Don’t Use The SPR To Manipulate Oil Prices

After going untapped for decades, the Biden Administration drew down the Strategic Petroleum Reserve by almost 300 million barrels during the pandemic when demand recovered faster than expected and OPEC+’s quotas led to the market tightening and higher prices (see figure). Most of the draw occurred when prices were above $80 but given that the maximum draw was about 1 mb/d for five months, while OPEC+ had somewhere around 4 mb/d of spare capacity, it could be argued that the draw was unnecessary.

That assumes that OPEC+ and the Saudis in particular would have stepped in to keep prices from going higher, which is uncertain. Quite possibly, OPEC+ members would have resisted requests from the Biden Administration to raise production, meaning prices would have remained above $100. But the U.S. could have tried other policies, for example, removing sanctions on Iran, Russia and/or Venezuela, which might have added an additional 2 mb/d to the market. Admittedly, that was politically unacceptable.

Obviously, the Administration wants lower not higher oil prices in this election year, especially as we head into the all-important summer vacation and driving season. If gasoline passes $4 a gallon in most of the country, a lot of discouraging words will be heard on the range. Trump will naturally point to higher gasoline prices as a prominent indicator of what he considers failed Administration policies, comparing it to the low price of $1.81 a gallon in April 2020 while glossing over the role of the pandemic in the reduction.

So, the temptation for Biden will be to at the least try to talk prices down by threatening a new release, which could lead to a tit-for-tat war of words with Saudi Minister Abdulaziz bin Salman, already on record as warning short-sellers that they risked being caught out by a cut in Saudi production. Beyond threats and jawboning, a further release of oil from American strategic reserves could mean lower global prices but given how far the SPR has already been reduced, there are clear limits to how much more can be released. Of course, lower prices for a few months would satisfy Biden’s political needs.

The longer-term concern revolves around the use of the SPR for price manipulation rather than responding to political disruptions of supply, which is supposedly its primary purpose. Arguably, the SPR has played a role in deterring any new oil embargoes, but producers have shown no interest in enacting them in decades, given the negative political and economic consequences for consumers and producers following 1973’s embargo.

The use of the SPR to manipulate prices is fairly high on the list of bad ideas. The history of commodity price manipulation is a long and mostly sordid one. Economists have noted that most efforts result in prices set too high: prices affect producers more directly than consumers, creating a bias towards raising prices. This has been true for many commodity price stabilization agreements, which were popular after World War II and often seen as a form of foreign aid. But nearly all of which have collapsed when prices were set too high and brought on new supplies. Or, as economists would say, prices were set above market-clearing levels.

There are two basic reasons why politicians shouldn’t try to manipulate prices for oil (and most everything). First, they don’t know what the ‘appropriate’ price should be. Second, they often don’t care, focusing on the political benefits of setting prices to satisfy various constituencies.

The history of petroleum economics includes a huge number of failed efforts to calculate the sustainable price of oil, one which pleases both consumers and producers, and enables the market to balance. There is no reason now to think that anyone has a better idea of what the ‘appropriate’ oil price should be. But frankly it’s not clear if the Biden Administration is even considering that in its efforts to manipulate prices, as opposed to simply wanting them ‘lower’ for political reasons. It would be hoped that after the election, the Administration will revert to a laissez-faire approach, but then, it is not the way to bet, as Damon Runyon would say. (Look it up!)

The tendency to choose a price for political reasons is far more likely than any attempt to find a sustainable or market-clearing price. This is obvious from observations about farm policy, where the goal is to make rural voters happy. I mean, to help ‘preserve our national traditions.’…