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By James Hamilton on Mar 20, 2012 with no responses

Will Oil Release from Strategic Petroleum Reserve Lower Prices?

The United States and Britain have apparently been discussing a joint release of strategic petroleum stockpiles.

The U.S. Strategic Petroleum Reserve was intended to be used in the event of a “severe energy supply interruption” whose legal definition is as follows:

A severe energy supply interruption shall be deemed to exist if the President determines that–

  1. an emergency situation exists and there is a significant reduction in supply which is of significant scope and duration;
  2. a severe increase in the price of petroleum products has resulted from such emergency situation; and
  3. such price increase is likely to cause a major adverse impact on the national economy.

Historical experience has shown that seemingly temporary supply disruptions can have very long-lasting consequences. Libyan oil production in November was still only about a third of what the country had been producing in January 2011 prior to last year’s disruptions. Iraqi production still has not returned to the average value seen in 1989 prior to the First Persian Gulf War. Iranian production has never returned to the average values achieved in 1977 prior to its revolution.

The U.S. SPR currently holds 696 million barrels of crude oil, of which 62% is sour and 38% sweet. If we relied on this stockpile to replace Iran’s current 4 million barrels of daily production, the SPR would be drained in less than half a year.

The SPR is likely to be most effective as a short-term device to help bridge a temporary supply shortfall until other sources can become available. Is there a conception of our current situation in which the primary challenges are short term in nature?

Europe has been trying to get by with less oil from Libya and has been drawing down its private stockpiles, and is looking for alternative suppliers to replace imports from Iran. This market tightness is the key factor in the current price of Brent.

Source: IEA.

If one believed the Libyan problems will soon be resolved, an SPR release might make sense as a temporary assistance measure, though it is hard to find a basis for similar optimism for a near-term resolution of issues with Iran. Another development that could ease the situation in Europe will be completion by the end of the year of additional pipeline infrastructure to help transport crude from the central U.S. to the coast, which will relieve some of the competition with European refiners for buying international crude currently coming from U.S. refiners on the coast. However, some analysts worry that the added deliveries from the new pipelines will end up using some of the same limited distribution capacity required by an SPR release. And if the justification for the SPR release were just to buy time until more U.S. pipeline capacity can be added, surely the more sensible step would have been to speed up the regulatory review process.

I’m led to conclude that a more important rationale for another SPR release was expressed in the following report from Thursday’s Wall Street Journal:

A number of influential lawmakers, including Rep. Ed Markey (D., Mass.), have called on the president to tap the strategic reserve to deflate rising prices. “Releasing even a small fraction of that oil could once again have a significant impact on speculation in the marketplace and on prices,” Mr. Markey wrote last month in a letter to the president.

If that sounds familiar, it should. Here is what Representative Markey wrote in a letter to the President dated February 24, 2011:

Right now, the Strategic Petroleum Reserve holds 727 million barrels and is filled to capacity. Releasing even a small fraction of that oil could have a significant impact on speculation in the marketplace and on prices.

In fact we ran that exact experiment last year, which is the reason that Representative Markey would need to paste over “727″ with “696″ and cross out “is filled to capacity” if he wanted to re-issue the same letter this year as he did the previous year. Specifically, the IEA announced on June 23, 2011 that the OECD countries would release 60 million barrels from their joint stockpiles, half of which came from the U.S. Strategic Petroleum Reserve. There was an initial modest drop in the price of oil on the day of the announcement, though within two weeks the price was back up above where it had been before the announcement.

Crude oil prices, weekly, Jan 1, 2010 to Mar 9, 2012. Vertical line drawn at June 23, 2011. Data source: EIA.

The price of oil did decline later in the summer, though surely this should be attributed to deteriorating news from Europe rather than the SPR release. For example, last summer’s drop in WTI was mirrored by a drop in other financial indicators such as the S&P500.

Source: Yahoo Finance.

I see no evidence that last year’s SPR release accomplished anything, and would not expect the outcome of another release this year to be very different.

A far more sensible proposal would be to build the pipelines necessary to allow the oil currently in private stockpiles in the central U.S. to flow to refiners on the Gulf of Mexico.

Source: EIA.

This article originally appeared on Econbrowser.