The incoherence of the Biden administration policies toward fossil fuels is blatant, combining tightening constraints — formal, informal, direct, indirect — on investment in domestic crude oil production capacity and associated infrastructure (e.g., pipelines) with exhortations to both foreign and domestic producers to expand output so as to reduce the adverse political effects of high fuel costs. That abject confusion both reflects and encourages muddled thinking on the part of administration officials, the latest manifestation of which is the announcement on March 31 that over the next three months 1 million barrels per day (mmbd) of crude oil will be released from the Strategic Petroleum Reserve (SPR).

Where
to begin? One mmbd of crude oil is about 1 percent of global crude
output. Under reasonable assumptions about market
(demand) conditions, the maximum effect would be a decline in crude oil
prices of about 5 percent, or roughly $5 per barrel. That works out to
about 10–12 cents per gallon of gasoline. All of this assumes, not very
plausibly, that no other (major) producer anywhere cuts back on current
production as a result of any current price decline, in favor of
some increase in future production when the six months of SPR releases are
done.

In
other words, the naïve administration view is that there is no
market reallocation of crude oil production intertemporally (over time), a
premise that borders on the laughable. Moreover, the administration is
likely to attempt to replenish the SPR crude over some future time period, a
factor that, if the market believes it to be true, would put upward pressure on
future crude prices, and therefore on current ones as well due to the same
intertemporal shift, except in this case backward from the future to the
present.

It is almost certainly the case that market forces for the reasons summarized above will respond to the SPR announcement by reallocating crude oil use over time so as to smooth the price fluctuations. At any given moment the expected price path over time rises at the market rate of interest, because an expectation that crude oil prices will rise at a rate greater than the interest rate will lead the market to produce less today and more tomorrow, so that in equilibrium current prices increase and expected future prices decline, restoring an expected price path that rises at the market rate of interest. (The analogous argument holds for an expectation that crude oil prices will rise at a rate lower than the market rate of interest.)

Accordingly,
at most one would expect a very small price effect both initially and over
the six-month period, as the market expects that crude oil use will be shifted
over time, with an expected price at the end of the six months higher than that
initially (March 31) by the market rate of interest. And any announcement or
expectation that the SPR oil will be replenished would put upward pressure on
crude prices both now and later.

There are only two sensible economic arguments for a government oil stockpile; after all, the private sector is perfectly capable of storing oil, and does so massively. (Obviously, reserves in the ground also are a huge form of stockpiling.) The first is the expectation that, with some nontrivial probability greater than zero, some form of price controls (or “windfall profits” taxes, which actually are an excise tax on crude oil) would be implemented during a future large supply disruption yielding a big increase in prices. The expectation of future explicit or implicit price controls would reduce private incentives to invest in stockpiles, yielding investment in preparation (or insurance) below the efficient level.

Another
reasonable argument might be that the corporate income tax forces the
private sector to use a discount rate that is artificially high, so that,
again, incentives to prepare for future emergencies are weaker than optimal.

But such arguments are necessary conditions; they are not sufficient because there are few reasons to believe that government meddling in the stockpile market will yield an actual allocational improvement. Merely consider the US government’s use of the SPR over past decades: Policies to release the oil have been entirely ad hoc, driven by the perceived oil politics of the moment. It would be far better were the government simply to sell call options to the SPR oil, allowing the market to allocate it over time. But that would reduce the ability of the government to use the SPR to advance its political interests. Can it surprise anyone that government policies yield perverse outcomes?

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