As most Americans have noticed while filling up their cars, oil prices are on the rise again. Gas prices at U.S. pumps increased 42 cents (13 percent) over the past month and the average gasoline price is 77 cents (28 percent) higher than it was a year ago, according to the U.S. Energy Information Administration (EIA). The rise in oil prices is due in large part to speculation that unrest in the Middle East will negatively affect global oil production rates and supply lines. On January 25, the day before Egyptians initiated protests in downtown Cairo, the average price for a gallon of gas in the United States was $3.11. The price has since risen steadily, to $3.56 as of March 14.
U.S. households consume relatively similar amounts of gasoline regardless of income level, so when the price of oil changes significantly, lower-income residents feel a significantly heavier burden than those with higher incomes. As of March 9, the EIA projected gas prices to hit $3.71 at U.S. pumps during peak summer demand. If this projection proves accurate, the oil price increase in 2011 is expected to cost U.S. families an extra $700 by the end of the year (assuming an average driving distance of 20,251 miles at a fuel economy of 22.6 miles per gallon). Already, policymakers are weighing what the federal government can do to remove some of the pain that middle- and lower-income families may feel at the pump.
Enter the Strategic Petroleum Reserve…
One policy debate picking up traction in Congress is whether or not to release oil from the Strategic Petroleum Reserve (SPR). After the 1973 oil embargo caused a severe disruption to U.S. supplies, the federal government passed the Energy Policy and Conservation Act of 1975, which included a provision to build a strategic reserve that would stock upward of 1 billion barrels of crude oil. The intention was to help prevent an economic collapse in the event of a national energy emergency, and the SPR has since been tapped for emergency sales during Desert Storm in the early 1990s and in the aftermath of Hurricane Katrina in 2005. But precedence has also been set for tapping the SPR during a non-emergency situation: in 1996-7, oil sales were used to to raise funds for reducing the federal deficit.
Proponents make the case that lowering oil prices will help maintain the tentative economic recovery and prevent unemployment from increasing. Democratic Senators Chuck Schumer (NY), Robert Menendez (NJ), Dick Durbin (IL), and Jeff Bingaman (NM) are among those who have voiced support for tapping the reserve. In a sense, tapping the SPR would be treated like issuing an economic stimulus package while bringing in billions of dollars for the federal government.
Undoubtedly, the reserve has proved to be a good investment strictly from a financial standpoint. The federal government has spent $5 billion to build the facilities needed to stock 727 million barrels of crude oil, which it bought for $17 billion. This works out to roughly $30 of investment per barrel, meaning that the government would make a sizable return by selling the crude on a market where oil is currently priced above $100 per barrel.
Critics, however, argue that higher oil prices do not constitute a national energy emergency and that the reserve should remain intact to help protect the United States from future global economic shocks. There is also skepticism about how much tapping the reserve today would really affect U.S. market prices when oil is sold on a global market that is still fundamentally sound. Saudi Arabia alone has enough spare capacity to offset Libyan production, and even though Americans would likely feel some relief from tapping the SPR, oil suppliers worldwide can simply shift their supply lines to other markets that pay higher prices.
As long as the market fundamentals are working correctly and people act rationally, there should be no reason for the federal government to intervene directly in the market. Higher prices will attract further investment in finding and extracting more oil around the world to boost supply.
Whether the U.S. government should be leasing more permits for domestic drilling, and whether these permits will actually be used, are separate questions that demand careful reflection. The United States is currently the world’s third largest producer of oil with the 12th largest proven reserves. Given that the U.S. reserve -to-production (R/P) ratio, at eight years, is the lowest of the 17 countries with the largest proven reserves, engaging in further drilling to secure a cheap energy supply will likely be a short-lived option for the U.S.
On the demand side, higher oil prices will encourage investment in alternative energy sources and more efficient energy infrastructure. This is an area where national energy policy can make a lasting difference. Rather than try to stimulating already-mature markets, the government should help establish new energy and transportation markets by doing what businesses and individuals alone cannot do: funding basic research, supporting high-risk (and high-reward) applied research and demonstration projects, attracting and retaining advanced manufacturing plants for new energy technologies, and facilitating consumer demand for these new technologies. While the task of coordinating such strategies is multi-dimensional and daunting, the U.S. government is best equipped to fulfill the role of establishing an environment within which markets can succeed.