Strategic Petroleum Reserve: A Hedge against Economic Illiteracy

by David Bier on March 5, 2012

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Reps. Peter King (D-NY), Ed Markey (D-MA), and Rosa DeLauro (D-CT)  have written President Obama urging him to release oil from the U.S. government’s Strategic Petroleum Reserve (SPR) in order to help drive down high gas prices. Congressional Republicans are opposing the effort “to politicize” the SPR. Who’s right in this latest political squabble?

Well, Democrats are maybe 10 percent right. Congress should release oil from the SPR, but not just some—all of it! The SPR was created in 1975 after the OPEC oil embargo, which was instituted as retaliation for the U.S. intervention in the Yom Kippur War. President Nixon responded to the embargo with oil price controls. These controls created artificial scarcity as investors withdrew oil from the market to sell at higher prices later, causing massive shortages and gas lines.

In other words, the energy crisis was of Nixon’s own creation. Supposedly, the OPEC oil embargo so rapidly decreased oil imports that it was necessary for the U.S. to create a national reserve to hedge against another embargo. Except oil imports did not go down in 1973, or 1974, or 1975, they went up. All the embargo did was shift OPEC’s U.S. oil to other countries, and other oil normally intended for those countries to the U.S. Moreover, investors created private reserves as soon as they saw that Middle East oil was compromised, which means we exported less and imported more.

The SPR was created to solve an oil shortage, but since this was caused by Nixon’s controls, it seems that the reserve was actually created as a hedge against future politicians’ economic illiteracy—not future embargoes.

Nonetheless, many have argued the SPR serves a national security purpose, but this is codswallop. The Energy Policy and Conservation Act of 1975 created the SPR to prevent “severe energy supply interruptions” and prohibited private “hoarding” during a shortage beyond one’s “reasonable needs.” Furthermore, to think that the U.S. government—the organization with a printing press in their basement and the unlimited power to confiscate wealth and property—will somehow run short on oil is absurd in the extreme.

A supply disruption in the Middle East—even one caused by terrorists—does not imply the need for government action, especially when investors and private markets have already shown they can handle this economic risk. Since 1973, an oil futures market has developed to insure against fuel supply shocks. Moreover, private firms since that time have developed massive stockpiles of their own—325 million barrels worth. The SPR actually diminishes this market, as economists Jerry Taylor and Peter Van Doren explain:

Oil economists of all stripes acknowledge that maintaining public stockpiles discourages the accumulation of private inventories and perhaps even public inventories abroad because foreign governments have an incentive to “free ride” off U.S. inventories given that a U.S. release would reduce oil prices everywhere in the world. How much oil is displaced by the SPR is unknown, but prominent oil economists such as Philip VerlegerBrian Wright, and Jeffrey Williams suspect that the displacement is quite large. This stands to reason. It’s very expensive to hold oil in storage, and market actors aren’t going to be so inclined to do it if the government is going to step in and flood the market with crude whenever a nice profit opportunity materializes.

The bottom line is this: the government took over private activity in response to economic problems it created, and now it’s using that power to play hero at our expense—an expense of well-over $50 billion—all in order to save us from other problems of its own invention. Politicians argue over it without anyone questioning the premise that government should have an SPR at all.

Nor is spending billions of dollars on a useless service “better safe than sorry”—it’s stupid. And spending billions of someone else’s dollars on a useless service is worse than stupid—it’s immoral.

 

Henry S. Kramer March 6, 2012 at 11:59 am

The strategic reserve should only be large enough to meet any and all needs of the US military in the event of a disruption. We must always have enough fuel at the ready to be able to project US power throughout the world. It should not be for civilian use. The closer we get to the presidential election the more likely the incumbent president will release oil from it, for political reasons.

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