Obama calls for an SPR release, Russia produces less oil

As McCain was winning over voters by pretending that opening offshore oil to drilling would reduce oil prices significantly within the next few years, Obama had to do something louder than encouraging people to drive more efficient vehicles. Unfortunately, due to Bush’s catastrophic lack of fiscal responsibility, the Presidential candidates can only do things that cost nothing or completely pay for themselves. So, Obama’s new support for a release from the Strategic Petroleum Reserve (SPR) comes as little surprise. But now is a good time to debate the merits of such a plan…

When I say debate the plan’s merits, I will not focus on whether it works as a vehicle to win the election – though that may be the most important factor under consideration for both parties. I will rather talk about whether such a plan can help US citizens handle the difficult spike in energy prices.

We have just over 700 million barrels (Mb) of oil in Louisiana salt caverns. The SPR was set up as a response to the oil shocks of the 1970s when embargoes caused serious shortages of oil in the US and other major importing countries. The SPR is a useful tool in the case of future embargoes or major oil disruptions. For instance, if there were an attack on Iran and the country responded with a blockade that curtailed 3 million barrels per day (Mbd) of flow — a release of ~1.5 Mbd for several weeks could help replace the Saudi Arabian oil that we would lose access to. Assuming somewhat quick resolution that allowed most of the oil to flow again within a few months (a la the first Gulf War), the SPR release would help avert a physical shortage and bullish chaos in oil prices during that period. The SPR would unquestionably help maintain some stability during a difficult time.

But what about the current situation, when the oil market is characterized by the last six years of rapid demand increases that producers struggle to supply? The benefits versus costs of an SPR release at this time are more ambiguous, since it acts as a temporary band-aid to what may be a much deeper problem of oil supply stagnation (and even imminent decline).

The proposal: Since I have not seen the exact details of Obama’s plan I will estimate his proposal is similar to ones put forward by members of Congress. Averaging ideas in their discussions, I will consider a 50 Mb release over 100 days (September 1-early January) at .5 Mbd that lowers the SPR by ~7% to ~650 Mb.

1. Will it help reduce prices?

Maybe in a miniscule way. This would reduce our import need by ~4% (.5/12.5), but prices are determined globally — where .5 Mbd is less than .6% of global oil flow. Based on an equation I have put together that matches supply/demand balance to prices over the last 15 years, this change may reduce prices by ~3% or 10 cents/gallon. So, the change may reduce average drivers’ gas bills by ~$14 during the 100 days.

But there are no guarantees that prices would be reduced significantly because a futures market would discount the oil today by the fact that less oil is available in the SPR tomorrow. And OPEC producers may welcome the .5 Mbd addition to the world market by reducing their own production by an equal amount to maintain current prices, thus making the SPR release impotent. It is in their interest to do such cuts to maintain their astronomical revenues.

2. Will it generate optimal revenue? The release (or sale to refiners) could generate ~$6 billion (50 million barrels*~$120/barrel) in revenue.

The opportunity cost of releasing the oil in 2008 would be the 7% less security and reduction in assets for the future. If we think that prices should be heading down in the future then releasing oil makes financial sense as the federal government would make higher revenue selling it to the market now and would help to mitigate a temporary market imbalance. But if the demand/supply imbalance were long-term as current trends appear to support, then our government may miss out on the opportunity to sell our SPR at a higher price in the future. For instance, the 50 Mb would generate $12.5 billion (not $6 billion) if it were sold to a $250 per barrel oil market. But we need to discount that opportunity with a discount rate (let’s say its 3.5%/yr, so if the price of oil increases faster than 3.5%/yr then it is not a sound decision based on long-term revenue potential to sell it now versus later as a nominal $250/barrel in 2028 is ~the same as $125/barrel in 2008).

3. Would an SPR release help the economy avert a major recession?

The last question is whether an SPR release would act as a sort of stimulus package to help relieve temporary economic difficulties, helping to lower the inflation rate and giving consumers a few more dollars to pay off their credit card debt or contribute to their mortgage payment. But the case could also be made that such a release will give people the counterproductive idea that it’s OK for them to stay addicted to oil at current levels.

In sum, an SPR release is set up to provide temporary relief to mitigate supply deficits. As long as Obama’s proposed release isn’t too large, such a policy probably couldn’t cause much harm and may do some good. But the big picture remains: increased oil demand in emerging economies and Middle East producers while oil production is declining throughout most of the non-OPEC world make US consumption levels dangerously high. Our oil focus needs to be on the efficiency and deployment of plug-in hybrid electric vehicles and transit/bike/ped infrastructure throughout the next two Presidential Administrations at least. And of course such a focus could help us mitigate the threat of rapid climate change as well.

Since gas prices are almost four times what they were when Bush came into office, you’d think it would be easy for Democrats to mobilize public outrage over energy prices for a change of the guard to their choice of Obama. But how that plays out remains to be seen. I hope that the big picture remains in view. Just as today’s Russian production totals for July at 1% below last year remind us, supply is struggling to keep up with demand. The biggest lever we have is our ability to transport ourselves and our goods more efficiently. And we can act in a matter of weeks to lower our bills, rather than wait years to see ANWR and offshore oil change our prices by a few small percentage points.

Let’s choose the sustainable energy transition.

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