What Next For The Strategic Petroleum Reserve?

The Administration has released nearly 200 million barrels of oil from the Strategic Petroleum Reserve and will presumably refill it later. Hopefully, it will do so after prices have come down (yes, prices do drop sometimes), but the question of exactly how much the Reserve should hold has long been a contentious issue, especially now that the U.S. imports little or no oil (net, not gross), in part because of uncertainty as to its purpose.

When established in the late 1970s, there was pressure from the U.S. military to ensure that the SPR would always retain enough oil to supply U.S. forces during a land war in Europe, under the belief that Soviet submarines would interdict supplies from the Middle East. Of course, the amount needed depended heavily on assumptions about the length of such a conflict, although now one could be forgiven for thinking it would be Hobbesian: nasty, brutish and short. (As opposed to Leviathan, which is nasty, brutish and long.)

It was also feared that drawing the SPR down completely, or to the war-minimum reserve level, would increase vulnerability to new oil supply disruptions and thus send prices soaring—the security premium. Such fear was not unwarranted, given the perception in the early 1980s that Islamic fundamentalism, encouraged by the Iranian government, might topple other oil producing governments or at least cause enough unrest to affect oil production. Although those fears proved excessive (only the Iraqi government has been changed since then, and not by Islamic fundamentalists), the future stability of global oil producers including those outside the Gulf cannot be predicted. Even U.S. oil production is subject to political interference, after all.

The prospect that the U.S. SPR would be nearly drained and then another supply disruption occur is worrying, but does the lower level of oil imports—and often net exports—mean that the SPR need not be refilled to previous levels? Which brings us back to the question of the purpose of the SPR: replacing lost imports, guaranteeing supplies for U.S. refiners, or stabilizing global oil markets?

As the figure below shows, the size of the SPR measured in days of U.S. oil consumption and/or refinery runs has been fairly constant for several decades, with the slight decrease in demand that appeared after prices soared post-2000. While providing ‘only’ 30 to 50 days of support might seem meager, that assumes the SPR would replace all U.S. refinery inputs or consumption, which is beyond fantastical. There is no scenario where the bulk of U.S. oil production would be exported or diverted to, say, the military and thus unavailable to consumers. Given that the U.S. no longer imports significant amounts of oil, does that mean the SPR is unnecessary?

Arguably, its goal has become to support global oil markets; certainly, it has not done so recently. Net imports of oil into the U.S. have recently been negative, meaning oil is exported, as the figure below shows. Clearly, the release of the SPR facilitated greater exports—equal to roughly 75% of U.S. exports. This means that the SPR release served to balance the global oil market rather than strictly filling U.S. oil tanks.

This is not meant to support criticism from either America Firsters who think the oil should have been kept at home or liberal politicians who argue for an export ban in order to drive down domestic prices. Sadly, growing economic nationalism has seen attempts to control trade in everything from vaccines to onions, typically to benefit domestic consumers. This has historically meant economic inefficiencies and losses, even if some groups benefit in the short-run. Mandating lower prices means more consumption and less production, which is not a recipe for balanced markets, whether in housing, oil or onions.

But should the SPR be used to balance global markets? Much of the research in the 1970s noted the potential free-rider problem, that is, the U.S. would be spending money to protect not just the U.S. but the global economy. This certainly seems unfair and was the same as President Trump’s complaints about NATO members not picking up their fare share of the alliance’s defense. No doubt the Saudis are similarly unhappy that they often carry the burden of stabilizing oil markets while other OPEC members honor their quotas mostly in the breach.

The figure below shows releases from various OECD government stocks in recent quarters, and the U.S. clearly dominates, although adjusted for demand levels Japan and Korea have made significant contributions. Unsurprisingly, Europe’s effort has been minimal, but free-riding often succeeds because the riders know that the dominant player also benefits and will choose to act even without their support.

But where to now? The Biden Administration’s plan to begin refilling the SPR when prices drop a target level implies that it is now being used more to manipulate prices then to provide energy security. While many, including myself, believe OPEC+ was mistaken to allow global inventories to drop as low as they did, pushing prices to unsustainable (IMHO) levels, treating strategic reserves as tool to pressure OPEC into raising production—or punishing them for not doing so—is a slippery slope. And while the IEA and OPEC regularly meet to discuss cooperation, efforts to decide on a mutually acceptable oil price have always been elusive for the obvious reason that they have divergent goals.

The IEA should certainly not get into the position of trying to offset OPEC production cuts, in part because it would almost certainly lose such a contest. The OECD government oil stocks could not support a 3 mb/d drawdown for a year, whereas OPEC alone (excluding the + members) cut production by over 4 mb/d in 2020. On the other hand, the OECD has not had much success in convincing the OPEC+ members to raise pre-planned quotas in 2021/22, when markets tightened unexpectedly.

Given OPEC+’s recent track record of cooperation and flexibility, it would seem that they would be better served by showing a greater willingness to revise quotas upwards when markets tighten, as they did last year, thus obviating any need for the IEA to consider using strategic reserves for price moderation. This would not be an easy task but is worth pursuing and the Biden Administration might encourage it by refilling the SPR as prices drop to ‘reasonable’ levels. Reasonable, of course, being highly subjective.