US Energy Policy - Drawing Down The Strategic Petroleum Reserve: “Stakes Is High”
It has been a busy week:
On top of Pebble getting SEC registered we also had the start of Q3 earnings season, the endless UK political drama and the seemingly ever growing existential threat of nuclear war it would be understandable if you missed the fact that the President ordered the release of his final tranche of his authorized sale from the Strategic Petroleum Reserve.
The Strategic Petroleum Reserve is what it sounds like: a national repository established after the 1970s OPEC oil crisis and intended to help smooth out and possibly lower oil prices after unexpected shocks like national disasters or terrorist attacks.
Releasing oil helps keep the market supplied in the event of such an event and it also signals to the market that any short term spike in prices will be very short term or the government will intervene.
It keeps investors honest and teaches them to be careful about trying to exploit any unexpected price dislocation - there could be more supply suddenly entering the market.
Overall, it is a pretty good idea but one that is limited by scale. The US uses 20 million barrels of oil a day, roughly speaking, and last year at this time there were 620 million barrels in the SPR reserve.
Now we haven't covered this topic except in passing but we think it may be time as we are entering another critical period for the energy market and not just for investors but, well, all of us.
As the House of Stark never fails to remind us: "Winter is coming."
There are two important takeaways from President Biden's action:
A lot of the criticism of the President's decision to release this oil was that it was politically motivated and he is doing this to help suppress prices ahead of his election. This is sort of silly.
Regardless of the specific motives behind the decision, this action could still be a big mistake!
Let us deal with each in turn.
So, first off, to be fair to the occupant of the White House and his administration, this release isn't "new."
President Biden set up this program of release back in March after the start of the war in Ukraine and this is the final tranche. It is not "new." It was likely always going to happen for the obvious reason that oil (and gasoline) prices have stayed elevated.
Critics will point out that it conveniently ends right before the midterm elections and that this was politically motivated. Well, sure. All actions by politicians are politically motivated?! The SPR release was motivated by politics back in March and it is motivated by politics now. Guilty.
Even if that isn't true there are legitimate reasons for such a release to occur. Oil prices are very high which hurts regular Americans and this is why we have the strategic reserve after all.
Criticizing this tranche of released oil is sort of pointless and, anyway, it isn't news. It is like complaining about the rain you fully well knew was coming. Go for it but it seems like a waste of time to us.
But the real interesting aspect of all this might be more centered around the second point above:
The authorization of release might have been justified in March but what if it was a bit premature.
What if this oil reserve might be far more needed this winter?!
We aren't sure whether this is true but we are nervous.
What is clear is that this has been both an unprecedented release from the Strategic Petroleum Reserve and a significant one. It has dropped from well over 600 million barrels and will soon be beneath 400. This is the lowest level since the early 1980s as you can see here.
Which means we have far less of a cudgel to threaten traders and also, more significantly still, far less of a cushion to help alleviate any future spike in prices.
We have “shot our shot,” as the Gen Z kids might say.
And well, perhaps we are just negative Nancys but it is now the cusp of winter in the northern hemisphere and oil prices are elevated and supply is still tight.
Here is the state of US oil inventories compared to other years:
Our fears are pretty simple, once we are through the election period the political needs for lower oil prices might drop off but the real world pressures might only be getting started.
The 1709 Winter "Anno Terrible" was in Europe last time but that continent doesn't have a monopoly on either bad luck or bad policy
It isn't as if there are not other reasons or motivated actors to send prices higher. Here are just a few:
There is Vladimir Putin for one
And the more important fact that, thanks to his barbarism, we (and the EU) are about to formally embargo Russian oil in December.
We cannot also forget that we need to start trying to refill the Reserve now, which will mean switching from a seller to a buyer of oil.
Our oil demand could be historically high, this winter, because Europe is buying up so much of the world's natural gas trying to replace Russian supply.
And yes, we are also staring at an elevated risk of economic recession but we are also entering into what is likely a multi-year period of low oil supply and high demand and doing so with our petroleum piggy bank severely depleted. Any unforeseen events could prove very expensive and very damaging for far more than *just* economic growth.
Black- or brownouts are even less fun if you don't have a job.
And the critics are right that this was always politically motivated. And the real consequences of that error will now likely come to pass. So, just be aware that after the elections in November the SPR release will be over and the bill will start to come due.
We can hope that a further release won't be necessary and the Biden administration will have gotten away with it but you don't need to be a fire breathing Republican to not feel great about the state of energy security.
We will likely have to pay in one form or another - and we will certainly have to fill the SPR up at high(er) prices.
In conclusion, this entire Strategic Petroleum Reserve release will, regardless of its motivations, almost certainly be looked at as a major policy mistake and misguided short term thinking. The best we can hope for is that it won't be an even bigger mess in the new year.
It will also be very expensive and as we have covered elsewhere, deficits and spending do actually matter.
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