Consumer Energy Report is now Energy Trends Insider -- Read More »

By Robert Rapier on Apr 7, 2011 with 21 responses

Speculator’s Political Reserve?

Strategic Petroleum Reserve or Speculator’s Political Reserve?

An aerial view of the Bryan Mound storage site of the Strategic Petroleum Reserve. Photo: Dept. of Energy.

In the previous essay, Senator Chuck Schumer (D-NY) was quoted in a letter to then-President Bush: “The [strategic] petroleum reserves are intended to provide relief at times when working families are struggling to make ends meet.” Politicians have a long history of requesting that the Strategic Petroleum Reserve (SPR) be utilized in an attempt to influence gasoline prices. But is that an appropriate usage of the SPR?

The Purpose of the SPR

Let’s review the purpose of the SPR. From the Department of Energy’s website on the SPR:

In the event of an energy emergency, SPR oil would be distributed by competitive sale. The SPR has been used under these circumstances only twice (during Operation Desert Storm in 1991 and after Hurricane Katrina in 2005). Its formidable size (700-plus million barrels) makes it a significant deterrent to oil import cutoffs and a key tool of foreign policy.

So the question becomes, “Do high energy prices constitute an energy emergency?” I understand that high fuel prices are a financial burden on most people, but I believe there is a big difference between high gas prices and a true emergency.

A True Energy Emergency

Fuel shortages have happened in the U.S. before, and could happen again for a variety of reasons. If a major source of U.S. oil imports was cut off, shortages could quickly develop and our society could come to a grinding halt. Imagine another 1973 oil crisis that resulted not only in much higher oil prices, but in gas lines and fuel shortages. The SPR could then be tapped to ease those shortages, and if it appeared that they would be extensive it would buy time to implement emergency measures such as rationing.

And as others have pointed out, OPEC can respond to a release from the SPR by simply cutting back on production. If we had released oil from the SPR every time Senator Schumer requested it, oil prices would almost certainly still be over $100 a barrel, and we would be sitting here as a country with a depleted reserve — albeit not very strategic in that case.

Ironically, Senator Schumer once said that “A well-stocked SPR is our best defense against OPEC supply quotas that threaten the western economies.” Just wait until he hears about the Senator Schumer who seems determined to deplete the SPR. Those guys won’t get along very well.

Shorting is a Form of Speculation

One of the biggest ironies is that some lawmakers argue that we need to use the SPR as a tool to fight against the speculators. But what is speculation? While we generally think of speculation as investing in some sort of commodity and hoping the price goes up (or actively trying to influence the price), it is also speculation to sell something in the hopes of buying it back later at a lower price (in essence, the same idea as short selling). Both of these involve risk and speculation on the direction of prices, and the same lawmakers who condemn the speculators become speculators themselves when they use oil from the SPR in an attempt to manipulate oil prices.

Besides, the rise in oil prices over the past decade isn’t primarily due to speculation, it is due to the fact that supplies are depleting while global demand has grown. Playing political games with the SPR won’t do anything to change that equation. Indeed, such games merely confuse people into believing that oil prices are high mainly for reasons other than supply and demand. No doubt there are elements of speculation, but without the supply/demand problems speculators couldn’t have much impact on the price of oil. Therefore, it is highly unlikely that the SPR could have anything more than a short-term impact, and once that impact is over oil prices will return to their previous levels and we will have used up some of our insurance policy.

Conclusion

So, contrary to Senator Schumer’s belief, the purpose of the SPR is not to play the oil futures market in an attempt to bring oil prices down. The “S” stands for “Strategic”, not “Speculative.” The SPR is there to guard against a severe energy supply interruption. It is one thing to deal with the financial inconvenience of higher prices, but it is quite another to be unable to get fuel.  If we start using the SPR in a speculative fashion in an attempt to curb oil prices, and then a true supply interruption occurs, how bright are our lawmakers going to look then?

Additional Reading

More SPR Nonsense

Stop Filling the SPR?

Critiquing the SPR Swap Plan

Schumer: Wrong on the SPR Since 1999

  1. By Wendell Mercantile on April 7, 2011 at 11:31 am

    So, contrary to Senator Schumer’s belief, the purpose of the SPR is not to play the oil futures market in an attempt to bring oil prices down. The “S” stands for “Strategic”, not “Speculative.” The SPR is there to guard against a severe energy supply interruption.

    RR~

    Agree completely. The SPR should be tapped only in true national emergencies. I can think of two:

    1. To keep the economy from coming to a standstill and collapsing.
    2. National Defense — to make sure we don’t lose the means to defend our sovereignty.

    As you said, the “S” stands for strategic not speculation. The “P” also stands for petroleum, not politics.

    [link]      
  2. By Rufus on April 7, 2011 at 3:52 pm

    I gotta agree. Sometimes Schumer is right; but, when he gets it wrong, he Really gets it wrong.

    [link]      
  3. By Nick de Cusa on April 7, 2011 at 3:56 pm

    Robert, it’s demoralizing to see you turn down my comment, which was both factual and courteous. I didn’t think I would see this here.

    [link]      
  4. By Tom on April 7, 2011 at 4:54 pm

    Even if you are short, someone has to take the long side. When the price moves up, if you are short, you need to protect yourself which spurs more buying.

    Saying speculators are not affecting the market is untrue. Their purpose is necessary because they take a future view. However, some speculators (dumb money) takes the view that they will buy today just because prices will be higher tomorrow. Where have I seen that? (Dot Com craziness and the Housing Bubble).

    The market is too volatile and Wall Street likes it that way since they make a bunch of money off of trading volume alone. There is incentive to fight any regulation which would damage your lucrative revenue streams and ultimately your bottom line.

    All I would do to tamp down on volatility is to raise margin requirements. I wouldn’t do $5000 or go to $7000. I would do it as a percentage of the barrels that are being controlled. Require 20% down and if volatility goes up, raise it to 25% etc… if volatility drops then reduce the margin requirements. We want speculators but we don’t want them owning more paper barrels than oil that actually exists and we also don’t want over 80% of daily trades be done for pure financial gain (Meaning those 85% don’t take oil of the actual product).

    Producers and Consumers deserve a fair stable price. This is what the futures market is supposed to give you. It is not serving it’s purpose and we need to fix it.

    [link]      
  5. By rrapier on April 7, 2011 at 4:12 pm

    Nick de Cusa said:

    Robert, it’s demoralizing to see you turn down my comment, which was both factual and courteous. I didn’t think I would see this here.


     

    Nick, I can assure you that I didn’t turn down any comment. I don’t approve comments; you post them and they go up.

    Sometimes, the automatic spam filter will mistakenly grab a comment which is probably what happened here. I will ask Sam to see if that is what happened.

    Comment moderation isn’t enabled, so any time you don’t immediately see your comment either the poster did something wrong or the spam filter caught it. When that happens, just mention it and it will be fished out and posted.

    RR

    [link]      
  6. By Tom on April 7, 2011 at 4:57 pm

    Forgot to add, all speculators take long and short views of the markets for fundamental reasons. Smart money buys because they have done their homework. So if they think supply will be hampered or demand will increase they buy. But so far I don’t see supply being affected. Supply is plentiful. The dumb money is rushing in to make a quick buck. Nothing wrong with that except the fact that it is messing up the market. It is distorting it.

     

    As Warren Buffet once said, “What the wise man does in the beginning the fool does in the end.”

    [link]      
  7. By Walter Sobchak on April 7, 2011 at 10:19 pm
    [link]      
  8. By armchair261 on April 8, 2011 at 1:22 am

    When Schumer or other politicians talking about tapping the SPR, what kind of rate are they talking about, and for how long? I recall that the feds were getting heat a few years ago for adding an average of about 70,000 barrels per day, which if they now reversed would be about 0.07% of global production. Not very impressive. North Dakota production alone has risen by over 100,000 barrels per day in the past 8 months, and we still have high prices. Seems like a nonstarter to me, if long term lower prices are your objective. Why risk an asset that may save lives one day, in exchange for the questionable chance of lower prices in the short term? The obvious answer: votes.

    [link]      
  9. By paul-n on April 8, 2011 at 4:20 pm

    I am no doctor, but maybe Senator Schumer suffers from premature speculation?

    [link]      
  10. By OD on April 9, 2011 at 1:05 am

    The relentless march of oil prices is quite frightening given the fragile state of most world economies.

    Will we get a repeat of 2008 in late summer/fall? Perhaps worse?

    [link]      
  11. By rate-crimes on April 9, 2011 at 9:38 am

    Strategic Pedaling Reserves

    Liz Hatch

    Oil is too valuable to burn.

    Get outta your car, get off your butt, and go chase life.

    [link]      
  12. By moiety on April 9, 2011 at 11:38 am

    Paul N said:

    I am no doctor, but maybe Senator Schumer suffers from premature speculation?


     

    Cool

    Apologies for the spam.

    [link]      
  13. By JR.EWING.78 on April 9, 2011 at 2:13 pm

    Charles Schumer is a special kind of stupid: he’s a cynical politician. You could argue with him all day long about the true purpose of the SPR and he would never blink. He wants to get reelected and to do that he has to “represent” his constituents who pay $4 for a gallon of gasoline and see red. So he blames “speculators” and demands that “working people” be “protected” and as far as he’s concerned, he’s done his job. That’s all there really is to it. It’s not leadership, it’s electioneering.

    [link]      
  14. By rate-crimes on April 9, 2011 at 3:35 pm

    If the U.S. had changed its fleet-average fuel economy decades ago, and if Americans had not been stroking their fragile egos with so many unneeded SUVs, and if we had designed our cities for humans instead of automotive bloat, there would probably be much less talk today about the SPR.

    [link]      
  15. By Mercy Vetsel on April 9, 2011 at 4:15 pm

    Okay, so I’ll agree that Schumer is the slimiest man in the Senate, but there are some times when it would make sense to use the SPR for speculation.

    When prices are expected to go higher, participants can realize the long pressure on oil by stockpiling oil and even leave it sitting in oil tankers offshore, but it’s much harder to adjust to short pressure. Not many people have oil just sitting around and there is a limited capacity to short oil prices and therefore sometimes short term imbalances between supply and demand can cause backwardation so that it’s cheaper to buy oil in the future than it is now.

    In such a situation where immediate supply/demand imbalances are driving prices up in the short term but the expectation of more supply has driven the forward price down, having a huge pool of oil is a speculator’s dream.

    At times like this, the government could sell oil now and simultaneously buy it back via forward contracts — a risk-less arbitrage. This is the situation that developed in 2008 but instead of taking advantage of the short term need for oil, the Bush administration was actually buying oil and adding to the reserve.

    -Mercy

    [link]      
  16. By paul-n on April 11, 2011 at 3:58 am

    At times like this, the government could sell oil now and simultaneously buy it back via forward contracts — a risk-less arbitrage.

    Not quite…

    One of the reasons prices rise, is the anticipation of the possibility  of shortages – just look at what happened with the oil embargo of ’73, or the price repsones to the various Gulf wars and even Libya.

    So, if the gov does what you suggest, and sells SPR oil in a time of rising prices – i.e. a possibility of shortage, it will have much less oil available if there is a real shortage.  Being able to buy it back in the future at a lower price is small comfort if essential services are running out today – the very situation the SPR was designed to prevent.

    So, while from a financial point of view, there may not be much risk, from a functional point of view, you are increasing risk of the supply failure the SPR is meant to make up for.

    The government’s primary concern is (or should be) the protection of the country and the people – leave the speculation to speculators.

     

    [link]      
  17. By quasecarioca on April 11, 2011 at 7:34 pm

    I generally think most political commentary about the SPR is idle chatter meant to stir up constituents, but I would like to play Devil’s Advocate for a moment.

    The problem here is that people want to distinguish “a supply emergency” from a simple rise in the price of oil, but it’s hard for me to say there’s a clear line between the two. We’ve not had a genuine lack of oil supply since the last OPEC embargo – this is not because America created the SPR, but simply because of the world created a spot market for oil in which lower supply is compensated by higher prices.

    The underlying problem here is that the entire concept of the SPR is now 40 years out of date, it was created at a time when oil sales were based on individual contracts between countries and companies, a time when today’s market did not exist. Gone are the days in which one country can “cut off” oil to another by halting shipments (don’t tell Hugo Chavez, who hasn’t seemed to figure this out) – what they can do is raise prices by increasing market uncertainty or by taking fields out of production. This is not the same as halting supply.

    The Iraq invasion of Kuwait in 1991 is a good example of this – some oil stopped getting produced and prices shot up, but we did not get an interruption in supply but rather more costly supply. Right before the start of the war, the government stepped in to lower prices by releasing oil from the SPR, more because people were yelling and screaming about fuel prices. Ditto Hurricane Katrina – Gulf of Mexico oil production gets shut in, oil prices rise, government steps in to lower them.

    Then there are the issues of loans. The government has repeatedly stepped in to lend oil to companies that happen to have an operational problem such as ARCO in 1992 or Conoco in 2000. Were people in the Midwest really going to go without gas, or were they simply going to pay more for it?

    And there were also a number of sales from the SPR the mid-1990s during the budget cutting frenzy (sound familiar) in efforts to raise money. In the end, it’s hard to say the SPR has ever been separate from politics.

    [link]      
  18. By Steve Funk on April 12, 2011 at 10:00 am

    That site (Bryan Mound) looks awfully vulnerable to a hurricane. In fact, the two nearest roads are levee road and floodgate road. I wonder whether it was directly in the path of Ike?

    [link]      
  19. By Mercy Vetsel on April 13, 2011 at 12:22 am

    So, if the gov does what you suggest, and sells SPR oil in a time of rising prices – i.e. a possibility of shortage, it will have much less oil available if there is a real shortage.

    No, make sure to read my prior paragraph. I’m only talking about a situation of backwardation where forward contracts are cheaper than spot. If there is a genuine threat — say a 10% risk that the Saudi fields get wiped out, the price uncertainty will affect forward contracts just as much, perhaps more. In that case no arbitrage opportunity exists, so yes, wait until we see if the threat comes to pass before tapping the reserve.

    I’m talking about situation like 2008 where there is a genuine imbalance in supply and demand in the spot market with a forward market expecting lower prices.

    -Mercy

    [link]      
  20. By Mercy Vetsel on April 13, 2011 at 12:22 am

    So, if the gov does what you suggest, and sells SPR oil in a time of rising prices – i.e. a possibility of shortage, it will have much less oil available if there is a real shortage.

    No, make sure to read my prior paragraph. I’m only talking about a situation of backwardation where forward contracts are cheaper than spot. If there is a genuine threat — say a 10% risk that the Saudi fields get wiped out, the price uncertainty will affect forward contracts just as much, perhaps more. In that case no arbitrage opportunity exists, so yes, wait until we see if the threat comes to pass before tapping the reserve.

    I’m talking about situation like 2008 where there is a genuine imbalance in supply and demand in the spot market with a forward market expecting lower prices.

    -Mercy

    [link]      
  21. By paul-n on April 13, 2011 at 11:00 pm

    Mercy – I’m not expert on futures, but what happens if the gov takes that trade, but then something happens – a genuine shortage, and the suppliers can’t deliver those contracts at any price – can traders declare force majeure?

    Regardless of the market conditions, taking oil out of the SPR, for non ememrgency reasons, on the exectation of filliong it up in the future, is weaking the very purpose of the SPR.  If, say OPEC wanted to impose an embrgo to do maximum damange to the US, right after such a  trade has been made is a perfect time.  The gov is reducing energy security to make a buck – seems like  a bad trade to me.

     

     

    [link]      
Register or log in now to save your comments and get priority moderation!