It’s a Crude, Crude World

The Post has an interesting piece on the debate about tapping the U.S. strategic petroleum reserves in response to the supply disruptions and price hikes stemming from Libyan unrest. The relevant 1975 legislation that established the reserves says that the president may release them in response to a "severe energy supply disruption," defined as one which:

1) "is, or is likely to be, of significant scope and duration, and of an emergency nature"; 2) "may cause major adverse impact on national safety or the national economy" (including a spike in oil prices); and 3) "results, or is likely to result, from an interruption in the supply of imported petroleum products, or from sabotage or an act of God."

Here’s a graph of U.S. gas prices per gallon over time:

(Here’s a chart of crude barrel prices by month for the last forty years) (and here is a good piece on the relationship between crude prices and the price you pay at the pump.)

Presidents have dipped into the reserves three times since they were established. When George H.W. Bush did so in late 1990 in response to Gulf War jitters, the price per barrel had climbed to the crisis-level price of $34, resulting in a pump price of about $2.25/gallon. A few months later it was back down under $2/gallon where it stayed for much of the next decade. In 2000, Bill Clinton opened the reserves when the pump price again rose above the apparent psychological threshold of $2.00/gallon. And in 2005 George W. Bush loaned out 30 million barrels following supply disruptions resulting from Hurricane Katrina.

Since 2002 we see the price rising steadily, and in recent years we’ve been between $2.50 and $3.50/gallon, with a brief respite due to the financial crisis in 2009. Since 2006 the yearly average for a barrel of crude has floated between $53 and $91. Today oil is about $105/barrel with an average pump price of around $3.50/gallon. 

So how do we know what an "emergency" requiring intervention looks like? In the Post piece Harvard economist Greg Mankiw argues that "release from the SPR makes some sense if the market thinks prices are temporarily high. But if the market thinks we are in for permanently high prices, we might as well live with the high prices, as there is little we can do to ameliorate a permanently higher price."

From the chart above I think it’s pretty clear that the general price trend since 2000 reflects something structural going on which can be explained almost fully by rising global demand. Here’s a hint: The International Energy Agency recently reported that just ten years ago, the U.S. consumed twice as much energy as China. Since then China’s energy demand has doubled, with China recently overtaking the U.S. to become the world’s largest energy consumer. And of course the same story is happening in India and every other developing country.

So the trend of expensive oil is not exactly an abberation or a temporary puzzle we just need to solve. But the recent volatile spikes can’t possibly be explained only by supply and demand, or by Libyan unrest. The instability in Libya has resulted in diminished output of only about 750,000 barrels/day, which is about half of its total production. The U.S. imports close to 12 million barrels/day, and Libya does not even crack our top 15 source countries, from whom we receive well over 90% of our total. Most all of Libyan oil goes to to Europe and China.

If the price spike is not—as the strategic reserve guidelines spell out—of an "emergency nature" resulting from a major supply disruption, what’s the cause?

At the Nation, Chris Hayes points a damning finger at the Wall Street speculators. Look at the massive price increase in the summer of 2008. Hayes reminds us of the practical impact of such volatility:

That summer, oil hit $147 a barrel and gas hit above $4 a gallon; airfare went through the roof and nearly every single major carrier came very close to declaring bankruptcy. Food prices shot up as well, with wheat trading up 137 percent year over year in July 2008, and corn 98 percent. Famine and food riots spread throughout the globe.

He also notes that the 2008 oil spike completely dominated our domestic political discourse for months. Simply put, precipitously higher energy prices are a very big deal. When they’re caused by speculation bubbles, they’re an even bigger deal. In Hayes’ piece, a commodities expert explains: "If you start talking to industry people, they’re pulling their hair out. American Bakers Association is going bananas. They all believe that the markets are going screwy because of Wall Street." Hayes points out that other industries are equally exasperated with the speculation.

What to do about it?

One way to attempt to constrain these volatile mini-bubbles is for the Commodities Futures Trading Commission to impose “position limits,” essentially limits on the size of the bets that speculators can make. The New Deal–era Commodities Exchange Act gives the CFTC power to curb “excessive speculation,” and the just-passed Dodd-Frank bill explicitly calls for the CFTC to promulgate position limits.

Hayes notes that the president will soon be appointing a new commissioner to the CFTC, whose view on speculation limits will be dispositive. As for tapping the strategic reserves, I don’t think correcting for excessive Wall Street speculation is within the scope and spirit of the original reserve guidelines. It seems to me that rather than using our emergency stores to smooth out the pernicious impact of the speculators, we ought to first try and curb the speculation itself.

Researching the circumstances surrounding previous presidents’ use of the reserves, I notice that they all first very conspicuously announced that they were "considering" it, and that they’d be "willing" to do it if necessary. President Obama and his chief of staff Bill Daley have been making similar noises this week, no doubt attempting to signal to speculators that the party is over and precipitate a sell-off. Anyway I’ll be interested to see how this goes. 

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