President Bush made the right call in making 5 million bbl of crude available for sale on a test basis from the Strategic Petroleum Reserve.
A frantic market needed to know that SPR crude would be available and that the system works, Until the President's decision last week, it had no way of factoring SPR's 590 million bbl into its perception of future supply.
That perception is the most important fundamental force in the current market. Equally important, although not fundamental in the sense of supply and demand, is fear. Together, those forces have driven crude prices to their highest levels in years.
FEAR AND PRICES
Fear will influence prices as long as war threatens the Middle East. Futures prices, especially, will zig-zag on rumors of war or truce. President Bush can rail against futures market "speculation," as he did when he announced his SPR decision, all he wants. But it's like scolding tornadoes or hurricanes.
Operation Desert Shield and 4.3 million b/d of oil lost to an international embargo represent excellent reasons for oil traders to worry about future supply. To expect those worries not to influence current prices is absurd. Bush's nonsensical bluster can be excused as politics. What's important is that he 'Made the correct decision, despite the silly stated reasons.
SPR critics will disagree. They'll chafe at this intrusion in the market. They'll say SPR crude should be used to offset physical shortage, not to influence price. But those are arguments against the very existence of SPR; they're a decade and a half late.
The U.S. has 590 million bbl of crude oil in storage, bought and paid for with $19 billion of taxpayers' money. Good or bad, the mere existence of all that oil is an intrusion in the market. And waiting for a "physical shortage" to develop would mean never employing the asset. The market won't tolerate "physical shortage." When the market anticipates limits on suppliers' ability to meet demand, it raises price to cut consumption and stimulate development of new supply. That's what's happening now. Physical shortages don't occur unless governments create them.
Sometimes, the market's exertions to align consumption with constrained supply occur rapidly. War, for example, might knock much of Saudi Arabia's production capacity off stream. Some would call that a "physical shortage." In fact, the resulting price leap would pare demand immediately; consumers willing to pay the price would still find supply. The process would be simply a compressed version of what's happening now.
TIME TO ADJUST
But now the market has the luxury of time. The disruption occurred with inventories high and spare production capacity available to partly offset the loss. The problem remains demand in the Northern Hemisphere's rapidly approaching heating season. Total supply without Iraq and Kuwait can't meet demand at levels anticipated before the invasion. So the market is discouraging consumption. And the price comes out of economic activity.
SPR sales can lubricate the adjustment process. Bush's decision to allow them lets the market know that the oil won't stay in the ground awaiting a "physical shortage" that will never develop. Yes, the sales will moderate price. So what's wrong with that? There are no circumstances under which an addition to supply would not, to some extent, ease crisis price pressures.
The market is contracting in anticipation of a physical shortfall it won't tolerate. Given developments and tensions in the Middle East, the process is necessary, however much it damages economies. SPR exists for emergencies like this. Now is the time to use it.
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