On June 23, the Obama administration, in conjunction with other governments, announced a plan to release a total of 60 million barrels of oil from strategic oil reserves in the U.S. and other countries, at a rate of 2 million barrels per day for 30 days.
That day, oil prices dropped by more than 4 percent. But within a week they had returned to pre-announcement levels, and by July 12 the price of crude was about $2 per barrel higher than it had been on June 22, the day before Obamas announcement.
Its notoriously difficult to determine the actual results of an economic policy change, because there are so many moving parts. After all, perhaps the price of oil would have risen even faster had governments done nothing. Yet economic theory provides insight into why the SPR release apparently failed to hold down oil prices.
First, we need to consider the perspective of the owners of large deposits of oil, such as the Saudis. If they extract and sell more oil today, the benefit is higher revenues today. Yet for every barrel pumped and sold today, there is one fewer barrel available for sale in the future. So when deciding how many barrels to sell in the current period, the owners must make forecasts about the future market price of oil. When the current price is below the expected future price (after taking interest rates into account), owners make more money by slowing down current output and deferring sales into the future.
In this context, consider what happens when Obama and other leaders announce that an additional 60 million barrels will hit the market. Other things equal, this additional supply will push down the current price of oil. The change will give other producers an incentive to cut their own sales, deferring them to future months when they wont have to compete with the SPR release. Once the market had adjusted to the news, the price changes would be smoothed out, leaving little net effect from the policy, as we apparently just witnessed.
In contrast, suppose Obama had announced his administration would do everything in its power to expedite the development of domestic oil and natural gas resources, such as those in the Arctic National Wildlife Refuge (ANWR) and the Outer Continental Shelf (OCS). According to government estimates, the 1002 Area of ANWR contains 10.4 billion barrels of recoverable crude, while the OCS has 59 billion barrels of recoverable crude. Combined, this represents a reserve more than 96 times the size of the SPR.
A policy shift in favor of domestic production would lead to an immediate reduction in the price of oil. Producers with excess capacity, such as Saudi Arabia, would realize that the enhanced American production would eventually reduce the world price of oil. Consequently, the Saudis would tweak their own output in order to sell more oil in the near term, while prices were still relatively high. The net result would be lower prices right away, even though the ANWR and OCS production might take years to hit the market.
These conclusions are grounded in experience. The price of oil fell $9 during President George W. Bushs July 2008 speech announcing the end of the executive branchs moratorium on offshore drilling. Oil speculators can push prices up and down, depending on their interpretation of new information.
Obama and other world leaders are correct that increased oil supply is the solution to high gas prices. Yet opening up the vast reserves in offshore and ANWR deposits is a more sensible approach than raiding the limited SPR.