Originally published in The Boston Globe
Tuesday, February 29, 2000

Poor solution to oil problem
By Martin and Kathleen Feldstein

"Drawing on strategic reserves would be shortsighted"

As anyone who drives a car or uses oil for home heating knows, US energy prices have risen dramatically over the past year. The sharp increase in the world price of oil from less than $15 per barrel a year ago to more than $30 per barrel in recent weeks has resulted from production limits by OPEC countries, combined with the robust demands of a strong economy and a cold winter.

In an election year, it is hardly surprising that oil prices are becoming a political issue. Already the Clinton administration is considering ways to pick up political support with a program to increase oil supplies and bring down prices. Senator Charles Schumer of New York, a state seriously affected by the oil price hikes, has suggested drawing on the Strategic Petroleum Reserve (SPR), a decision that can be made only by the president. The administration is investigating a variant of Schumer's proposal, one that might have broader political appeal.

We think it is a bad idea to invade the SPR, which was set up in 1975 for national energy emergencies. The oil embargo of 1973-74, when OPEC countries cut off oil flows to the United States, highlighted the need to stockpile oil reserves. The legislation setting up the SPR established a goal for a reserve of as much as 1 billion barrels of petroleum. Today, more than 500 million barrels of oil are stored in salt caverns located along the Gulf of Mexico. The SPR has been drawn down only once, during Operation Desert Storm in 1991.

The United States, which imports close to 10 million barrels of oil a day, is clearly dependent on continued supplies of oil from abroad. Any halt in the supply of oil caused by a war in the Middle East would not only send consumer energy prices skyrocketing, but also would risk interrupting our industrial activity and our national transportation. It is basic to US energy security that the SPR be maintained for such national emergencies.

Nevertheless, the Clinton administration is considering drawing down these reserves in order to reduce current oil prices. They are working on a politically clever way of packaging the depletion of reserves in order to deflect criticism on national security grounds.

Instead of selling oil outright from the reserves, the proposal under consideration would allow domestic oil companies to "borrow" from the reserves. In return, the oil companies would repay the borrowed amount plus some additional amount at some time in the future.

This side-door approach could be a nice windfall for domestic oil producers, who would be able to sell additional oil at current market prices and replenish the borrowed oil at lower market prices in the future. If there were a strong consensus for using reserves to reduce oil prices, wouldn't it be better for the US government to sell at today's high prices and buy back later at lower prices? Why should the oil companies, rather than the American taxpayers, be the beneficiaries?

Under the Clinton proposal, the SPR would hold IOUs from the oil companies. But the IOUs wouldn't change the fact that our strategic reserves would be diminished by this manipulation and that the US would be more vulnerable to a major interruption of oil supplies. If we lend our neighbor our fire extinguisher on the promise of a better one next year, we are still without that fire protection for the year.

It's hard to come up with a nonpolitical rationale for the government to interfere with the market in this way. It cannot be concern over rampant inflation, with consumer prices rising at only about 2.5 percent over the last year. And since oil price futures show a decline to about $24 per barrel within the year, there is little danger that inflation is about to pick up dramatically as a result of the price of oil. In fact, the OPEC countries may agree to increase oil supplies as early as late March.

Nor would this proposal make a big difference to those low-income families who are in fact suffering from the impact of high home heating prices. The entire SPR is less than 600 million barrels of oil; world production of petroleum is over 70 million of barrels a day. It would take a dangerously large release of petroleum reserves to have any sizeable impact on domestic oil prices. Moreover, any price decrease would be shared by consumers and businesses around the world.

Finally, as always, there is no free lunch. Whatever benefit might flow from lower oil prices today would be offset in the future when prices are bid higher by the need to replenish and add to the reserves. The idea of SPR swaps may be a good political gimmick, but it is a bad economic strategy.

Martin Feldstein, the former chairman of the Council of Economic Advisers, and his wife, Kathleen, also an economist, write frequently together on economics.