The U.S. is making real progress toward the goal of longer-term energy independence. Deploying the so-called Strategic Petroleum Reserve for a short-term fix would not aid this effort.
First, some background: Domestic crude oil production surpassed 6 million barrels per day (b/d) in January for the first time in 15 years. Production of natural gas liquids (NGLs) is also setting new records nearly every month, increasing in the latest data by over 300,000 b/d year over year. This recent growth in hydrocarbon production has managed to reverse nearly three decades of persistent annual declines. Progress is also being made on the demand side of the ledger. Despite U.S. real GDP surpassing 2007 highs, oil consumption is down by 9% or nearly 2.0 million b/d. While partly attributable to lower employment relative to 2007 highs, automobile, airplane and trucking efficiencies have improved. Moreover, consumers are learning to optimize usage.
Despite the progress that has been made, the U.S. remains highly exposed to the vagaries of the global oil market. The U.S. still imports over 45% of our oil at a cost of $340 billion in 2011, constituting nearly 50% of U.S. merchandise balance of payments. A $7/barrel – rise in the price of oil more than offsets the trade balance improvement resulting from the progress in supply and demand discussed above. Meanwhile, oil prices have risen more than would be expected, given the macroeconomic backdrop, due to a series of geopolitically related production outages in Libya, South Sudan, Yemen, and Syria, as well as significant declines in the North Sea. In addition, we estimate the oil market has roughly a $5-$6/barrel premium due to the small probability of a conflict in Iran, which is very slight when compared with the full range of potential outcomes.
It is against this backdrop that we hear politicians, specifically ones in the middle of an election cycle such as France and the U.S., discussing releases from the Strategic Petroleum Reserves (SPR). Rising gas prices are increasing pressure on politicians globally to “do something about rising oil prices.” While we enjoy French wine and would love more vacation, we think this is an area where we should let the French go their own way.
The SPR is a valuable first responder in meeting outages, particularly short-term outages such as hurricanes or wars. However, in our opinion, the SPR is an ineffective tool to manage prices. Oil prices are a function of both near-term supply and demand and perceived long-term balances. A temporary release aimed at influencing short-term prices could actually send an unintended bullish signal to the market that long-term spare capacity in OPEC producers is insufficient to meet supply losses. The release of oil from the SPR in 2011, several months after the Libyan conflict began, seemed to have precisely this effect. Prices initially fell by 7%, but quickly rebounded as the market priced in the challenge of redelivering the oil to the SPR in the future.
Other short-term solutions, such as waiving the Jones Act, a U.S. law that requires vessels working in U.S. waters be flagged in the U.S. and be crewed by U.S. workers, or easing emissions standards for producing gasoline, could partially ameliorate gasoline tightness this summer, particularly on the East Coast of the U.S. These policy changes, however, will be difficult to enact for political, environmental and operational/technical reasons.
With few options, governments have limited ability to influence oil prices and so should focus instead on policies that affect the medium to long term. Altering the long-term outlook for oil consumption and production could actually have a bigger impact on prices. There are a number of policies to explore.
- Promoting the expansion of pipeline capacity from West Texas, the U.S. midcontinent and Canada to ensure producers investing in new fields will not encounter stranded production. Safeguarding the environment makes economic sense, and prudent policy would demand the most modern pipeline technology in exchange for bringing nearly stranded crude oil to the coastal regions.
- Clarifying environmental standards to be employed in hydraulic fracturing would ensure continued growth in domestic output.
- Growing domestic U.S. natural gas production, which has driven U.S. prices to a fraction of global oil-linked natural gas prices, also creates tantalizing options for reducing oil consumption in favor of a cleaner burning domestic resource. Policies directed at improving liquefied natural gas (LNG) and compressed natural gas (CNG) infrastructure to significantly increase their use in transportation, while controversial in the dawning age of fiscal austerity, could also lead eventually to further reduction in oil imports and further improve U.S. energy security.
This is not an exhaustive list of policies to consider, but when combined with tightening corporate average fuel economy (CAFE) standards, could have a bigger influence over perceived future balances and prices than an SPR release.
While loaning oil from the U.S. SPR would likely be ineffective in lowering prices, rising domestic production affords the U.S. the opportunity to permanently reduce stocks. With production undergoing rapid growth and oil consumption declining secularly, U.S. imports of oil have dropped rapidly in recent years. As such, the U.S. commercial and government inventory cover has grown from 140 days of imports in 2007 to 206 days of imports in 2011, more than double the IEA mandated level of 90 days. U.S.-government-held inventories, by itself, has increased from 55 days to 80 days since 2007. If the U.S. government sold enough oil to retrace half of the increase in SPR cover, the U.S. could sell 100 million barrels. This would also raise $11 billion, funds that could go towards the budget for the Department of Energy, U.S. Bureau of Ocean Energy Management, Regulation and Enforcement (to speed up drilling permit processing), or to fill holes in the Highway Bill.
To conclude, since we are making enough progress on the energy front that we can afford to take the long view, we should not let short-term political expediency distract us from this goal. A temporary release of oil from the SPR before we have an emergency need for it would be shortsighted and possibly counterproductive (a permanent reduction in the size of the SPR due to our lower import dependency would be more effective).
Employing a long-term strategy would also possibly incentivize petroleum exporters to contain prices for fear of lost market share. Achieving energy independence, beyond pure economic benefits, would also help us reshape our foreign policy, our military spending, and our relationship with the rest of the world. What American wouldn’t want that?