Does the US need the Strategic Petroleum Reserve (SPR)? An analysis by the Cato Institute concludes that it does not.
With a capacity of 727 million bbl, expected to be full in a few months, the SPR is the largest government-owned stockpile of petroleum in the world. Established 30 years ago in response to the Arab oil embargo, the goal of the SPR is to store oil for use in a “severe energy supply disruption” at the US president’s discretion.
The SPR has been tapped only three times. In each instance, the release was too small and too late to produce significant benefits, Cato says, with the exception of this year’s release related to Hurricane Katrina.
Politics, insurance
The Cato paper says that the operation of the SPR has become politically controversial in recent years, with the central question being whether the stockpile should be used only during a national emergency or whether it should be used occasionally as a means to suppress high oil and gasoline prices.
And secondary political issues surrounding the SPR have arisen, including whether the president should suspend additions when global oil supplies are tight, thereby helping to reduce oil prices. Other issues are how quickly the US government should increase the amount of oil in the reserve and the extent to which it should increase the SPR’s capacity.
How effective is the SPR at protecting against oil price shocks? The inventory provides insurance for only a subset of the possible supply disruptions that could occur, Cato reports. Oil releases can ameliorate temporary events but can’t affect long-term disruptions because the stockpile isn’t large enough to affect world oil prices over extended periods of time.
Cato further asserts that the SPR is ineffective as an embargo hedge. “An oil embargo against the US is incapable of preventing oil imports from reaching US ports. Once oil leaves the territory of a producer, market agents dictate where the oil goes, not agents of the producer.”
Costs vs. benefits
The US Department of Energy reports that through 2003, the US government spent $18 billion for the oil in the SPR and nearly $6 billion on associated operation and maintenance costs.
With adjustments for inflation, recognition that some contributions to the SPR are in-kind and don’t involve cash outlays, and consideration of the opportunity cost of holding the oil, Cato figures that the minimum real cost of the SPR has been $41-51 billion. If so, the SPR has cost US taxpayers $64.64-79.58/bbl.
Cato outlines a number of benefits of the SPR. First, the government might make money by buying oil at low prices and selling at high prices. In reality, though, with its costs so high, this is unlikely. Second, SPR releases might dampen oil price hikes during disruptions and reduce wealth transfers from oil consumers to oil companies during a shock.
The third possible benefit of holding the SPR is that it might deter oil speculation during crises and deter producers who might otherwise contemplate politically inspired production cutbacks. However, the executive branch has been so reluctant to use the SPR that whatever deterrence value it might theoretically hold is not that great in practice, the Cato analysis says.
Finally and most importantly, the SPR might deliver macroeconomic benefits by dampening future oil price increases, as the main economic damage caused by oil price spikes is from secondary reactions in the economy rather than from the price of oil itself.
Faulty assumptions
Cato finds three common problems in most cost-benefit analyses of the SPR. First is an excessive fear of supply interruption. Most analysts have expected that supply disruptions would be more frequent and more severe than has actually been the case.
Second, politicians are unlikely to order inventory releases as quickly or as robustly as economists would recommend. Cato contends that if the SPR is not used robustly and immediately at the onset of a disruption then it is of limited value.
And the third problem is that few studies consider the possibility that private oil inventories-estimated at three times the size of public stocks-will release significant oil volumes to the market in response to a disruption.
Cato concludes that if the SPR were shut down, the US could avoid paying for it during good times and simply pay market prices during shocks. Instead, it pays both the costs of the SPR and market prices during shocks.✦
