Exports Raise the Bar for US Strategic Petroleum Releases

I've seen a number of Tweets suggesting that the US will release oil from its Strategic Petroleum Reserve (SPR) sometime in the next month or two, perhaps in tandem with other member countries of the International Energy Agency.  Although circumstances might provide several possible rationales for such a release, including the implementation of tougher sanctions on Iran's oil sector and the possibility that Hurricane Isaac will disrupt some production in the Gulf Coast, it's hard to avoid a political interpretation, as well.  As we head into a close Presidential election, gas prices are rising again, and that's never good for an incumbent.  Selling oil from the SPR is one of the few levers available that might affect short-term energy prices.  However, much has changed since the Clinton administration released 30 million barrels (via exchange) in the lead-up to the 2000 election.  In particular, the country's switch from net importer to net exporter of petroleum products implies that a release in response to events other than a physical disruption in oil supplies could result in some of the benefit of such a release being exported, as well.

When it comes to uses of the SPR, I'm a purist, probably because I can recall sitting in gas lines and participating involuntarily in the bizarre "odd-even" rationing-by-license-plate scheme introduced during the oil crisis following the Iranian Revolution.  The SPR was designed to provide a backstop for our vital energy supplies in a true physical emergency, not as a tool for price manipulation.  I've also suggested for some time that the SPR is overdue for a comprehensive reassessment of its structure.  Our energy situation has changed significantly since the mid-1970s, when the present SPR was established, and we are in the midst of the biggest changes in US energy supply and demand patterns in decades.  We ought to invest the time and money required to bring this institution into the 21st century.  Earlier this year, I also suggested an alternative mechanism for leveraging SPR inventories without depleting them. These are tasks for after the election, whoever wins.  For now, we have what we have, and we should think carefully about the implications of using it in situations less compelling than a war in the Persian Gulf or an unanticipated disruption in North American or global supplies.

One of the changes that must be taken into account is our recent shift in refined product exports, about which I've written previously.  US refineries are capitalizing on the expansion of domestic oil production in a period of weak US demand to continue to operate at high utilization rates and export the resulting surplus output to growing economies in Latin America and elsewhere.  This is generally a good thing, because it helps preserve capacity that might otherwise no longer be available when our own economy eventually resumes healthier growth. It also sustains employment we would sorely miss in a terrible job market.  Furthermore, we have benefited greatly in reliability and flexibility from participating on both sides of the global market in refined products. Still, although I view our petroleum product exports as generally positive--just as I do Boeing's exports of jetliners--I wouldn't advocate using petroleum stockpiles purchased with tax dollars to drive down oil prices to give these refiners an even bigger export advantage.  Yet because of its temporary nature, in contrast to new pipelines or new production, that's exactly where at least some of the benefit of SPR oil released in the absence of a serious supply crisis would go now. 

That doesn't mean I regard rising oil or gasoline prices as harmless to the economy. Consumers are facing the highest pump prices heading into Labor Day weekend since 2008, and that could have a ripple effect throughout the economy.  But even if one ignores the longstanding bi-partisan principle that the SPR is intended only as a crisis-management tool, its effectiveness at moderating oil-price volatility is limited.  Last year's coordinated SPR release, prompted by the Libyan revolution, had little persistent effect on either oil or gasoline prices. A release now is likely to be no more effective when US refineries are already running above 90% utilization and the current 4-week averages show 3.6% of US gasoline production and 23% of diesel output being exported. None of these statistics suggest refiners are experiencing difficulties in obtaining feedstocks, other than on price.  Putting SPR oil into such a market might boost refiners' margins for a while, but it's doubtful it would do much for the product prices that matter to consumers. 

There are sharp differences between President Obama and Governor Romney, not least on energy policy. We're sure to hear more about energy from both campaigns in the weeks ahead, and I plan to analyze their positions closer to election day.  However, one factor this election doesn't need is a release of oil from the SPR that appears to be aimed at dampening gasoline prices that often decline after Labor Day without intervention, rather than being justified by a tangible threat to US oil supplies, and that fails to take into account the added complexity of net product exports. That wouldn't serve the interests of voters, taxpayers or consumers, and it would come at the expense of a little bit of our collective energy security. 

Ratcheting Up Another Notch

Last week's increase in crude oil prices seems to have had more to do with the fundamentals of supply and demand, than a change in perceived geopolitical risks. But while estimates of US demand growth have sent the oil market up and down over the last several months, tensions with Iran seem to be moving in only one direction. The Islamic Republic's pursuit of nuclear technology remains the headline issue, and the UN Security Council has just unanimously agreed to tighten sanctions, but the more immediate worry is Iran's seizure on Friday of 15 Royal Navy and Marine personnel. Although a similar crisis was resolved peacefully three years ago, it illustrates the heightened risk of miscalculation created by the proximity of one potential crisis to an another, active one.

Although the experience of pre-war intelligence on Iraq has taught us all caution, the pattern of Iran's nuclear activities makes the most sense as a program to develop nuclear weapons. Diplomatic efforts to block this path have been agonizingly slow, and the lowest-common-denominator sanctions that we and our European allies have pushed through the Security Council may seem timid to some, compared to the proliferation risk involved. However, they are starting to bite, and even Russia is chipping in with some useful commercial pressure. President Ahmadinejad doesn't look quite so formidable as he did a year ago, notwithstanding the doublespeak coming out of his foreign ministry. His position could grow even more tenuous, once Iran starts rationing gasoline. Years of heavily-subsidized gasoline prices have created more demand than the country's refineries can meet, and this is consuming precious hard currency. In this context, sustained diplomatic pressure to contain Iran's ambitions is no longer just a means of buying time; it now looks like our most promising option.

However, as long as we're fighting next door in Iraq, the downside of this approach is that it will keep generating opportunities for one side or the other to make a tactical miscalculation that could spiral out of control. Whether the orders to seize the two British patrol boats came directly from Tehran--as a tit-for-tat reprisal to the US arrest of suspicious Iranian "diplomats" in Baghdad--or from an overzealous local commander, the Iranians are playing a dangerous game. I'm not familiar with the rules of engagement under which the Coalition forces in the Persian Gulf operate, but it's not hard to imagine a different outcome to this incident, if Coalition naval or air support had been a little closer to hand, or a trigger finger on either side slipped. With both sides on edge, this sort of behavior a recipe for disaster, and I hope that message is being conveyed to Iran's diplomats in the strongest terms.

Too much of the world's oil transits those waters to take this risk lightly. Although the Persian Gulf "tanker war" of 1984-87 failed to halt the overall steep slide of oil prices at the time, the market today is tightly enough balanced that it wouldn't take much to send prices back to last summer's record highs and beyond. That might benefit Iran in the short term, increasing the value of its exports, but I suspect they'd soon find that oil weapons, like nuclear ones, are more effective as long as they remain in the realm of threats and uncertainties. The last thing the mullahs should want is to teach us how to do without their oil.