and optimum inventory size.
Some economists have challenged theSPR on a more fundamental level. Disputesinclude (1) whether the development of finan-cial instruments for hedging against oil pricesin the early 1980s have rendered the SPR lessimportant
and (2) whether, in a serious cri-sis, the SPR might be used as part of somefuture multinational oil price and allocationcontrol regimen under the auspices of theIEA.
Historically, however, both economistsand politicians have supported the SPR.
The SPR is popular with politicians becauseit allows them to tell their constituents thatthey have done something to protect thenation against a future oil embargo. The SPR is popular with many economists because itis seen as a hedge against the economicimpact of future supply disruptions.
The Theoretical Case forthe SPR
The SPR is best conceptualized as a pub-licly provided insurance policy against petro-leum market shocks. The cost of the SPR program is the premium. The benefits are theprice reductions that result from its existenceor use.The SPR, however, provides insuranceagainst only a subset of the possible supply disruptions that could occur. Oil releasesfrom the SPR can ameliorate temporary events but cannot affect long-term disrup-tions in the market because the reserves arenot large enough to affect world prices overextended periods of time.
The oil within theSPR—the largest publicly managed oil stock-pile in the world—would have increased glob-al oil supplies by only 2.55 percent (about 9days) had it been released in its entirety in2004.
The combined public reserves of theUnited States, Japan, and Western Europeequal only 20 days of world consumption.
Is there need for insurance against supply disruptions and, if so, does the governmentneed to provide it? The answer to those ques-tions would appear to be “maybe” and “no.”
What’s Wrong with Private Inventories?
Is the management of private oil inventoriesinefficient?
As economists Douglas Bohi andW. David Montgomery note: “the presence of disruption risks alone does not alone justify government intervention. The rationale forsuch action must be based on some deficiency in private preparations.”
Economists believethat profit-seeking investors will make effi-cient decisions regarding oil inventories unlessthe price signals they rely on fail to reflect totalcosts and benefits. Although the literature per-taining to the SPR frequently reports that pri- vate inventories are meager compared to thesize of publicly held inventories, a properaccounting as of December 2004 concludesthat, worldwide, publicly held reserves totaledroughly 1.5 billion barrels, whereas privateinventories stood at 4.8 billion barrels.
Those who argue for the existence of mar-ket failure make several claims. First, privateactors hold too little inventory because they anticipate that price controls or other regula-tory interventions will confiscate their profitsduring market shocks.
Although the risk of such policies is clearly above zero (oil pricecontrols were imposed in 1971 and they lastedthrough 1981
), we know little about how great that risk might be—or how worried mar-ket actors are about future intervention. Inthis case, however, it is ironic that public stock-piles are proposed, not as a correction for mar-ket failure, but for government failure.
Second, if the total economic benefitsprovided by oil inventory cannot be fully cap-tured by the inventory holder, private actorswill invest less in oil inventories than is opti-mal.
Said differently, oil inventories arethought to produce significant macroeco-nomic benefits upon release that are not cap-tured by inventory holders.How much larger would private stockpilesbe if the macroeconomic benefits of releasecould be fully captured by inventory holders?The answer depends on the macroeco-nomic damage that results from oil price
Is there needfor insuranceagainst supply disruptions and,if so, does thegovernment needto provide it? Theanswer to thosequestions wouldappear to be“maybe” and“no.”