By Bob Iaccino
The term “historical” is often used casually in financial markets, whether referring to historical rate hikes, historical inflation, or historical yield curve movements. Sometimes, however, things happen that actually deserve to be called “historic.”
In November 2021, President Joe Biden ordered the release of 50 million excess barrels of crude oil from the Strategic Petroleum Reserve (SPR). Then at the end of March 2022, it continued with the release of 1 million barrels per day until a total of 180 million barrels were sent to the general market. This release schedule was indeed “historic” in both size and speed.
The Strategic Petroleum Reserve was created in 1974 to protect U.S. national energy security against possible events such as the 1973 Middle East oil embargo, when some oil-producing nations temporarily halted shipments of crude oil to the United States and several other countries in protest. The embargo caused prices at the pump to skyrocket and petrol stations to run out of fuel. The era was marked by images of long lines of cars waiting to fill up and gas stations with no gas to sell.
The Strategic Petroleum Reserve, or SPR, is a complex of four locations that store emergency petroleum in deep underground storage caverns created in salt domes along the Gulf Coasts of Texas and Louisiana. Although the idea of storing emergency oil emerged as early as 1944, it took the oil embargo of 1973-74 to spur the creation of the Strategic Petroleum Reserve, which was included in the Policy and conservation of energy signed by President Ford in late 1975.
The SPR was not technically designed to help the US government manage the price consumers pay for gasoline at the pump, but it has been used that way by several jurisdictions. Whether it works or not is another question.
According to a study made to the Treasury Department by Undersecretary for Economic Policy Benjamin Harris and Deputy Undersecretary for Climate and Energy Economics Catherine Wolfram, Biden’s massive SPR release “lowered the price of gasoline from 17 cents to 42 cents per gallon, with an alternative approach suggesting a point estimate of 38 cents per gallon.”
The question now becomes, “Is releasing emergency oil supplies when there are no shortages of fuel or lines at the gas station worth what might happen next?”
According According to the US Energy Information Administration, the SPR fell to its lowest level since 1985. Inventories fell to just under 445 million barrels from their pre-release levels of just over of 612 million.
This represents a depletion of approximately 27% of crude inventories in a very short time, and given the current geopolitical tensions, the SPR needs to be recharged. The SPR was built to alleviate domestic supply shortages. In May 2022, the Department of Energy released a purchase plan to fill the SPR, but it was only about 60 million barrels, and it said these would be purchased “next year” at lower prices.
The DOE noted that it was intended to encourage U.S. drillers to boost activity now and “lower prices by securing that demand in the future at a time when market participants expect crude oil prices to be significantly lower than what they are today”.
This buying plan essentially introduces a buyer into the market at lower levels, that buyer being the US government, and it potentially keeps crude oil prices higher than they would be without that buyer. Worse still, if there is an exogenous shock and the supply of crude is interrupted, prices may not be lower.
The DOE may be forced to purchase at any market price at the time, or it may delay purchases altogether. Bids solicited from producers are taken well in advance of actual trade dates, so pricing and timing alone can cause volatility from a hedging perspective. Filling the SPR to such a degree at any time may affect an artificial floor in the crude oil market.
There are many other concerns about the whole operation of such a large and rapid release, but make no mistake, this was indeed “historic”. The filling of the SPR can also be.
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