As Oil Prices Fluctuate, We Need Long-Term Solutions
The recent action by the International Energy Agency (IEA) to release 60 million barrels of oil from its 28 members’ strategic petroleum reserves (SPR) seems to be the combination of both a logical decision and a politically motivated one. While the events in Libya may be rationale for the IEA to increase the world’s supply of oil and decrease oil prices in the short run, this does not fix our long-term energy problems.
The strategic petroleum oil reserves are designed to be used when the oil market is disrupted by political events and/or catastrophic disasters. Coordinated actions have occurred only twice before, during the Gulf War in 1991 and after Hurricane Katrina in 2005.
Based on these past actions, some would argue that the IEA’s decision was appropriate. Specifically, the IEA chose to act after assessing the political upheaval and loss of production of 1.5 million barrels per day in Libya. Considering that the agency typically takes 30 days to review any proposed release of reserves, the situation in Libya was deemed to have caused a shortage of oil supply and therefore necessitated a release of the reserves to stabilize the oil market.
After the IEA agreed to start releasing 2 million barrels of oil per day within a week, oil price futures traded on the New York Mercantile Exchange fell 4.6%. This drop in the price of oil appears to be the premium from the loss of oil production in Libya.
Others would say this is a political maneuver to lower prices in the short run for political gain. The situation in Libya certainly had an impact on the price of crude oil, but the price was not as high as it was in 2008 at $145 per barrel. With the federal government out of weapons to combat sluggish economic growth, this could be a move by the Obama administration to prop up consumer confidence by pushing down oil and gas prices.
But the decline in the price of oil will only be in the short run. Since oil is traded in the world market, the reaction to this news by the Organization of Petroleum Exporting Countries is important. Initially OPEC did not agree with the IEA's actions, but cooler heads seemed to have prevailed. Either way, lower prices will increase the quantity of oil consumed and impact the decisions made by oil producers to produce over the next month and beyond. Moreover, the reserves that are released will have to be returned by oil producers once the 30-day period is over.
Government activity in the oil market distorts the price of oil and it may be better if governments did not have any reserves. The U.S. alone has 727 million barrels of oil in its SPR, which could support our daily oil consumption for 34 days. These reserves are held to counter any disruptions in oil supply from other countries, such as Iran.
Considering that holding these reserves artificially creates higher oil prices, releasing these in the market would push down the price of oil, but leave us vulnerable to future political actions by foreign countries. Hence, the government not having any oil reserves is unlikely in the current political environment, especially since there does not appear to be any political will to release all of these oil reserves.
The release of oil from the SPR is a short-term fix for high oil prices that needs a long-term solution, which is apparent with the price of oil being back at $95 per barrel within one week after the announcement. Many of the Obama administration’s actions have contributed to the rise in oil prices from the restrictions on oil drilling and numerous environmental regulations. Further expansion of oil production and a diversification of energy sources that we consume through the free market would be a more sensible approach to stabilizing the energy sector in the short and long run.
This action by the IEA, where the U.S. is providing 50% of the total release of oil reserves, may win political points now, but we will have the same problems of uncertain energy markets moving forward. Energy economist James Hamilton summed this up nicely by stating that “a one-time release from the SPR, or even a series of releases until the SPR runs dry, does nothing whatever to address those basic challenges” of global energy demand.
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