Increase the Strategic Petroleum Reserve - Oil is too important

In the Wall Street Journal last week, there were two articles about strategic petroleum reserves.  The first was an Op- Ed Piece by Austan Goolsbee, former Chairman of President Obama’s council of Economic Advisors and professor of economics at the University of Chicago – Booth School of Business.  In his article, Mr. Goolsbee lays out the case for reducing the size of the US Strategic Petroleum Reserve from its current level of just under 700 Million barrels to 510 million barrels as this more closely reflects the generally accepted level of 75 days worth of oil imports.  In the Markets section there was also an article about China steadily adding to their strategic oil reserves to achieve a level that will cover the petroleum needs for the entire country for 90+ days.

I found the contrast startling.  On the one hand we have President Obama’s former chief economic advisor advocating for a reduction in our Strategic Petroleum Reserve, while China continues to increase their strategic oil reserves.

First let’s take a look at what the Strategic Petroleum Reserve (SPR) is and why we have it.  The SPR was created in 1975 in response to the Arab Oil Embargo of 1973-74.  As a result of the embargo, the US realized that it had become too dependent on foreign oil producers and decided to create its own stockpile of oil to ensure the flow of oil for domestic needs in the event of a significant supply disruption.  The result is the U.S. has currently just under 700 million barrels of oil stored in four sites along the Gulf of Mexico. 

According the Energy Information Administration (EIA) the US consumes about 20 million barrels of oil per day so that 700 million barrels represents about 35 days of supply.  Domestically the US produces just over 5.5 million barrels of oil per day, which in the event of a supply disruption will stretch the SPR to just over 48 days of total domestic usage.  None of this takes into account the oil we import from Canada and Mexico, the US’s two main suppliers of oil.

China has a known history of stockpiling grains and other staples as insurance against drought or any type of supply disruption.  China will typically keep a year’s worth of corn, wheat, and soybeans in state owned warehouses to ensure its population will have access to these basics in the event of a calamity that might severely curtail their domestic food production.  Copper is another commodity the Chinese stockpile in bulk.  Copper is considered the bellwether of economic health and the Chinese economy has been experiencing rapid growth over the past several years.  China keeps vast stores of copper on hand to ensure that its manufacturing sector has access to a stable supply stream.  It only makes sense that China would now look to increase its reserves of its most important commodity, oil.

The recent tensions and oil export restrictions with Iran highlight China’s vulnerability to oil supply disruption.  China is a big purchaser of Iranian crude oil and is building and delivering a number of crude oil tankers to Iran this spring.  Not surprising, Iran is taking several steps to circumvent the sanctions being placed on it by the U.S. and world community.  I would not be surprised if a good portion of Iranian crude winds up in Chinese storage facilities in the coming months.

The bottom line here is that like it or not, the U.S. and world economies are still dependent on cheap, reliable fuel from oil and natural gas to fuel their economies.  It would be a grave mistake for the U.S. to ignore the realities of high oil prices and possible supply disruptions and reduce the amount of oil in the SPR as Mr. Goolsbee recommends.  In my opinion the Chinese economic model has some serious flaws, but stockpiling a crucial ingredient to the national economy makes sense.  Any reduction in the SPR for short-term price gains would be harmful in the long run, while increasing the amount of oil in the SPR is likely the right answer.  Oil is here to stay and the U.S. should take the appropriate steps to avoid another crisis like the 1973-74 Arab Oil Embargo.