Is the Strategic Petroleum Reserve our ace in the hole?

The Strategic Petroleum Reserve (SPR) is often touted as a vital asset in mitigating the adverse effects of oil supply disruptions on the economy. The importance of SPR, however, largely depends upon the effect of stock sales on market prices. To address this question, this study develops a

monthly econometric model of the world crude oil market. Inventories, consumption, production, and prices for crude oil are determined within a dominant producer pricing framework in which Saudi Arabia adjusts output based upon market demand and competitive fringe supply. The estimation results provide additional support for the dominant producer pricing model for world oil markets and reasonable estimates of short-run supply and demand elasticities. Several model simulations are conducted to assess the impacts of SPR policies. For example, the gradual build-up of the SPR by the Bush Administration resulted in a very small, almost imperceptible increase in world prices. Similarly, the Clinton sale from SPR had minor impacts on market prices. Another simulation indicates that while SPR sales can lower world prices during a supply shock, the required drawdown would be so substantial the reserve would be significantly depleted after just a few months. These findings suggest that once played, the SPR card has modest impacts on world prices and could be easily trumped by actions of other players, including output adjustments by world oil producers.

1. INTRODUCTION

"Gas prices are burning a hole in New Yorkers' wallets, putting at risk the economic recovery, and the Administration insists on throwing fuel on the fire. Instead of playing our one ace in the hole and releasing oil from the Strategic Petroleum Reserve to help cut prices, they are buying oil on the market and driving up prices even higher,"

--US Senator Charles E. Schumer, May 19, 2004

Senator Schumer's statement suggests that the Strategic Petroleum Reserve (SPR) can be used to significantly affect world oil prices. In fact during late 2000, the Clinton Administration did exactly what the Senator wanted and released nearly 30 million barrels of oil from the SPR. How much did this stock sale reduce prices? The Senator correctly points out that the Bush Administration decided to expand the size of the SPR, increasing it from 550 million barrels in late 2001 to over 690 million barrels in early 2005. Did this stock build "throw fuel on the fire," by contributing to higher prices as the Senator claims and, if so, by how much? To address these questions, a framework is needed of how SPR stock changes affect world oil supply and demand. In developing such a framework, market structure is a central question.