the benefits of using such a policy when the risk of commodity inflation looms. According to Davidson,
...commodity price inflation occurs whenever there is a sudden and unforeseen change in demand or available supply for delivery in the near future [and] can be avoided easily by an institution that is not motivated by self-interest but instead wants to protect society from inflationary pressures. Preventing commodity price inflation requires the government to maintain an inventory of the commodity as a buffer stock to prevent changes in demand and/or supply from inducing significant price movements. A buffer stock is nothing more than some commodity shelf inventory that can be moved into and out of the market to buffer the market from disorderly price disruptions by offsetting previously unforeseen changes in demand or supply as they occur. (p. 69)
Currently, the SPR has a capacity of over 725 million barrels of oil that can be drawn down at a rate of 4.4 million barrels a day. These amounts are more than sufficient to cover the shortage of approximately 1.5 million barrels a day caused by the disruptions in Libyan oil supplies. In fact, it would not even be necessary for the US to replace all of the oil affected by the shortage, as half of that amount would probably be sufficient to return the price of oil to a more reasonable level that is consistent with current growth trends.

Of course, such a strategy would only be temporary since there is no reason to believe that the supply disruptions will be permanent. In 1990 and 1991, during Desert Storm, the US sold some of its reserves to stabilize prices for short periods with great success. The result was that the price of crude oil remained quite stable during that period. A similar strategy should be followed today. The uncertainty surrounding OPEC's oil production capacity represents at this time simply too great a risk to the US and other world economies, including China, a country that stands to be severely affected by any future slowdown in the US and Europe.

From a legal standpoint, the US is fully authorized to use the SPR at this time. In accordance with the Energy Policy and Conservation Act, the SPR can be drawn down if the increase in the price of oil is "likely to cause a major adverse impact on the economy".

On a final note, it is worth mentioning that this policy would actually be profitable to the US government given that the oil would be sold at the ongoing market price. According to the US Department of Energy, the average price paid for the oil in the reserves was $29.76 per gallon.

2 comments:

  1. Indeed they should dip into those reserves; however the reserves would only serve as a soft transitioning for the econ to adjust as $100+ oil will most likely be the reality in the medium to long term considering the ever increasing demand and the increase in cost of increamental supply (further and more expensive to extract).

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  2. 2plates, thanks for your comments. Yes, it'll be interesting to see what the future holds in terms of energy prices. Some would say that the future is not grim at all. See here: http://www.nytimes.com/2010/12/28/science/28tierney.html?_r=1

    Although I am not fully convinced by their views, I must admit being somewhat sceptical about arguments that see the price of oil and other commodities increasing by as much as what the headlines suggest.

    But then again, I think you are correct in saying that governments and businesses must get used to the idea of paying higher prices than what we've had in recent years.

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