Site icon IER

Ending Permitorium Could Lower Oil Prices More Than Reducing SPR

Believe it or not, there apparently is a consensus among most policymakers that lower gasoline prices would be a good thing for Americans, and that increased access to oil is the way to achieve them. The only difference is, some officials only want certain kinds of oil to be used to help Americans in this fashion.

We have already discussed President Obama’s support for Brazilian offshore drilling, even while his Interior Secretary continues to drag his feet on granting permits for domestic development off American shores.

Source: U.S. Dept. of Energy

Other examples of this split-personality syndrome are those calling to draw down the Strategic Petroleum Reserve (SPR). Proponents of this plan argue that the increased availability of oil would lower gasoline prices and help beleaguered Americans. Yet many of these same people do not support drawing down the petroleum “reserves” sitting in the ground in ANWR or on the Outer Continental Shelf.

This strategy baffles us, because the SPR is a smaller stockpile than the other deposits that are currently off-limits to development. Furthermore, economic theory suggests that ending the permitorium might reduce oil prices right now even more than drawing down the SPR.

Senator Jay Rockefeller: More Oil Helps Americans

In a recent USA Today op ed, Senator Jay Rockefeller gave a standard case for tapping into the SPR. Here are some excerpts in which Rockefeller makes the obvious connection between abundant energy and a healthy economy:

Gas prices are not just a short-term inconvenience — they are an unsustainable burden on our economy and a challenge to our efforts to bring this country out of the greatest economic recession since the Great Depression. Rapidly rising gas prices caused by threats to the global oil supply hurt business and industry.

To reduce the very real burden on Americans and address any further oil supply disruptions, I have asked President Obama to consider releasing oil from the Strategic Petroleum Reserve.

We sympathize with Rockefeller’s explanation. High gasoline (and other energy) prices are a burden on Americans, and pose a drag on the economy which is already struggling. We simply point out that Rockefeller is unwittingly making a stronger argument for removing the federal impediments to the development of America’s oil reserves.

Comparing the SPR with Other “Reserves”

According to the official website, the Strategic Petroleum Reserve (as of late November) had a total of 726.5 million barrels of oil stockpiled for an emergency, with 434 million barrels of sour crude and the balance consisting of sweet crude. Although an impressive figure, the number pales in comparison to the estimated crude domestically available in areas currently off-limits to development.

For example, the “1002 Area” of the Arctic National Wildlife Refuge (ANWR) has a mean expected 10.4 billion barrels of technically recoverable oil, according to the government’s own survey. Once up and running, ANWR alone could yield one million barrels of oil per day in production, which would make it the single-largest producing field in North America.

If we turn our attention to the Outer Continental Shelf—of which 97 percent does not have leases for development—again the government’s own estimates claim there are 86 billion barrels of oil.

If policymakers think it makes sense to tap into the SPR, with its relatively tiny 726.5 million barrel stockpile, why not allow American companies tap into the other reserves under their jurisdiction? ANWR and the OCS combined have more than one hundred times the amount of oil stored in the SPR.

Lowering Prices Now or in the Future?

Back in 2008, I testified to Congress on the matter of rising oil prices (see part 1 and part 2). Naturally I made the case that if the government wanted to lower gasoline prices, it should eliminate its (then still official) moratorium on offshore drilling and other impediments to oil exploration on federal lands.

The main objection I received was that even if full approval were granted immediately, it might take years for new fields to reach maximum production levels. This supposedly meant that removing the official moratorium would do nothing to bring immediate price relief to motorists.

First, it’s important to point out that had my analysis been heeded back in July 2008, we would have had three years of progress under our belts before this summer’s potentially record gas prices hit. It’s not as if the American economy’s need for energy is a fleeting goal. If bringing extra oil deposits into development would help in a few years, then it makes sense to get the wheels in motion now. Nobody says that it’s pointless to send your kid to school, since the payoff is years in the future.

However, that’s not the end of the story. When then-President George W. Bush removed the executive moratorium—even though the Congressional version was still in effect—oil prices dropped more than $9 during his announcement.

This wasn’t magic; other analysts and I had been predicting that it would happen, if the federal government were to loosen its choke-hold on domestic development. A little economics will explain what happened:

The owner of a given oil field has an exhaustible resource at his disposal. He has to decide whether to extract more barrels for sale in the present, or if he should slow his production and leave more barrels in the ground for sale in the future. One of the primary influences in this calculation is the owner’s guess as to whether oil prices will be higher in the future, compared to the present. (I spell out the argument more fully here.)

Now suppose the owner learns some new information, telling him that there will be more oil production occurring in a few years. (For example, the president of the United States lifts the executive moratorium on offshore drilling, making it more likely that Congress will follow suit and that drilling will actually occur.) That means his previous estimate of the future price of oil was too high; oil in fact will be cheaper down the road, because of the new oil production.

Whatever his previous decision on how many barrels to produce this year, the new information will give the owner an incentive to bump up the number, because now the current spot price of oil is more attractive compared to his new (and lower) estimate of the future price of oil.

So we see that there’s no magic involved, no time machines bringing future oil into the present. Current oil producers with excess capacity—such as Saudi Arabia—can increase output immediately, and bring immediate price relief, if the U.S. government takes steps that will yield higher global oil output down the road. To repeat, this isn’t just theory; oil prices really did drop significantly in response to the lifting of both the executive and congressional moratoria in 2008.

Selling From the SPR Could Backfire

Ironically, the same logic shows that selling oil from the SPR might have much less impact than we might otherwise expect. As University of Rochester economist Steve Landsburg pointed out in his critique of Senator Rockefeller, we can’t look at U.S. policy in a vacuum.

If the government begins releasing oil from the SPR, it’s true that the extra barrels on the market would tend to push down the current price of oil. But that means other oil producers would now have an incentive to slow their current production, to hold more of their barrels off the market until the future, when prices will be relatively higher.

To be sure, selling oil from the SPR wouldn’t make oil prices go up, but Landsburg’s point is that they might not drop very much, because other producers could offset much of the impact.

Conclusion

If policymakers such as Senator Rockefeller want to bring relief to Americans through lower gasoline prices, we agree that increased oil supplies on the market are an obvious solution. However, compared to drawing down the SPR, there is a much more compelling case for allowing the development of domestic oil resources.

Exit mobile version