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Strategic reserves -- no strategy
Townhall.com ^ | Wednesday September 1 2005 | Alan Reynolds

Posted on 09/01/2005 12:29:37 AM PDT by Brian Allen

Hurricane Katrina slashed U.S. oil production by 1.4 million barrels a day -- the global equivalent of suddenly losing two-thirds of all oil produced by Iraq or Kuwait.

"President George W. Bush has responded quickly to Hurricane Katrina," said a Bloomberg report, "suggesting that Hurricane Ivan last year taught him a lesson about opening up the reserve." Energy Secretary Bodman announced he had "approved a request for a loan of oil from the Strategic Petroleum Reserve" and "continues to review other requests as they come in.''

That announcement should have been made by the president at least a week before the hurricane actually hit. He should have said, "The United States stands ready to replace all oil production loss resulting from the hurricane for as long as necessary." If that had happened, oil would now be at least $10 a barrel cheaper than it is. Since 1991, however, it has always been safe for traders to bet against the SPR being used in such a serious way.

The new SPR loans did arrive a few days sooner than the expensive11-day lag following Hurricane Ivan. But a loan is just a loan. To loan oil from the SPR (rather than sell it) does not add a drop to world oil supply over the medium term. On the contrary, it ultimately reduces world oil supply because those who borrow oil have to return more than they borrowed, as interest.

Moreover, supplying oil only at the initiative of U.S. refiners delegates the management of SPR to those with a conflict of interest. As producers of crude, as well as refiners, integrated oil majors are naturally reluctant to encourage the president to do anything that might frighten oil speculators and drive the price down.

Yet energy.gov explains, "The Strategic Petroleum Reserve exists, first and foremost, as an emergency response tool the president can use should the United States be confronted with an economically threatening disruption in oil supplies." Although oil interests would have you believe "economically threatening" means something other than high prices, the legislative language is clear that Congress intended the SPR to be used in cases of "significant" supply disturbances, which are defined as those causing "a severe increase in the price."

Since November 2001, the Strategic Petroleum Reserve (SPR) has been increased by 108 million barrels and is now up to 700 million barrels. Those extra 108 million barrels were imported, or had to be replaced with imports, making the SPR a price-support program for oil producers.

New reports quote interested parties who offer the following laundry list of reasons why the SPR should be tapped as little as possible, if at all:

-- The real problem is insufficient refinery capacity, so more crude won't help.

This common delusion results from ignoring the law of one price. Aside from shipping costs and tariffs, the same product cannot sell at significantly different prices in different places. If any fuel became much more valuable in Elbonia than Slobovia, that fuel would be diverted from Slobovia to Elbonia until the difference disappeared.

If Slobovia had ample crude oil and no refineries, while Elbonia had no crude oil and many refineries, the price of crude oil and refined products would be the same in both countries. Would anyone think that U.S. states without refineries pay more for gas?

-- The reserve is too tiny to matter.

A 700 million barrel reserve is large enough to replace the entire loss of 1.4 million barrels a day for 500 days. But a million barrels a day for a month might suffice. To keep speculators off balance, however, neither the daily amount to be sold nor the duration of sales should be too predictable. I'd sell a few million barrels on some days, none on others.

-- There is no reason to do anything, because U.S. refiners have sufficient crude inventory to last seven to 10 days.

That irresponsible comment came from a top official at the International Energy Agency, who seems to view governmental oil hoarding as an end in itself. It is foolhardy to advise drawing down private inventories to a precariously low level simply to preserve overstuffed official inventories that ought to be privatized. Another week of SPR diddling, while private oil reserves were allowed to dwindle to a paper-thin level, would be irresistible bait for oil speculators, who would rightly bet that oil prices would spike on the slightest disruption in that situation.

-- Selling oil from reserves couldn't have any immediate effect because it takes 13 days to get the oil from the SPR to market.

Markets price-in future events, just as they priced-in the risk of Katrina before it happened. On Jan. 16, 1991, when George Bush Sr. threatened to sell SPR oil, the price of oil fell from $32.25 to $21.48 that same day, though SPR oil did not reach the market until Feb. 5.

-- Sales from the SPR would discourage producers and consumers from doing what they should do to adapt to high prices.

Unlike other excuses for foot-dragging, this one (from a Texan) implicitly acknowledges that SPR sales would bring energy prices down significantly for households, manufacturers, farmers, truckers and airlines. Absent recessions somewhere in the world, oil would still be sufficiently costly to encourage supply and discourage waste.

The mere existence of government stockpiles discourages precautionary inventory holding by private investors, as do political attacks on "gouging." But that is an argument against having an official reserve, not an argument against using it sensibly.

-- The rainy day reserve should never be used to offset actual supply disruptions, but must instead be saved for even nastier hypothetical storms and wars that may lie ahead.

Unless threatened by a "major adverse impact on ... the national economy," the laws governing the reserve normally permit only a limited drawdown of 30 million barrels -- merely 4.3 percent of the reserve. President Bush has expanded the reserve by 108 million, so why is a 30 million drawdown now considered a really big deal, while adding 108 million was not?

Although 30 million barrels is just a few drops out of the reserve, the lesson of 1991 proves it is nonetheless a potentially potent device to convert oil speculation into what Larry Kudlow calls "a two-sided bet."

SPR oil sales would add to the domestic supply of oil, and therefore reduce U.S. import demand by the same amount. World oil prices would fall to clear the market. Competition between world refiners would drive down the price of gasoline, diesel and jet fuel. Cheaper crude would also drive down the price of natural gas, because gas and oil are substitutes in global uses. The price of electricity would also fall.

When it comes to economic fallout, I don't worry much about the price of gasoline to U.S. motorists. What I worry about is the cost of energy for airlines, trucking, agriculture, petrochemicals, plastics, synthetic textiles, aluminum, paper, etc. And I worry about fragile foreign economies, some in Asia, being pulled down by energy costs. The SPR could be intelligently used to minimize these risks, but only the brave would bet on that happening. Too many speculators are, in fact, now getting rich by betting against it.

Doug Bandow is a senior fellow at the Cato Institute, a Townhall.com Gold Partner.

©2005 Creators Syndicate

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TOPICS: Business/Economy; Government; Society; Weather
KEYWORDS: conflictofinterest; oil; president; spr; strategicreserves
<< That announcement should have been made by the president at least a week before the hurricane actually hit. He should have said, "The United States stands ready to replace all oil production loss resulting from the hurricane for as long as necessary." If that had happened, oil would now be at least $10 a barrel cheaper than it is ....

.... supplying oil only at the initiative of U.S. refiners delegates the management of SPR to those with a conflict of interest. >>

Hmmmmmm: Borders, Language, Culture, Conducting a liberal-styled PC War -- and conflict of interest insofar as the oil industry is concerned.

Getting to be an interesting second term.

1 posted on 09/01/2005 12:29:37 AM PDT by Brian Allen
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To: Brian Allen

>>That announcement should have been made by the president at least a week before the hurricane actually hit

A week before it hit, it was a tropical storm meandering around the Bahamas. This guy is an idiot for that statement alone.


2 posted on 09/01/2005 4:43:08 AM PDT by FreedomPoster (Guns themselves are fairly robust; their chief enemies are rust and politicians) (NRA)
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To: FreedomPoster

<< A week before it hit, it was a tropical storm meandering around the Bahamas. This guy is an idiot for that statement alone. >>

A week before "it" hit, the intelligence and strategy-challenged and effectively-corrupt policy that placed effective control of the SPR's seven-hundred million barrel reserve in interest-conflicted hands, that place their owners' advantage ahead of the nation's most-advantageous strategic employment of its reserve -- and caused the post-storm price of crude to be around 20% ahead of where it aught be -- was the wrong policy.

And, while your inability to get any of the writer's points [About the flawed policy and its consequential damage to the national interest and consequential effective corruption] has you engaged in the solo convulsions of chronological crabbiness that do in fact give the clue to there being an idiot about, the writer, whose remarks were as true a week before the storm as they are today and will be a week from now, is not the idiot!


3 posted on 09/01/2005 5:21:36 AM PDT by Brian Allen (All that is required to ensure the triumph [of evil] is that Good Men do nothing -- Edmund Burke)
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