Policy Debate: Should the Strategic Petroleum Reserve be used to Reduce Fluctuations in Oil Prices?

....if withholding a few hundred thousand barrels a day from the market can drive prices sky-high, putting a similar amount back in can bring them back down to earth -- as demonstrated by the sharp drop in oil prices that followed the announcement of plans to tap U.S. strategic reserves. And Western governments have more than a billion barrels in reserve. Why not use those reserves to break the market corner, or at least to limit its effectiveness?
~Paul Krugman, New York Times, September 9, 2000

...I have always viewed the Strategic Petroleum Reserve as a reserve in the event of a serious crisis. By that, I mean a shutdown in Middle East oil or something of that nature, because of a catastrophe of some form.

I think it would be a mistake to try to move market prices by small additions or subtractions from the Strategic Petroleum Reserve. We are dealing with an overall world market which is huge relative to our Strategic Petroleum Reserve. It is foolishness to believe that we could have any significant impact short of a very major liquidation in the short term of that reserve, and I don't think anybody is arguing for that.
~Alan Greenspan, February 17, 2000 Testimony Before the House Committee on Banking and Financial Services

The Strategic Petroleum Reserve (SPR) was created as a result of the Energy Policy and Conservation Act in December 1975 in response to the 1973-74 oil embargo. This Act allowed the U.S. to store up to 1 billion barrels of petroleum in salt caverns located near the Gulf of Mexico. Oil has been added to these salt caverns from June 1977 to the present. The SPR now holds approximately 700 million barrels of crude oil. This reserve contains enough oil to provide for approximately 2 months of oil use at current consumption rates.

Oil was first withdrawn from the SPR during 1991 to help prevent price hikes during the Persian Gulf War. While the U.S. originally planned to withdraw 33.75 billion barrels of crude oil during the war, only 17.3 million barrels were actually withdrawn from the SPR since oil supplies and prices were more stable than originally anticipated.

In energy markets, short-run demand and supply elasticities are relatively low. Consequently, relatively small changes in demand and supply can have large impacts on prices. Oil prices had risen rather dramatically in the 1970s and early 1980s in response to the Arab oil embargo. Throughout most of the 1980s and 1990s, real oil prices had been trending downward. In 1999, real oil prices fell substantially in response to a glut in the world oil market. In response, the Organization of the Petroleum Exporting Countries (OPEC) reduced the supply of oil during the winter of 1999-2000. This reduction in oil production, combined with growing demand as the Asian economies recovered from recession, resulted in a tripling in the price of a barrel of oil in a one-year period.

In recent decades, the U.S. economy has dealt with three substantial oil price shocks associated with the Arab-Israeli war, the Iranian Revolution, and the Gulf War. The first two of these shocks resulted in recessions in the U.S. This past experience raises at least some concerns that the current price shock may have an adverse effect on the U.S. economy. In response to these concerns, President Clinton, on September 22, 2000, authorized the release of 30 million barrels of crude oil from the SPR. This move resulted in a fair amount of controversy. In 2005, a similar release of 30 million barrels of oil to the open market was used to help reduce domestic oil prices. Oil was also temporarily loaned to producers to meet supply disruptions caused by hurricanes in 2002, 2004, and 2005.

Those who believe that the SPR should be used to moderate oil price fluctuations argue that OPEC has manipulated production to artificially increase the price of oil. They suggest that higher oil prices may result in higher inflation rates and higher production costs in oil-consuming nations. Advocates of the use of the SPR also note that the supply shocks of the 1970s resulted in a state of "stagflation" in which increased inflation occurred while output declined. Paul Krugman and others have noted that cartels such as OPEC tend to have difficulty in maintaining supply restrictions for long periods of time (since each participant has an incentive to cheat on the agreement). They suggest that the release of oil from the SPR can offset the temporary control that OPEC has been able to achieve over world oil prices.

Economists opposed to the use of the SPR to moderate fluctuations in oil prices argue that interference with market prices distorts incentives. They note that higher energy prices provide increased incentives to conserve energy and to discover and tap new sources of energy. It is also noted that the economic situation today is quite unlike that of the 1970s. Inflation remains relatively low and economic growth does not appear to be threatened by higher energy costs. Opponents of the use of the SPR argue that even though the price of oil has increased, the real cost of energy is substantially lower today than it was in the 1970s. Conservation measures and technological change have also resulted in a reduction in energy costs as a share of total production costs. Thus, it is suggested that the SPR should be saved for a more serious emergency that threatens national security.

There is also a question concerning how OPEC might respond to the use of the SPR. If OPEC responds to releases of oil from the SPR by reducing oil production, then the release of oil will have no effect on oil prices. If, on the other hand, the increase in the supply of oil to world markets threatens to lower oil prices, OPEC members have an incentive to increase current supply in response to lower expected future prices.

• U.S. Department of Energy
  http://www.energy.gov/
  The U.S. Department of Energy website contains information about energy markets, energy conservation, federal strategic energy plans, and an extensive collection of data and statistics concerning energy consumption, production, and prices.

• U.S. Department of Energy, "Strategic Petroleum Reserve"
  http://www.spr.doe.gov/
  This website provides a history of the Strategic Petroleum Reserve. It also provides energy statistics and information about the individual storage sites used for the reserve program.

• U.S. Department of Energy, "The Energy Policy and Conservation Act: Statutory Provisions for an SPR Drawdown"
  http://www.fossil.energy.gov/programs/reserves/spr/spr-epca.html
  This page, provided by the U.S. Department of Energy, contains the text of the sections of The Energy Policy and Conservation Act that state the legal requirements for the withdrawal of oil from the Strategic Petroleum Reserve.

• U.S. Department of Energy, "Fossil Energy"
  http://www.fe.doe.gov/
  The Fossil Energy website provided by the U.S. Department of Energy contains information on the release of oil from the SPR, as well as other information related to fossil fuel energy markets.

• Energy Information Administration, "International Energy Prices"
  http://www.eia.doe.gov/emeu/international/prices.html
  The Energy Information Administration provides recent weekly, monthly and/or annual data on a variety of energy prices at this website.

• United States Geological Survey, "Energy Research and News"
  http://energy.usgs.gov/
  The Energy Resources Program of the United States Geological Survey conducts research concerning underground oil and natural gas supplies. This website contains information about their research programs, online versions of their publications, and other information concerning energy resources.

• Federal Energy Regulatory Commission
  http://www.ferc.gov/
  The Federal Energy Regulatory Commission regulates interstate commerce in natural gas and electricity. It also oversees the enforcement of environmental regulations related to energy production and distribution. This website contains information about its history and operations.

• Organization of the Petroleum Exporting Countries
  http://www.opec.org/
  The OPEC web page contains general information about OPEC, an extensive collection of speeches and press releases, and a FAQ dealing with oil prices and OPEC policy.

• INO.COM, "New York Mercantile Exchange"
  http://quotes.ino.com/exchanges/?e=NYMEX
  This page provides information on a variety of energy prices determined at the New York Mercantile Exchange (NYMEX). Current market prices are displayed for electricity, heating oil, natural gas, light sweet crude oil, unleaded gasoline, and propane.

• Paul Leiby, Donald W. Jones, T. Randall Curlee, and Russell Lee, "Oil Imports: An Assessment of Benefits and Costs"
  http://pzl1.ed.ornl.gov/ORNL6851b.pdf
  In this November 1, 1997 Oak Ridge National Laboratory paper, Leiby, Jones, Curlee, and Lee note that oil imports have been steadily rising in the U.S. They examine the costs of these imports in this study. In particular, they focus on the influence of OPEC, the impact of oil supply disruptions and price spikes, and environmental damage resulting from oil imports. Their results suggest that the marginal cost of these factors amount of an amount between $0 and $10 per barrel of oil above the market price of oil. (Caution: portions of this paper are relatively technical. Most of the paper, though, can be read by a student with only a knowledge of introductory economics.) The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here.

• Paul Krugman, "A Drop in the Barrel?"
  http://www.pkarchive.org/column/92700.html
  Paul Krugman argues, in this September 9, 2000 New York Times article, that it is appropriate to use the Strategic Petroleum Reserve to stabilize oil prices. He notes that the oil shortage beginning in the winter of 1999-2000 is a short-term phenomenon that has allowed OPEC to regain greater control over oil prices. Krugman argues that strategic oil reserves in the U.S. and other countries should be used to stabilize prices and to limit OPEC's impact on world oil prices. He suggests, though, that the long-run policy should be to encourage production and reduce consumption so that such a problem does not recur.

• Paul N. Leiby and David Bowman, "The Value of Expanding the U.S. Strategic Petroleum Reserve" http://pzl1.ed.ornl.gov/ORNL_SPRSizeStudy11302000.pdf
  Paul N. Leiby and David Bowman discuss the costs and benefits of expanding the size of the U.S. Strategic Petroleum Reserve in this January 23, 2000 Oak Ridge National Lab working paper. They use simulation analysis to examine the possible effects of supply disruptions. Leiby and Bowman conclude that net benefit would increase if the level of reserves were to increase by at least 120 million barrels. (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here.)

• Paul N. Leiby and David Bowman, "The Value of Expanded Drawdown Capability"
  http://pzl1.ed.ornl.gov/ORNL_SPRDrawReport2v0.pdf
  In this October 18, 2000 Oak Ridge National Laboratory study, Paul N. Leiby and David Bowman examine the costs and benefits associated with an expansion in the drawdown capability of the U.S. Strategic Petroleum Reserve. They find that an expansion in the size of the reserve and in drawdown capacity would be beneficial. (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here.)

• Lorraine Woellert, "Hands Off the Strategic Petroleum Reserve"
  http://www.businessweek.com/bwdaily/dnflash/mar2000/nf00306d.htm
  Lorraine Woellert argues against the use of the SPR to lower oil prices in this March 6, 2000 Business Week Online article. She notes that world oil consumption is about 77 million barrels per day. The U.S. uses about 20 million barrels per day. In light of this, the entire SPR only contains enough oil for less than a month of U.S. consumption. Woellert argues that this should be saved for a real emergency and not used to deal with a short-run problem.

• Alan Greenspan, "2/17/2000 Testimony Before the House Committee on Banking and Financial Services"
  http://commdocs.house.gov/committees/bank/hba62930.000/hba62930_0.HTM#40
  In this testimony, Alan Greenspan argues that releasing oil from the SPR will have only a negligible impact on world oil prices unless there is a massive release.

• John Anderson, "The Surge in Oil Prices: The Anatomy of a Non-Crisis"
  http://www.rff.org/rff/Documents/RFF-DP-00-17.pdf
  In this April 2000 Resources for the Future discussion paper, John Anderson argues that releases of oil from the SPR or rollbacks in the federal gasoline tax would be expected to do more harm than good. He argues that releases from the SPR would have only a minor impact on prices over a prolonged period. Anderson suggests that the SPR should be held for use only in dire emergencies. (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here.)

• Robert L. Bradley, Jr. "What Now for U.S. Energy Policy? A Free-Market Perspective"
  http://www.cato.org/pubs/pas/pa-145.html
  Robert L. Bradley, Jr. argues for a free-market approach to U.S. energy policy is this January 29, 1991 Cato Institute Policy Analysis. He argues that the problems associated with the oil price shocks of the 1970s were, in large part, the result of price ceilings on gasoline. He argues that high prices stimulate increases in production and exploration and encourage conservation. Bradley believes that the SPR should be privatized, even if this means that it would be liquidated. He suggests that the government should reduce taxes and regulations that reduce incentives in the production and distribution of oil and natural gas.

• American Petroleum Institute
  http://www.api.org/
  The American Petroleum Institute argues that government regulations are the primary cause of supply restrictions and higher energy prices. They note that there are large supplies of oil under government owned land and in offshore locations that cannot be exploited due to environmental regulations. They suggest that a reduction in government regulation would lessen U.S. dependence on foreign oil supplies.

• D. Mark Wilson and Angela Antonelli, "Overtaxed at the Pump: What's Behind High Gas Prices"
  http://www.heritage.org/Research/EnergyandEnvironment/BG1386.cfm
  D. Mark Wilson and Angela Antonelli examine the causes of higher gas prices in this July 19, 2000 Heritage Foundation Backgrounder article. They argue that the price of gasoline increased as a result of higher demand and a reduction in production. Wilson and Antonelli argue that the federal government has not undertaken any policies that will alleviate this problem and instead have made the problem worse through environmental mandates. They also suggest that federal and state taxes on gasoline should be reduced to reduce the impact of higher gas prices on low-income households. (Their argument ignores the effect of lower gas prices on gasoline consumption.) Wilson and Antonelli argue that the patchwork of different state taxes on gasoline results in substantial variation in gas prices across state borders. They also suggest that different mandated reformulations of gasoline substantially raise refining and distribution costs.

• James Phillips, "Declining U.S. Credibility and Rising Oil Prices"
  http://www.heritage.org/Research/TradeandForeignAid/EM663.cfm
  In this March 17, 2000 Heritage Foundation Executive Memorandum, Jack Phillip argues against the use of the SPR to smooth out oil price fluctuations. He indicates that the SPR is designed to be used only for a crisis situation and its use for other purposes would leave the U.S. vulnerable to a serious energy crisis if foreign supplies are cut off. Phillips encourages more extensive exploration and exploitation of domestic oil reserves.

• Alan Reynolds, "Oil Reserves and Politics"
  http://www.cato.org/dailys/04-08-04.html
  In this April 8, 2004 Cato Institute article, Alan Reynolds argues in support of selling some of the oil in the Strategic Petroleum Reserve. He suggests that even the threat of such a release would be likely to result in a significant reduction in world oil prices.

• Timothy Considine and Kevin M. Dowd, "A Superfluous Petroleum Reserve"
  http://www.cato.org/pubs/regulation/regv28n2/v28n2-3.pdf
  In this article, appearing in the Summer 2005 issue of Regulation, Timothy Considine and Kevin M. Dowd argue that there is no need to maintain the Strategic Petroleum Reserve. They argue, though, that the buildup of the oil reserve had no significant effect on oil prices during the period from 2001 to 2004. Considine and Dowd argue that the allocation of oil across time and space would be done more efficiently by the market in the absence of government intervention. (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here.)

• Jerry Taylor and Peter Van Doren, "Strategic Petroleum Reserve Inflating Oil Prices"
  http://www.heartland.org/Article.cfm?artId=16201
  Jerry Taylor and Peter Van Doren, in this January 1, 2005 article, argue that buying oil to fill the Strategic Petroleum Reserve drives up the price of oil, resulting in higher U.S. energy costs. They suggest that the government should not be involved in the business of maintaining inventories of commodities because this encourages the government to engage in inefficient intervention in the oil market. Taylor and Van Doren advocate selling off the oil reserve and allowing the oil market to function without government intervention.