Wednesday, May 19, 2004

Savings vs. Withdrawals
Many politicians are calling for changes to the Administration’s policy of continuing to fill the nation’s Strategic Petroleum Reserve (SPR), aimed at reaching a level of 700 million barrels by next year. Some are suggesting that oil be released from the reserve to put downward pressure on prices, while others, including Senator Kerry, are asking for a suspension of additions to the reserve. These two alternatives have very different ramifications.

First, in terms of the efficacy of SPR sales in dampening the market, the New York Times correctly cited the poor results achieved in past experiments of this type. There is little chance of better results today, given the very high utilization rate of US refineries. (96% based on the most recent data.) This means there are essentially no refineries that lack crude oil from which to make gasoline. The best-case result of a release might thus be to back out some deliveries of high-sulfur crude, replacing it with “sweeter” SPR crude, and improving refinery yields slightly. This would provide scant relief at the gas pump, which is the real issue for consumers, since they can’t burn crude oil in their cars.

More fundamentally, there’s a real problem with releasing SPR oil now. As most market commentators have noted--echoed in my blog yesterday--we are not in a crisis of disrupted oil supply, for which the SPR is intended. The chance of such a crisis is higher than normal now, as the current risk premium on oil attests. It is not prudent to release SPR oil unless and until we are in a real crisis, in which case we will need every drop and 659 million barrels will seem like a very modest emergency stock. This total is equivalent to only about 150 days’ shipments at the maximum SPR output rate.

Turning to the idea of halting additions to the reserve, my reaction in February (see posts of 2/17 and 2/18) was that it would make no real difference, since the SPR fill comprises only a tiny fraction of global demand. With oil prices over $40 today, I see things differently. The volume may still be miniscule, but a change in this policy could stimulate a change in market psychology, and that could be significant.

Rather than being based on detailed assessments of the chance of a disruption of shipments from Saudi Arabia or other key Middle East suppliers, a portion of the current risk premium on oil comes from traders assuming that the government’s actions in the market validate their own views of those risks. In other words, if the government is “going long”, so should I, because they have access to secret information that I don’t.

Taking a breather on additions until prices return to a more normal level would force market players to reassess their positions, and this might have a disproportionate impact on the market. That could be very helpful, and the foregone additions would make little difference in the country’s preparedness for a real crisis. It would also show that the Administration can be flexible in its responses, rather than simply continuing on a path that has become counterproductive.

By the way, there's an email chain letter circulating, trying to organize today as "Stick It To Them Day", a national gasoline boycott. This sort of thing would only harm the tens of thousands of independent businesspeople who own and operate most of the gas stations in the country, without sending any kind of signal to the global markets, unless people actually stop driving their cars, too.

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