Notwithstanding vociferous criticism of the politicized use of the Strategic Petroleum Reserve by the Biden administration, such drawdowns have been employed for decades by Democratic and Republican administrations alike as an ad hoc and futile response to short-run increases in fuel prices. 

Unlike the case for all previous administrations, which viewed the domestic production of fossil fuels as a positive or at least necessary objective, the major difference introduced by the Biden administration is the incoherence of its policies on conventional energy. To wit: a combination of “net-zero” climate policies supposedly ending the use of fossil fuels and desperate attempts to avoid sharp increases in gasoline prices in the here and now. These goals are impossible to reconcile; that is how we wind up with constraints on domestic oil production combined with supplication to the Saudis for increases in output. But careful thinking about the purpose and efficient use of the SPR leads to a surprising conclusion: The Biden SPR drawdown policy on net is likely to improve allocational efficiency in the narrow context of emergency preparation. 

In order to see this, it is useful first to ask whether there is a reasonable argument in support of an emergency oil stockpile owned and managed by the government. After all, the private sector can — and does, emphatically — maintain such stockpiles, both domestically and internationally. U.S. commercial stocks of crude oil are over 400 million barrels, while domestic consumption is about 20 million barrels per day (mmbd). Commercial petroleum inventories for the Organization for Economic Cooperation and Development are approximately 2.5-3 billion barrels, while consumption is about 46 mmbd; accordingly, commercial stocks for the OECD are roughly 60 days of consumption. Global commercial inventories are about 4.35 billion barrels, or about 44 days of consumption.

Such figures demonstrate that commercial stocks are maintained not merely to smooth very short-term fluctuations in demand and supply conditions. Instead, there always is a threat of an important supply disruption somewhere — such disruptions are a permanent feature of the international crude oil market — a reality that has the obvious expected effect of increasing world crude oil prices on a long term basis. Moreover, a given supply disruption, even if temporary, might change market expectations of the frequency and/or magnitude of such disruptions, with longer term price impacts. Accordingly, investment in such stockpiles is profitable prospectively, and the equilibrium size of the aggregate stockpile is that equating the expected return to such investment with the market rate of interest. 

So far, so good: The economic insurance provided by private-sector investment in stockpiles is economically efficient in that it does not protect against all (substantial) effects of future supply disruptions, but instead equates the marginal costs and benefits of such insurance. (I shunt aside here other forms of insurance: investments in assets the value of which are correlated inversely with oil prices, the use of capital equipment and other facilities affected less rather than more by fluctuations in oil prices, location decisions providing some insulation against increases in oil prices, and so forth.)

Let us now consider the effect of efforts by governments to confiscate some substantial part of the economic value of such commercial stocks. Price controls, “windfall profits” (excise) taxes, threats of adverse future regulatory or litigation actions, mandatory delivery of supplies to government agencies (often on national security grounds), and nationalization threats are only a few examples of the tools with which governments can reduce the expected returns to investment in stockpiles made in anticipation of future supply disruptions. Confiscatory behavior by the government can surprise no one, in particular given incentives for public officials to adopt short time horizons, a feature of democracies and autocracies alike. Because the corporation income tax forces the private sector to discount the future too heavily, that is, to use a discount rate too high, ongoing proposals to increase such taxes are likely to exacerbate that problem. The habit of the Biden administration narrowly, and the political left more generally, to blame the private sector for increases in the price of energy and to threaten retaliatory policies may have yielded an increase in the disincentive to invest in insurance against supply disruptions. 

Such reductions in expected returns to investment in stockpiles obviously would reduce such investments to levels inefficiently small, that is, that provide too little insurance given market expectations about the prospective price effects of future supply disruptions. The ability of foreigners to make stockpile investments overseas as a substitute for investments forgone by domestic investors is unlikely to solve this problem fully, in that under some conditions the sales of foreign oil into the domestic market might be suppressed by price controls. 

So a government stockpile combined with (inefficiently small) private stockpiles might yield an aggregate amount of insurance roughly efficient. The obvious problem is the predictably inefficient use of the government’s portion of the aggregate stockpile, in particular the allocation of the supplies over time. In principle, the government ought simply to sell call options on the oil that it owns, thus allowing market forces to allocate the oil across current and future time periods. It is virtually certain that such a market allocation process would yield economic benefits greater than those engendered by government incentives, whatever the private-sector distortions created by tax and other policies.

But no such sensible policy has ever been adopted by the federal government, regardless of which party has controlled the presidency or Congress, for the obvious reason that the use by government of such an asset cannot be driven by anything other than political imperatives rather than considerations of economic efficiency. And so whether a government stockpile yields a net improvement in overall economic wellbeing — given that government itself has created disincentives for an optimal private stockpile — is a proposition very far from obvious. 

So given a policy environment leading the private sector to invest too little in insurance against future supply disruptions, and given perverse incentives for government to use its own stockpiles inefficiently, there is a clear economic benefit from finding one way or another to get the government petroleum into the hands of the private sector, so that the oil can be allocated over time on the basis of market incentives. This imperative seems obvious, and so — however ironically — the Biden use of the SPR to serve its perceived short term political interests is likely to improve the aggregate economic value of the SPR, an outcome that is a subtle confirmation of the inherent truth of Adam Smith’s “invisible hand” metaphor.

The Biden Treasury Department argues, with a straight face, that the release of 240 million barrels of oil (180 million from the SPR and 60 million from allies) over six months has “lowered the price of gasoline by 17 cents to 42 cents per gallon.” That assertion is deeply problematic because it assumes away the obvious market response to the release: If prices are going to be lower currently and higher later when the SPR is replenished, would other producers not reduce their output now and increase it later? After all, it is axiomatic that at any given moment, expected market prices rise over time at the market rate of interest. The implicit DoT answer is “No.” Seriously?

The silliness has been bipartisan. Some conservatives and Republicans have complained that the oil sold from the SPR has wound up in the hands of foreigners, the Chinese in particular. Because the market for crude oil is international by its very nature — oil from a given supplier can be shipped anywhere — this complaint is preposterous. Had the SPR oil gone to, say, Europe or Japan or the Republic of North (South) Korea, either non-SPR oil would have gone to China or the SPR oil would have been reallocated to China by market forces. Do those making this complaint actually believe that sale of the SPR oil to China changes anything fundamental?

The larger criticism of the Biden SPR sales is that the SPR is considerably smaller as a result and that therefore the U.S. somehow is less prepared for a future supply disruption. That argument is fundamentally misguided because the SPR releases do not change the perverse policies leading the market to invest too little in preparation — the degree to which stockpiles are inefficiently small remains the same — so that private incentives to store oil, however, distorted, remain unchanged. But by moving oil from the SPR into the private sector, we obtain an improvement in the allocation of emergency supplies over time because that function is served far better by market forces than by political institutions. The Biden administration’s energy policies may be deeply perverse, and its assertions about the effects of its SPR sales laughable, but unanticipated consequences are always to be expected, and occasionally prove fortuitous. 

This piece originally appeared at RealClearEnergy.com and has been republished here with permission.