As we have noted numerous times, the federal government leases a mere 3 percent of federal lands for energy production.[i] The United States is already the world’s third largest oil producer, but we could produce a lot more oil if the federal government would let the American people explore for oil on more federal lands.

The 1002 Area is the North Slope of the Arctic National Wildlife Refuge (ANWR) and is approximately 70 miles from the Trans-Alaska Pipeline System (TAPS – known colloquially as “the Alaska Pipeline”).  In 1980, Congress and President Jimmy Carter set aside 1.5 million acres of ANWR’s 19 million acres for future study of its energy resource potential.[ii] These 1.5 million acres, known as the 1002 Area, have no trees, deepwater lakes, or mountain peaks, but contain immense energy resources.[iii]

The U.S. Geological Survey has estimated that the 1002 Area has an expected value of 10.4 billion barrels of recoverable oil that could be produced at a rate of about one million barrels of oil per day.[iv] This potential resource could make the North Slope of ANWR the largest oil-producing field in the United States. The area’s oil and natural gas resources could be developed using merely 2,000 acres of the surface area, or less than 0.01 percent of ANWR’s total area.[v]

Despite ANWR’s great energy potential, Congress has not allowed the development of these resources for over 30 years. One of the many reasons used by the opponents of energy production there is that it might adversely impact caribou populations.  Yet, since energy production began in nearby Prudhoe Bay in 1977, the size of the Central Arctic Herd has grown more than 1,015 percent, from about 6,000 animals in 1978 to record levels of an estimated 67,000 caribou in 2009.[vi]

Meanwhile, TAPS—once capable of delivering over 2 million barrels per day to the West Coast—is running at less than one-third of its capacity.  The underutilized capacity of TAPS is more than the total amount of oil removed from the market in early 2011 by the Libyan civil war which sent world prices skyrocketing.  The consequences of the decline in TAPS oil supplies for the West Coast have been enormous; the West Coast has gone from being a region of the country that exported oil to the rest of the country to the region of the country most dependent on OPEC imports.

President Obama lately has been calling for more domestic energy production, but his continued opposition to energy production on the North Slope of ANWR deprives Americans of the benefits of the $1 trillion of oil locked in the frozen tundra there.  ANWR stands as a symbol that his actions do not yet match his words.  If President Obama announced his support for legislation to open ANWR, America would have more domestic energy, more jobs and much more needed revenue, and the Alaska Pipeline could once again approach its full capacity.

Although the surprise announcement did lead to an immediate drop in the price of crude, the fall was not as much as some might have expected and prices returned to the pre-release levels within 1 week. Economic theory can explain why. Moreover, to the extent that the Obama Administration recognizes that more oil leads to lower prices, it should tap into America’s vast “reserves” located in the Outer Continental Shelf and ANWR. These holdings dwarf the salt caverns of the SPR and tapping them would lead to a real increase in production as opposed to a short-term band-aid “fix.”

SPR Drawdowns and the Price of Oil

As this CNNMoney article reports, the surprise announcement, which added two million barrels a day to the market, caused the price of oil to drop more than 4 percent by the close of the day. (Interestingly, as of this writing—exactly one week later—the world price of oil is higher than it was before the announcement.)

As I have written previously on this blog, economic theory suggests that one-shot sales from the Strategic Petroleum Reserve under normal market conditions would be offset by the response of other players in the market, so that releasing oil from the SPR wouldn’t depress prices as much as one might have originally thought.

Here’s a summary of the argument: People who are sitting on large deposits of oil (the Saudis for example) set their current production rates to maximize the market value of their asset. If a producer extracts and sells more barrels of oil today, he earns more revenue today, but his actions (a) push down the current market price of oil, while (b) leave him with fewer barrels of oil to sell in the future, and therefore also (c) push up the future market price of oil.

Because of reasoning like this, we don’t need to worry about all the major oil producers foolishly selling every last barrel of oil this year. That would be a horrible business strategy, because it would crash the current price of oil while leading to $500-a-barrel oil next year. Since the owners of major oil fields are anything but stupid, they plan their operations out decades into the future. Rather, they decide on current production rates in order to maximize the long-run profitability of their operations.

So if the world oil market were more or less in equilibrium, what effect did the surprise announcement have? All of a sudden, it meant that two million more barrels of oil per day would be coming onto the market, than the major oil producers had previously forecast. That in turn means that the market price of oil in July will be lower (other things equal) than what the major oil producers had anticipated, before hearing the announcement.

Because of the changed circumstances, the original production plans are no longer optimal. Major producers could make more money (in light of the surprise SPR sales) if they reduced their output over the summer months, and deferred the extraction and sale of more of their inventory to the future, after the SPR drawdowns have finished. Even if the total amount of oil hitting the market remained above the original level, private speculators (sensing the prices were artificially low) would have the incentive to buy the excess oil and store it, waiting for prices to return to their normal levels.

If there were no real-world frictions, in principle the SPR announcements would have virtually no effect on oil prices at all. The extra two million barrels coming onto the market from the SPR sales would be perfectly offset by a combination of production cutbacks and private inventory accumulation. Effectively, the Obama Administration would have simply transferred 30 million barrels of its inventories from salt caverns in the southern United States, into the warehouses of private speculators and into the possession of Saudi Arabia in deposits buried under the sand.

Of course, in the real world, there are all sorts of complications with this theoretical benchmark. Oil prices really did drop upon the announcement. But the point remains that economic forces limit the lasting impact that even large-scale inventory sales can have on the world price of crude.

Getting a Bigger Bang

Since the Obama Administration apparently understands the (obvious) point that more oil leads to lower prices, it should heed IER’s long-standing call to remove the statutory and regulatory obstacle to the development of offshore, ANWR, and other oil resources. Whereas the SPR had (before the recent announcement) 726.5 million barrels of oil, the “1002 Area” of ANWR has an estimated 10.4 billion barrels of technically recoverable crude, while the figure for the OCS is more than 59 billion barrels. Thus there are about 96 times more oil “reserves” in ANWR and the OCS, than is contained in the SPR.

What’s even more interesting is that the conventional criticism of expanded domestic production—that it will take years to bring that new oil to the market—turns the economic logic above on its head. Suppose Saudi Arabia has made long-term planning decisions under the assumption that the roughly 70 billion barrels of U.S. crude will remain forever locked-up due to federal barriers. Then the U.S. government surprises everyone by announcing that this oil will actually be coming onto the market in a few years. Saudi officials would realize that their original forecast of the world price of oil over the next few decades was overly optimistic (i.e. too high), and they would rearrange their plans to extract more oil in the present before having to compete with the new U.S. production. This would cause more oil to hit the market in the present, thus lowering the present price of oil—even though the promised U.S. production might be years in the future.

Real-World Facts

Although our economistic reasoning sounds Ivory Tower, we have real-world evidence: When President George W. Bush announced in the summer of 2008 that he was ending the executive branch’s moratorium on offshore drilling, the price of crude dropped $9 per barrel during the speech itself. This was an immediate impact at least as great as the immediate drop in crude prices, following the recent SPR announcement. Yet Bush’s announcement by itself didn’t guarantee a single drop in new production, because the Congressional moratorium was still in place. Just the increased possibility of more future U.S. production, caused prices to drop as much as Obama et al.’s guaranteed delivery of 60 million barrels in the next month.

Conclusion

President Obama and his advisors undoubtedly recognize that Americans are seething over soaring energy and other prices. The drawdown in the SPR did push down prices (at least temporarily), but economic theory suggests that other forces would largely offset its impact. In both theory and practice, we know that opening up domestic energy resources to development would cause much bigger and lasting reductions in the price of energy, not to mention providing economic growth.

Speculators are characterized as cogs in the Wall Street greed machine who seek to make a quick buck off betting on oil commodity futures, an idea that many are all too happy to entertain in this post-financial meltdown age. However, the argument that speculative activity has caused this most recent escalation in gas prices ignores the fact that there has been speculation on commodities for centuries, and as Stossel writes, the players are “no more greedy or clever than they have been all along.”

The answer is, in fact, much more simple than politicians want you to believe as they lay blame at the feet of oil companies and speculators. It’s a straightforward matter of supply and demand. World crude oil and liquid fuels consumption grew to the highest level ever in 2010, with 86.7 million barrels per day (bpd) consumed in total. Most of the increase can be attributed to countries outside the Organization for Economic Cooperation and Development (OECD)—China, Brazil, and those in the Middle East—where rapid economic growth and quality of life improvements have led to increasing amounts of energy being used. Fatih Birol, chief economist at the International Energy Agency, said growth in worldwide oil demand is exceeding growth in new supplies by 1 million bpd per year, with much of the new demand coming from China. Factor in Organization of the Petroleum Exporting Countries (OPEC) production restraints that seek to maintain favorably high oil prices, anticipated losses in Gulf of Mexico production, and recent global disruptions, it is unsurprising that oil commodity prices have spiked.

Furthermore, the U.S. Federal Reserve’s second round of inflationary monetary policy (QE2) has prompted investors to flee a devalued dollar in favor of non-income generating real assets, like oil and precious metals, and makes crude cheaper for investors using foreign currencies. As in 2008, when the first round of the Fed’s inflationary monetary policies began, oil prices have steadily risen since Federal Reserve Chairman Ben Bernanke’s announcement that the easy money policies may continue past the end of QE2 this June.

Speculators are merely a symptom of oil spikes, not the cause. Birol, in an interview with CNNMoney, said, “Speculators are only responding to what is going on in the markets… We don’t see enough oil in the markets. The major driver is supply and demand.” Furthermore, speculation even serves as a stabilizing function in a market that would otherwise be exceedingly volatile. In his op-ed, Stossel writes:

“Speculators help keep prices stable. When they foresee a future oil shortage—that is, when prices are lower than anticipated in the future—speculators buy lots of it, store it and then sell it when the shortage hits. They know they can charge more when there’s relatively little oil on the market. But their selling during the shortage brings prices down from what they would have been had speculators not acted.”

To reinforce the point that speculation is a legitimate economic function and that federal intervention would ultimately prove to be worse than the status quo, Stossel cites the 1958 Congressional action to ban speculation on onion prices. That’s right, Congress passed a law, amid mass public outcry, to ban speculative activity on the price of onions. The end result? Onion prices are actually some of the most volatile of all goods, and a study by the Financial Times found that the ban actually did the opposite of the intended effect.

Instead of trying to meddle with the market, Washington should focus on removing the roadblocks to domestic energy exploration to give America more leverage in the oil game. When President Bush finally lifted the U.S. embargo on its own offshore oil in July 2008, the price of oil dropped $9.26 per barrel while he was giving the speech. Crude oil traders and speculators believed that oil supplies would increase in the future, reducing prices. However, it is interesting to note that the market had a fairly apathetic response to President Obama’s recent proposals to increase domestic production.

The only marginal decrease in oil prices since the President’s announcement is indicative that players in the market do not anticipate that the proposals—which are simply reversals of policies implemented during the Obama Administration—will significantly increase the supply of oil. To impact oil prices on the scale of what happened when the Outer Continental Shelf (OCS) moratorium was lifted in 2008, the Administration will need to adopt an energy policy that includes exploration in ANWR, more of the OCS, and more than the current 3 percent of onshore federal lands that are available for leasing. Until the Administration takes these major steps to produce more oil at home, its recriminations against speculators and shadowy market manipulators hold little water.

The National Petroleum Reserve – Alaska (NPR-A):

Formerly known as the Naval Petroleum Reserve No. 4, the vast 23-million acre area on Alaska’s North Slope has a history of nearly 100 years of petroleum exploration. In 1923, mindful of the land’s conceivable petroleum value, President Harding set aside these 23 million acres as an emergency oil supply for the U.S. Navy. In 1976, in accordance with the Naval Petroleum Reserve Production Act, the administration of the reserve was transferred to the Department of the Interior, more specifically the Bureau of Land Management, and was renamed to what is now known as the National Petroleum Reserve-Alaska (NPR-A).  The BLM has held four lease sales in the NPR-A (Northeast – 1999 and 2002 and Northwest – 2004 and 2006) and currently administers more than 300 Federal oil and gas leases.  NPR-A is estimated to contain 10.6 billion barrels of oil.

Prudhoe Bay

In between NPR-A and ANWR lies Prudhoe Bay.  Oil was discovered in Prudhoe Bay in 1967, and production began in 1977 when the Trans-Alaskan Pipeline (TAPS) was completed.  Since that time, the United States has sent more than 15 billion barrels of oil down TAPS to consumers in the lower 48 states.  Production continues today, even though Prudhoe Bay was originally estimated to contain only 9 billion barrels of oil.  Unlike NPR-A and ANWR, Prudhoe Bay energy production occurs on state, not federal, lands.

The 1002 Area of ANWR

Section 1002 of the law that established the Arctic National Wildlife Refuge (ANWR) set aside 1.5-million acres of the northern coastal plain for future production of its enormous petroleum resources.  This 1.5 million acres is known as the 1002 Area after that section of the law, and is estimated to contain 10.4 billion barrels of oil.  However, unlike NPR-A, Congress must vote to approve energy production in ANWR’s 1002 Area.  It has not yet done so.

Key Questions

Q: Would it be faster and/or more environmentally sound to drill in NPR-A instead of ANWR’s 1002 Area?

A: No.  While both NPR-A and ANWR’s 1002 Area were set aside specifically for their oil and gas resources, NPR-A oil is spread out over its entire 23 million acre expanse.  The 10.4 billion barrels in ANWR’s 1002 area, on the other hand, is concentrated in one relatively small area and, as such, can be produced with far less surface disturbance.  Also, 21st century technologies enable companies to produce energy safely, as they have been doing in Prudhoe Bay for more than three decades.

Q: Why isn’t oil being produced in the NPR-A today?

A: Lawsuits filed by environmental organizations such as Earthjustice, the Sierra Club, and the Natural Resources Defense Council have stalled production in NPR-A.  In addition, a U.S. Corp of Engineers permit has not yet been granted to install a critical pipeline.

Q: Which would require greater investments in surface roads, pipelines, and drill-pads?

A: NPR-A would require a much greater investment in surface infrastructure.

Q: Can and should oil be produced in both NPR-A and ANWR’s 1002 area?

A: Yes.

The Top Five Steps Your Federal Government Can Take to Increase Supplies and Lower Prices:

1. Lift the Presidential and Congressional moratoria on deepwater outer-continental shelf (OCS) energy exploration and production. The US is the only developed country in the world that restricts access to its offshore resources. Currently, 97% of America’s 2 billion acres of OCS are not being used for their energy potential. The U.S. Minerals Management Service (MMS) estimates that the outer continental shelf contains nearly 86 billion barrels of oil and 420 trillion cubic feet of natural gas. (The U.S. consumes roughly 7.5 billion barrels of oil and 23 trillion cubic feet of natural gas annually)  The MMS estimates are conservative due to the fact that “true knowledge of the actual volume of oil and natural gas resources can only come through the drilling of wells,” and in many places in the US, exploratory wells have not been allowed to be drilled. Simply put, the government does not know exactly how much energy lies beneath the OCS because it has been illegal to look.According to MMS, it has been more than twenty years since any exploration activity has been conducted on the Alaska and Atlantic OCS, and “no meaningful” exploration offshore Central and Northern California, offshore Oregon and Washington and the South Florida Basin, has been conducted since the 1960’s.
   
   
2. Repeal the Congressional prohibition precluding the production of oil shale leases on taxpayer-owned federal lands.As part of the Energy Policy Act of 2005, Congress directed the U.S. Secretary of Interior to develop a program to enable the production of America’s oil shale resources – the largest oil supply in the world – for American consumers.The United States has 2 trillion barrels of oil shale. This is more than 7 the amount of crude oil reserves found in Saudi Arabia, and is enough to meet current U.S. demand for over 250 years. According to the U.S Department of Energy (DOE):
   
   “Once developed, U.S. oil shale resources will be similar in extent and energy potential to Alberta’s tar sand reserves. When oil shale and tar sands are considered together, the United States and Canada will be able to claim the largest oil reserves in the world.”However, in 2007, Congress adopted a rider that prohibited the Department of Interior from completing the task it was assigned in 2005. Consequently, the United States is still without a program to bring this massive resource to market for American consumers.
3. Open the “1002 Area” of the Arctic National Wildlife Refuge (ANWR) for oil and natural gas development. In 1980, President Jimmy Carter and the Congress set aside 1.5 million of ANWR’s 19 million acres for potential oil development, subject to Congressional approval. This area is often called the “1002 Area” because it was set aside in Section 1002 of the law. It is located on Alaska’s Northern Coastal Plain. According to U.S. government estimates, the mean estimate of the oil beneath ANWR’s northern coastal plain is 10.4 billion barrels, or, nearly half of the total proven reserves of the entire United States. At peak production, ANWR could produce approximately 1 million barrels of oil per day, which is roughly equal to the amount the entire state of Texas produces each day, and about as much as we currently import from Nigeria. Moreover, the Congressional Research Service (CRS) recently estimated that ANWR energy production would generate about $180 billion in federal tax and royalty revenue.If approved by Congress, ANWR would be the single largest producing oil field in America and the entire Northern Hemisphere.
4. Appoint the U.S. Commission on North American Energy Freedom as mandated by the Energy Policy Act of 2005 (Sections 1421-1424). As part of the federal government’s national energy policy, Congress established the 16-member Commission on North American Energy Security, and directed the President to appoint representatives from the United States. The President has failed to do so. North America’s energy resource base is enormous. It includes the world’s largest oil shale deposits, the world’s largest coal deposits, and the world’s largest oil sands reserves. Combined, these resources are sufficient to power North America for centuries, giving us plenty of time to transition to new energy sources as they become affordable. Meanwhile, all of North America would benefit from more indigenous energy production. A coordinated effort between the United States, Canada and Mexico – as envisioned by the law – would facilitate the development of a comprehensive North American energy policy that seeks to achieve energy self-sufficiency by 2025 within the three contiguous North American nation areas of Canada, Mexico, and the United States.
   
   
5. Repeal Section 526 of the Energy Independence and Security Act of 2007 which prohibits federal contracting for “nonconventional” sources of petroleum. Section 526 of the Energy Independence and Security Act of 2007 prohibited U.S. federal agencies from contracting to procure non-conventional or alternative fuels that may emit higher levels of greenhouse gas emissions than ‘conventional petroleum sources.’ Investment in non-conventional fuels will play a critical role in reducing America’s dependence on foreign sources of energy. Advanced fuel technologies, including coal-to-liquids, natural gas-to-liquids, fuel from oil shale, an fuel from Canadian tar sands are specifically targeted by Section 526. Strategically, Section 526 was especially unwise, given America’s massive coal and oil shale resources, and the fact that Canada is America’s largest supplier of imported oil. Arbitrarily preventing the U.S. Government from procuring advanced non-conventional fuels could have negative impacts on the military, and therefore, our security. In the event of a national emergency, the U.S. military could be forced to obtain a greater percentage of petroleum from unstable regions of the world.