I’m as willing as many to criticize Joe Biden for his largely horrible economic policies. But we should still give credit where credit is due.
And he’s due some credit for his sales of oil from the Strategic Petroleum Reserve.
There are 2 justifications for his selling oil from the SPR currently. One is philosophical; the other is pragmatic.
The philosophical justification is that the government shouldn’t be in the business of supplying oil. One of the strongest arguments for futures markets is that they give private actors a strong incentive to store oil when they think the price will rise in the future and to sell oil when they think it will fall in the future. The government gums up the works by being an unpredictable participant in the market for oil. So it’s best not to have the government in that market at all. The way to get to that point is to sell the oil.
The pragmatic justification for selling oil right now is that the current price is unusually high and will likely be lower. The spot price of oil on October 20, reported by the Wall Street Journal on October 21, was $85.98 per barrel. The futures price for December 2023 was reported as $74.81. So this is a good time to sell.
When I was the senior economist for energy policy with President Reagan’s Council of Economic Advisers, one of my two bosses, Bill Niskanen, and I knew that we wouldn’t get far advocating what we both believed in: ending the SPR. So we instead advocated a price rule: buy low, sell high. Specifically, if I recall 1983 prices correctly, we advocating buying when the price of oil drops below $20 and selling when it goes above $40. We didn’t get what we wanted, but Biden is coming close. He’s selling when it’s high and I’m guessing that he’ll buy when it’s lower.
But isn’t the SPR meant to deal with crisis situations? To some extent, yes. But how do you know there’s a crisis? That’s why Bill and I came up with a price rule. If there’s an oil supply crisis, that will show up in the price.
READER COMMENTS
PeterJ
Oct 23 2022 at 6:24pm
Interesting thoughts Dave,
The Biden administration has made it clear it is against the petroleum industry, right down to the gas station owners. Policy examples abound.
We might see the SPR go dry simply because it will not be refilled, no matter the price of oil. It seems those hell bent against fossil fuel energy would rather see civilization collapse rather than allow a free market decide.
Best, Peter
David Henderson
Oct 24 2022 at 9:40am
You wrote:
Could you clarify the connection between these two sentences? Certainly, getting the government out of the oil business doesn’t seem to equate to not allowing a free market to decide.
PeterJ
Oct 26 2022 at 9:21am
Sure.
The Biden administration, and others, are against the continued use of petroleum products. With this mindset, the SPR could simply not be replenished. At the same time, through regulations, taxation, and demagoguery, the free market on oil could be restricted. A viable alternative to liquid fossil fuels is not readily available. Without transportation, heat, etc, society would suffer greatly.
I am not a conspiracy peddler. However, the back of my mind tells me something isn’t right with the manner and methods the transition to clean energy is being pushed. When free markets are not used to achieve change, drastic actions and coercion are implemented.
MikeW
Oct 23 2022 at 9:26pm
It seems optimistic to think that gasoline prices are going to come down. Maybe after Democrats are no longer in charge. They are simply too in thrall to climate-change activists.
David Henderson
Oct 24 2022 at 9:41am
The futures markets suggest that you’re incorrect. But if you’re quite confident, you can get into that market and make money.
Scott Sumner
Oct 24 2022 at 12:48am
I’m not expert in this area, but can’t you use futures markets to lock in replacing current oil sales with future purchases at a lower price? I.e., make it a zero risk operation?
(BTW, if I were a cynic I would argue that the “crisis situation” is the midterm elections.)
David Henderson
Oct 24 2022 at 9:42am
Yes, you can, and I wrote about this in Investors Business Daily in 2000. I didn’t mention it here because I don’t want to given Biden any ideas.
David Seltzer
Oct 24 2022 at 2:10pm
Scott: Yes when futures are in backwardation. Our former hedge-fund oil trader would argue that zero risk doesn’t obtain. Profits are not risk-free and are compensation for risk assumed. E.g. If the market is dominated by producers who want to hedge by selling oil futures, price might be abnormally low compared with expectations. The relationship between futures prices and expected spot prices are complex.
David Henderson
Oct 24 2022 at 6:55pm
You wrote:
Unless I misunderstand you, that’s incorrect. If you go into the market today and sell at $85 and buy futures today at $75, you make a sure profit of $10 minus various transactions costs.
Or are you saying that it’s risky because those who commit to deliver might not deliver? I would think that that’s a tiny risk, but maybe you can convince me otherwise.
David Seltzer
Oct 24 2022 at 7:14pm
£ 750 Million
That is the avoidable costs resulted from failed deliveries according to Andrew Starkey, head of e-logistics at Interactive Media in Retail Group (IMRG).
Today, thanks to the meteoric rise of the e-commerce sector, the volume of deliveries has increased exponentially, making the “last mile” problem extremely challenging. Every failed delivery attempt adds considerable costs as it necessitates a return trip to the warehouse, storage space, and a 2nd (or even 3rd) attempt. Should the delivery fail permanently, further costs incurred include returning it back to the shippers or retailers. In the UK, the sum of all the situations mentioned costs around US$7.44 per delivery attempt.
And it’s not just the financial losses – failed deliveries result in extremely dissatisfied customers who may never return to the retailers’ site. This ruins the customer service experience of the retailer, which, in turn, crushes the transporter’s reputation. Not such a tiny risk.
David Henderson
Oct 24 2022 at 8:00pm
David, Your link doesn’t work. Can you try again?
David Seltzer
Oct 24 2022 at 8:14pm
David, here it is.
https://versafleet.co/blog/talking-about-logistics/.
BC
Oct 24 2022 at 5:29am
“The government gums up the works by being an unpredictable participant in the market for oil. So it’s best not to have the government in that market at all. The way to get to that point is to sell the oil.”
It seems like the best way for the government to not be an unpredictable market participant would be to neither buy nor sell any more oil. The government previously participated in the market by buying oil. But, those are “sunk” interventions. By selling oil now, it adds to its interventions, especially if it is unpredictable about how/when/whether it will replenish the SPR with future purchases. It’s not as though Biden has announced that he will sell down the SPR permanently on some pre-announced schedule (or even price-based rule).
The relevant distinction for predictability is whether government’s transactions are discretionary or rules based rather than whether they are purchases or sales. Biden’s sales are discretionary, likely politically motivated by the elections calendar, not rules based. His sales seem to increase, rather than decrease, the precedent/norm for discretionary transactions.
David Henderson
Oct 24 2022 at 9:44am
You wrote:
But that seems to be simply a statement of your wish. Let’s say that the government announced that it will neither buy nor sell more oil. Why would that make the government predictable? We still have to believe that it will keep its word.
John Hawkins
Oct 24 2022 at 5:25pm
I think there’s an even better option: the government should sell options on futures within a specified “delta” (or likelihood of being in the money), say 5%-15%, on various short-dated contracts. calls would covered by the petroleum in the SPR, and puts would be covered by the unfilled capacity in the SPR that could accept delivery, making the project “riskless” from an accounting perspective. If the purpose is for the government to be an insurance provider, this is the way to do it.
Roger Levy
Oct 24 2022 at 5:26pm
Few people would disagree that the government should not be in the business of supplying oil. That position also holds for President Biden, who is now in the business of supply oil that by all accounts could be accomplished better by private industry.
However, your argument does not hold water, or oil, when the issue is national security or a national emergency. Oil prices won’t spike under either of those conditions until ‘after’ the events occur which then leaves everyone without the fuel necessary to respond. Private markets currently do not maintain large reserves necessary to support either national security of national emergency. A national petroleum reserve seems reasonable unless the Federal government intends to now regulate refiners and distributors, like banks, and mandate private reserves.
David Henderson
Oct 24 2022 at 6:58pm
You write:
If the government refrains from price controls AND refrains from selling oil when there’s a crisis, then participants in private markets DO have an incentive to estimate, as best they can, the probability of a crisis and stockpile accordingly. We see this with farm “crises,” e.g., poor harvests, a lot. Grain futures adjust in anticipation.
Radford Neal
Oct 24 2022 at 10:36pm
But in the current political climate, there is no reason to believe that the government will refrain from price controls on oil in a crisis. Even a government that wanted to commit to never imposing price controls would not be able to – everyone would believe that there is a significant chance that current leaders will change their minds come a crisis, or that some other leaders will by then be in power by then and not honour the previous commitment.
It would take many years of cultural change for it to become unthinkable that the government would impose such price controls. Until such time, private actors will underinvest in stockpiling oil (and other goods) for use in a crisis.
Vincent Liberto
Oct 25 2022 at 12:14am
The author seems to believe that now is a good time to sell the SPR reserves as the price will be lower in the future at which time it can be bought back at a lower price to fill the SPR. Trying to determine when to buy and sell oil by a government entity is not the job of government, it is the job of speculators.
David Henderson
Oct 25 2022 at 11:09am
You wrote:
Exactly, Vincent. Thus my proposal for draining the SPR.
Michael
Oct 25 2022 at 8:15am
The Biden Admin has announced a policy on refilling the SPR.
https://www.whitehouse.gov/briefing-room/statements-releases/2022/10/18/fact-sheet-president-biden-to-announce-new-actions-to-strengthen-u-s-energy-security-encourage-production-and-bring-down-costs/
TMC
Oct 25 2022 at 12:57pm
Economists could do with a little IT logic regarding redundant supplies, and basic disaster recovery. I also would like to minimize the SPR’s influence on the market, but still maintain it for true disasters, whether man made or natural. The SPR is there not to influence prices, but to provide oil in case of a situation where there truly is none available at any price. Hurricanes, foreign disruptions, or pipleline accidents would be good examples. Selling oil from the reserve is closer to the top of dumb things this administration has done, and done solely to manipulate November voting.
David Henderson
Oct 25 2022 at 2:49pm
You write:
I can’t think of any such cases. The ones I can think of where it was not available were cases where the state or local government had imposed price controls. But I can’t think of any actual instances where it wasn’t available at any price. Can you? If so, please provide them.
TMC
Oct 25 2022 at 3:19pm
Here is a list. I guess not zero available, but enough missing to cause considerable disruption.
https://www.energy.gov/ceser/history-spr-releases#2011-IEA-Coordinated-Release
Michael
Oct 26 2022 at 6:58am
That seems right – as of today, doesn’t the US produce most of its own oil? That means (regardless of whether this is good or bad) the only real purpose of the reserve is to influence the global market prices.
I suppose there could be certain types of disasters that disrupt US production. But then importing more oil is an option.
Joshua Zissman
Oct 26 2022 at 12:44pm
Not that i am in favor of the government being in the “oil reserve business” but couldn’t one argue that for national defense purposes (maybe rigidly delineated – to be used only to provide fuel reserve for the armed forces, and maybe the national guard) it is prudent for the gov’t to always have a backup supply ready?
Gary Nestrick
Oct 27 2022 at 4:13pm
The Biden administration wont buy a single barrel of oil, for any reason. There is no political gain for them to do so.
Michael
Oct 28 2022 at 5:23pm
https://www.whitehouse.gov/briefing-room/statements-releases/2022/10/18/fact-sheet-president-biden-to-announce-new-actions-to-strengthen-u-s-energy-security-encourage-production-and-bring-down-costs/
Steve B
Oct 31 2022 at 1:19am
Another argument for disbanding the strategic oil reserve is the US is no longer an oil importer. If we had to we could simply stop oil exports and that would make the price go down here, and really screw up the rest of the world.
We are no longer solely dependent on OPEC for our oil and we have enough at home that could be developed. Shale wells can be developed and brought online in months, if we were cut off from major oil suppliers we would feel the hurt but it wouldn’t be economy ending for the US.
So the strategic oil reserve is only good as a political tool, and not much good at that. I’d be all for the politicians not having a dial to push that doesn’t really move the price of oil anyway.
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