It’s Too Early to Use the Strategic Petroleum Reserve

The New York Times reports this morning that “calls have been growing in Congress for the Obama administration to consider tapping into the nation’s strategic petroleum reserve”. That understandable instinct is premature.

Strategic petroleum reserves technically exist to alleviate physical oil supply disruptions. No one is arguing, though, that the United States is facing such a situation. The case being made by more sophisticated proponents of tapping the reserves is that we may be experiencing one indirectly. In particular, Senator Bingaman appears to be arguing that Europe is experiencing a physical disruption of supplies from Libya, and that the disruption is being transferred to the United States through competition for high quality oil.

This does not qualify as a physical disruption of U.S. supplies. Markets appear working properly. The disruption is being felt through higher prices, not shortages. (The high/low quality meme is being overplayed a bit too.)

That said, I do not subscribe to the orthodoxy that says that strategic reserves should only be used in cases of direct physical disruption, and never in situations where broader market turmoil merely leads to dangerously high prices. If prices are sharply and temporarily elevated, and if an SPR release can address that, it should be strongly considered, as I argued in the FT last week.

But those conditions are not yet met.

First, the current oil price rise is not fundamentally threatening to the economy. It is simply not big enough. Take a look at the stock market if you don’t believe me.

Second, it is not clear that an SPR release would do much, if anything, about the current price situation. The current high prices appear to be more about fears of contagion in the Middle East than about actual supply disruptions in Libya (which appear to have been largely balanced by increased production from Saudi Arabia). If the immediate problem was a physical disruption, and U.S. strategic reserves could (and were needed to) compensate for that, then there would be an argument for using them. But strategic reserves don’t directly compensate for fear. There is no good reason to believe that a release would calm peoples’ nerves.

Indeed policymakers should be concerned that it would do precisely the opposite. Tapping the reserves right now could validate fears in the market – after all, it would signal that the United States government was worried. That could simply induce more precautionary buying, thus buoying prices, rather than depressing them. Such an outcome would be doubly dangerous, since, since it would undermine the psychological value of the reserves. Observers might come to fear that another SPR release under far more stressful circumstances would be similarly ineffective. That would tend to exacerbate the present stress.

There may yet be a time to call on the SPR. And I understand that policymakers want to do something about the situation. But we’re not there yet.