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The Case against the Strategic Petroleum Reserve, Cato Policy Analysis No. 555

The Case against the Strategic Petroleum Reserve, Cato Policy Analysis No. 555

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Published by Cato Institute
Executive Summary
The Strategic Petroleum Reserve has been almost uniformly embraced by politicians and energy economists as one of the best means to protect the nation against oil supply shocks. This study finds little evidence for the proposition that government inventories are necessary to protect the country against supply disruptions. Absent concrete market failures, government intervention in oil markets is unlikely to enhance economic welfare.

A conservative estimate finds that the SPR has cost taxpayers at least $41.2
Executive Summary
The Strategic Petroleum Reserve has been almost uniformly embraced by politicians and energy economists as one of the best means to protect the nation against oil supply shocks. This study finds little evidence for the proposition that government inventories are necessary to protect the country against supply disruptions. Absent concrete market failures, government intervention in oil markets is unlikely to enhance economic welfare.

A conservative estimate finds that the SPR has cost taxpayers at least $41.2

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Published by: Cato Institute on Mar 27, 2009
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The Strategic Petroleum Reserve has beenalmost uniformly embraced by politicians andenergy economists as one of the best means toprotect the nation against oil supply shocks.This study finds little evidence for the proposi-tion that government inventories are necessary to protect the country against supply disrup-tions. Absent concrete market failures, govern-ment intervention in oil markets is unlikely toenhance economic welfare. A conservative estimate finds that the SPR has cost taxpayers at least $41.2–$50.8 billion (in2004 dollars), or $64.64–$79.58 per barrel of oildeposited therein. Accordingly, the “premium”associated with the insurance provided by theSPR is quite high relative to market prices for oil,even during 2005.The SPR has been tapped only three times,and in each of those instances, the releases weretoo modest and, with the exception of the 2005release related to Hurricane Katrina, too late toproduce significant benefits. Accordingly, thecosts associated with the SPR have been largerthan the benefits thus far.The SPR insurance policy is unlikely to pay off in the future either. First, major oil supply shocksare much rarer than many observers believe.Second, the executive branch has been unwillingto use the reserve as quickly and robustly as econ-omists recommend. Third, the benefits from a release are almost certainly overstated.Policymakers should resist calls to increasethe size of the reserve and instead sell the oilwithin the SPR and terminate the program.
The Case against the Strategic Petroleum Reserve
by Jerry Taylor and Peter Van Doren
_____________________________________________________________________________________________________
 Jerry Taylor is a senior fellow at the Cato Institute. Peter Van Doren is senior fellow and editor of Cato’s
Regulation
magazine.
Executive Summary 
No. 555November 21, 2005
 
The Architecture of the SPR 
The Strategic Petroleum Reserve is a fed-erally owned and operated stockpile of 700.1million barrels of oil—285.2 million barrels of sweet crude and 414.9 million barrels of sourcrude—located in approximately 50 artificial-ly created caverns deep within salt-rock for-mations scattered throughout the coastalregions of Texas and Louisiana.
1
Its 727-mil-lion-barrel storage capacity will be reachedwithin several months, but the recently enacted Energy Policy Act of 2005 authorizesexpansion of the SPR to 1 billion barrels.The SPR was established in 1975 as partof the Energy Policy and Conservation Act asa response to the 1973 Arab oil embargo.
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The legislative goal is to store 1 billion barrelsof oil for use in a “severe energy supply dis-ruption.”
3
Use of the SPR is solely at the pres-ident’s discretion.
4
The SPR is the largest government-ownedstockpile of petroleum in the world.
5
To putits size into perspective, its draw-down capac-ity of 4.3 million barrels of oil a day is slightly larger than Iran’s daily contribution to worldoil supply. “In effect, a big, government-owned reserve like the SPR could be consid-ered a new oil-producing province entering a disrupted international oil market,” notes oilanalyst Edward Krapels. Withdrawing themaximum amount of oil possible from theSPR would enable the federal government toreplace about 36 percent of U.S. oil importsand add about 5.9 percent to the world’s daily oil supply for approximately 163 days beforethe reserve ran dry.
6
The maintenance and operation of theSPR is also governed by the InternationalEnergy Agency, which the United States joined in 1976. Founded in 1974 under theInternational Oil Program Agreement, theIEA was established to provide a consuming-nation counterweight to OPEC.
7
Under theterms of the agreement, if any of the 26 IEAmember countries experiences a 7 percent orgreater drop in crude oil supply, better-situat-ed IEA members are obligated to share theirsupply with that country (or countries), andthe IEA secretariat is charged with deciding atwhat price that oil will be shared and how much total oil consumption is to be allowedwithin each member state.
8
To make sure thatsuch supplies are available, IEA members areobligated to ensure that enough oil fromboth public and private stockpiles is on handto replace 90 days worth of imports if neces-sary.The operation of the SPR has becomepolitically controversial in recent years. Thecentral question is whether the SPR should beused only during a “national emergency” orwhether it should it be used occasionally as a means to alleviate high domestic oil and gaso-line prices. The controversy is well describedby Alvin Alm, former director of the HarvardEnergy Security Program: Although almost all energy experts andpoliticians agree that a strategic petrole-um reserve is desirable, serious disagree-ment exists on the purpose of thereserve and how it should be managed.Some view it as a tool of military andforeign policy, only to be used duringperiods of dire national security threats.The majority of political leaders andinterested citizens view the reserve as a source of fuel to prevent physical short-ages. The persistent concern of New Englanders and Hawaiians over region-al reserves, for example, attests to thedepth of this feeling. Finally, most econ-omists and energy experts view thereserve primarily as a tool to minimizeprice increases during and after oil inter-ruptions.
9
Secondary political issues that have ariseninclude (1) whether, to reduce oil prices, thepresident should suspend additions to theSPR when global oil supplies are tight, (2)how quickly the U.S. government shouldincrease the reserve’s stockpiles, and (3) towhat extent the federal government shouldexpand storage capacity. Academics have also sparred over the SPR,primarily concerning organizational struc-
2
The SPR isthe largestgovernment-owned stockpileof petroleum inthe world. Itsdraw-downcapacity of 4.3million barrels of oil a day isslightly largerthan Iran’s daily contribution toworld oil supply.
 
ture,
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release triggers,
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release mechanisms,
12
funding methods,
13
and optimum inventory size.
14
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
15
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.
16
Historically, however, both economistsand politicians have supported the SPR.
17
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.
18
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.
19
The combined public reserves of theUnited States, Japan, and Western Europeequal only 20 days of world consumption.
20
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?
21
 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.”
22
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.
23
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.
24
 Although the risk of such policies is clearly above zero (oil pricecontrols were imposed in 1971 and they lastedthrough 1981
25
), 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.
26
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.
27
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
3
Is there needfor insuranceagainst supply disruptions and,if so, does thegovernment needto provide it? Theanswer to thosequestions wouldappear to be“maybe” and“no.”

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