Wednesday, May 14, 2008

what to do with the Strategic Petroleum Reserve?

From Lincoln Anderson in the WSJ...

A very useful piece. The only thing he doesn't mention is the connection between high gas prices and the depreciating dollar...

John McCain and a number of other senators have been recommending that the Bush administration stop buying crude oil for the Strategic Petroleum Reserve (SPR). They're right.

Over the last eight months, the Department of Energy purchased more than 10 million barrels of oil for the SPR as the price rose $40 to above $120. This is not sensible. It puts upward pressure on oil prices at the worst possible time. It is a waste of taxpayer money. It gives aid and comfort to unfriendly nations. And it is an insurance policy that, for the most part, is no longer needed.

In fact, we should be selling oil from the SPR at $120. Doing so could be a powerful tool for U.S. energy policy.

First, a little background. The Strategic Petroleum Reserve was established in 1976 in response to the growing instability of the Persian Gulf oil supply, and to address the threat to oil imports in the event of a war with the Soviet Union. It's been used sparingly: The largest drawdown was only 17 million barrels in 1991 during Desert Storm.

Today we have 701 million barrels of oil stored, of which 4.4 million barrels a day can be pumped. This could replace three quarters of OPEC imports for about 150 days.

But we do not need a brim-full SPR for national emergencies. There is a terrorist threat, to be sure, but it would not shut down oil imports. Other types of energy crises require small oil releases or are not related to import supply constraints.

But the SPR could be used to counterbalance the Organization of Petroleum Export Countries.

The blunt fact is that the price of crude oil on global markets is controlled by this cartel of governments: With 40% of world oil production, it is the biggest player, and it uses its clout. True, OPEC's market share has eroded to 40% today, down from 52% in 1973. But non-OPEC production is already starting to falter.

Because oil prices do fluctuate over a wide range, some say that OPEC is not controlling them. But the cartel is not after stability; rather, it wants a high average oil price. One of its most powerful tools to control non-OPEC oil production and alternative energy development is to allow price crashes to occur from time to time, to cow the competition. In 1985, for example, OPEC increased production in the face of weakening demand, sending prices down to $10 per barrel; it did the same in 1998.

The answer to this situation is perfectly straightforward. We should sell oil out of the SPR when oil prices are high, say above $80 or $90 a barrel, and buy oil when oil prices drop below $40. The SPR would then become a powerful tool to stabilize crude oil prices but at a lower level, while generating a sizable profit for taxpayers. Is this government intervention in the crude oil market? It is. It is intervention in a market rigged by a cartel of governments.

Of course, it would be unwise to empty the SPR. Some oil, perhaps as much as a 120 million barrels, should be the minimum reserve. That reserve would be seven times larger than the largest drawdown in the history of the SPR, and it would provide adequate supply for a disruption.

But an SPR that is 80% empty is a very valuable thing when oil prices collapse. And a full SPR is great to have when oil prices are high.

Environmentalists should approve of this proposal. Oil price gyrations create havoc for long-term investments in alternative energies and conservation; they hurt everybody but OPEC.

When oil prices are $120, OPEC makes a huge amount of money. When oil prices are $15, OPEC is still profitable, because their production costs are low – but everyone else gets slammed around. Businesses end up with unprofitable investments, consumers make bad decisions on energy use and conservation, and environmentalists complain about under-investment in alternative energy. We have a great tool to address this problem: the SPR. Let's use it.


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