Why Biden Should Refill The Strategic Petroleum Reserve —Slowly

During the pandemic, the Biden Administration drew down the Strategic Petroleum Reserve (SPR), reducing it from 640 million barrels to 340, before replacing almost 20 million barrels in recent weeks. How much more it should be filled, especially given the U.S. shift from the world’s biggest oil importer to a net exporter, is a salient topic in Washington. The U.S budget deficit, now at $2 trillion, gives legislators pause about spending more on restoring the SPR to previous levels.

Strategic reserves are hardly a new policy tool. Even ancient societies undersood their value to cope with weather fluctuations. The Bible describes Joseph advising the pharoah to build grain reserves during a period of good harvests against later needs; it neglects to mention complaints about speculators, but they must have been lost in the editing.

And SPRs are not new either. During the English Civil War in the sixteenth century, King Charles I responded to a shortage of gunpowder by creating a strategic reserve of its components, including urine. Thus, the Strategic Pee Reserve (SPR).

Wars were typically the impetus for stockpiles of materials whose supply might be cut off by conflict. Germans lost access to British rubber supplies in World War I, the Japanese had their oil supplies cut off prior to World War II, and the U.S. stopped receiving pig bristles from Manchuria, used to make toothbrushes, when Japan occupied that area in 1931. Some disruptions were more serious than others. (Plastic toothbrushes saved the day, or at least American teeth.)

The massive material needs of World War II led to a creation of strategic stocks in the U.S. of many materials, but oil was not initially one of them even though the need was long recognized. Finally during the Carter Administration, the SPR began to be filled. Unfortunately, the U.S. government, like a number of others, worsened the tight market during 1979’s Iranian Revolution, adding 20 million barrels to the reserve that year, a small but not insignificant amount. More problematical were the various governments, including the U.S.’s, insistence that private companies increase their inventories despite the tight market.

Since then, the SPR has served to provide deterrence to potential embargo enactors, although producers like the Saudis have long eschewed any further politicization of petroleum supplies. Leaders like Saddam Hussein and Muammar Qaddafi occasionally threatened or even enacted their own mini-embargoes, but none was large or long enough to have any market impact.

Then, during the pandemic, the Biden Administration responded to soaring oil prices by drawing down the SPR by a massive 300 million barrels, at a time when OPEC+ had substantial surplus capacity. Whether or not the group would have increased production without the U.S. reserve drawdown is not clear, but as I have argued, the Biden Administration should not have used the SPR to alleviate the tight market conditions during the pandemic.

But there are those who feel that an SPR is no longer needed, inasmuch as the U.S. is not vulnerable to embargoes or supply shortages, now that the country is a net exporter. This is partially correct: no embargo against us would be more than a nuisance. The figure below shows the U.S. SPR in days of imports and as imports shrunk, the coverage from the SPR soared. (Now as a net exporter, that measure is meaningless.)

But oil embargoes have not been effective in general, especially since production spread around the globe after World War II. Before that, when the British-American-Dutch Seven Sisters dominated the oil market, it was possible to deny a country, Japan in 1941, oil supplies. But in 1967 and 1973, when embargoes were declared by some Arab oil producing states, they were not effective in denying oil to their targets. Oil is fungible and the industry allocated supplies more or less equally—despite the protests from some importing governments. It was the production cutbacks that accompanied the embargo in 1973 that caused the damage.

Which is a very pertinent lesson: it’s prices, not volumes that matter. Many governments opined in 1973 that they needed to prevent factories from going dark and homes from going cold, and so would pay any price for oil, bidding up the tight supplies. Unfortunately, many factories went dark and homes went cold because high oil prices caused a major recession.

That lesson was not well learned. In subsequent events, notably the Gulf War in 1990, governments did not release oil from storage because there were no major physical shortages. Prices doubled but only for a few weeks because other countries, particularly Saudi Arabia, raised production.

If the U.S. is a net exporter of oil, is the SPR needed? Arguably, the government should keep a small reserve for emergency usage, although the long-time scenario of a land war in Europe with submarine interdiction of oil supplies seems fantastical now, despite the Russian invasion of Ukraine. Instead, the government could simply accept that occasional price spikes will occur and be resolved by the response of supply and demand to those higher prices.

The alternative view, which I endorse, calls for the SPR to be treated as an insurance policy against unusual events, such as war, civil unrest or even labor strife in major oil producing areas. It is true that such actions are unlikely to mean actual shortages in the U.S., given oil self-sufficiency, which leads to the argument that the U.S. doesn’t need to hold an SPR which would primarily benefit other nations. But if global oil prices spike, the U.S. will suffer economic damage, even if our self-sufficiency reduces the impact somewhat. Still, the argument can be made that the U.S. should not bear responsibility for stabilizing the global market on behalf of our allies (and everyone else).

This is similar to the problem of cost-sharing in NATO, where the U.S., essentially the dominant firm in the organization, has no choice but to maintain a robust defense establishment while other members can shirk their responsibilities, knowing the U.S. has no option but to pick up the slack. (Saudi Arabia has a similar problem within OPEC.)

Of course, as the figure below shows, the U.S. is not carrying the sole burden of holding strategic stocks within the OECD. Some of those barrels are held by private companies under government mandated minimum holdings, and are thus less useful in a crisis. And China apparently has somewhere above 300 million barrels itself, but is not committed to coordinating releases with the IEA, so those barrels might not contribute much in a future crisis.

Restoring the SPR to its previous levels of over 700 million barrels appears profligate, and definitely should not be done when prices are elevated. But there’s the rub: is $80 elevated or the new norm? That is the sort of question that has driven economists batty for decades, and the answer seems no clearer now after all their work. Still, it is always best not to wait to buy insurance until you get sick, and the same is true for the SPR.