The Retired Investor: Time to Rebuild the Strategic Petroleum Reserve?

The nation's Strategic Petroleum Reserve (SRP) has been reduced by more than 25 percent over the last year. That is the lowest level in 40 years. Oil had dropped below $80 a barrel mark this week, causing some critics to argue that it might be time to start building the SRP back up. I disagree.

 

My reasoning centers on a handful of geopolitical events that could send oil prices soaring in the first week of December. To understand how important the SRP might be in that case, one needs to know more about the Biden administration's use of the SRP since 2021.

 

A year ago this month, on Nov. 23, 2021, President Joe Biden announced the release of oil from the Strategic Petroleum Reserve in response to the Ukraine/Russian conflict, which caused o and gas prices to explode higher. The president's stated goal was to lower oil and gas prices while addressing the lack of energy supply worldwide.

 

Since then, Biden's activist intervention in global oil markets has succeeded in reducing U.S. gas prices at the pump, as well as contributing to the decline in oil prices to their lowest level in more than a year. So far, 160 million barrels of oil have been released with another 10 million barrels scheduled to be drained this month. Some say that is more than enough. Maybe, maybe not.

 

To gain some perspective, let's look at the history of the SRP. It was first created by Congress back in 1975 in response to the 1973 oil crisis. For those who are curious, the nation's emergency crude oil is stored in underground salt caverns at four major storage facilities on the Gulf Coast, two sites in Texas, and two sites in Louisiana.

 

The purpose of the SRP was to manage market disruptions such as a war in the Middle East, an oil embargo, or a natural catastrophe. Our energy stockpile has been used by several presidents, most notably during the Iraq/Kuwait War in 1990-1991, Hurricane Katrina in 2005, and the 2011 Arab Spring energy disruptions. The Ukraine War and the subsequent sanctions on Russian-produced oil certainly fit the bill for use of the SRP and thus the release of oil from the U.S. emergency energy storage.

 

Criticism of President Biden's move to employ the SRP as an energy weapon has been harsh and varied. Some Republicans have called his decision reckless because it endangers our energy security at a time when there is so much global conflict and uncertainty. Others accuse him of a blatantly political move.

 

They say his use of the SRP before the midterm elections was simply a ploy to win over voters. If so, it worked. Gasoline prices dropped from more than $5 a gallon to $3.80 a gallon today. Voters may have also been swayed by the decline in pump prices since the GOP failed to score the "red wave" they were expecting. 

 

But to be fair, several presidents besides Biden have released oil from our stockpile during political campaigns. Bill Clinton, for example, did so just before the 2000 presidential campaign between Al Gore and George W. Bush.

 

However, this is the first time a president went on the record in admitting that he was using our petroleum reserves to reduce prices, rather than to bolster supplies. Most economists would laugh at that distinction, since ordinarily if you increase the supply of something, its price will decline over time.

 

To me, the Biden administration's activist interference in the global oil markets may just be the beginning. Until recently, the global price of oil has been in the hands of a few volatile foreign governments and OPEC. But a lot has changed in the American oil patch since the 1970s. The U.S. is now one of the leading producers of oil and gas and a major energy exporter. Pricing power comes with that kind of production.

 

The willingness of the U.S. government to enter the fray and become a price setter instead of a taker via the SRP could become a geopolitical tool and an answer to the OPEC+ Cartel's domination and control of energy prices and supply. The bottom line: by focusing on price, President Biden may be putting the price-fixing cartel of OPEC+, and Russia on notice that there is a new boy on the block.

 

I also believe that the administration's announced intention to start rebuilding the SRP somewhere between $67-$72 a barrel of oil is an attempt at establishing a floor of price support for oil. That may be comforting news to U.S. energy companies. If the oil majors and shale producers believe that the U.S. government is willing to backstop their business at a certain oil price, would that give them added confidence and an incentive to increase U.S. energy supplies? I think so, but now is not the time to start building back our oil reserves.

 

On Dec. 5, 2022, the Group of Seven (G7) and the European Union (EU) are planning to embargo Russian oil. In addition, a G7 plan, intended as an add-on to the EU embargo, would allow shipping services providers to help export Russian oil, but only at enforced lower prices. An embargo like that could take as much as 2.4 million barrels per day of Russian oil off the market. That could increase oil prices dramatically. There is also an added risk that Russia retaliates and cuts off energy supplies to Europe in response.

 

Oil analysts worry that these plans could backfire, at a time when seasonal energy demand is at its highest. OPEC is worried as well. They are rumored (officially denied) to be debating a 500,000 barrel per day increase in production just in case.

 

If the worse happens and oil prices skyrocket higher into the first quarter of 2023, what will be the U.S. response? Will the president stand fast, or will he be forced to order another 90-100 million barrels, of oil, or more to be drained from the SRP? I am betting he would be forced to release more barrels because the alternative could be $120 barrel oil in the months ahead.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.