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Manipulating the strategic oil reserve? <http://www.sfgate.com/cgi-bin/article.cgi?file=/chronicle/archive/2007/01/30/EDGCCNR5HA1.DTL>
- Thomas I. Palley Tuesday, January 30, 2007
Last year was the year that oil prices came close to breaching $80 per barrel. This was despite the fact that there were no significant supply interruptions and oil demand fell in industrialized countries. That raises the question of what caused the spike.
It turns out there is good reason to believe that record oil prices may have been due to our own strategic oil reserve, which the Bush administration may have been manipulating to drive up prices for the benefit of its supporters. This is something Congress must investigate, and here is some preliminary evidence.
Any finding of manipulation would be economic treason. When global oil prices increase, Americans must pay more for imported oil. That increases the U.S. trade deficit. Alternatively, one can think of price manipulation as the equivalent of a tax increase on American families paid to foreign governments.
While some energy scandals in the Department of the Interior are already under investigation by Congress, the big enchilada is the strategic oil reserve. The key to understanding any manipulation is demand and supply and oil storage capacity.
The last three years have seen rapidly rising oil prices, and a tight oil market has meant that even small increases in demand may have had large price impacts. During this period, the Bush administration purposely expanded inventories of the strategic oil reserve, which rose from 600 million barrels in May 2003 to 700 million barrels in August 2005.
The administration therefore increased demand by 125,000 barrels per day, and oil prices rose from $30 dollars per barrel to $70 dollars in that same time period.
As oil prices rose, Wall Street became increasingly engaged in commodity speculation, and this is where storage matters. As speculators entered the market, the spot price of crude oil rose significantly above the futures price in late 2003.
However, buying spot oil means taking delivery, which requires storage capacity. By adding to the strategic reserve, the administration not only increased oil demand but also increased storage capacity because the oil it bought was stored in the strategic reserve's caverns. That helped speculators by adding storage capacity vital for cornering the market.
Over the past month, spot crude oil prices have been tumbling. The reason is that the market has run out of storage capacity, which means that all oil produced must now be immediately sold -- and that has driven oil prices down. This suggests there has never been a supply shortage warranting $75 oil, and absent the administration's dealings, oil prices might not have risen as high as they did.
The story does not end here. With private-sector oil storage capacity exhausted, the president in his State of the Union address has now announced his intention to double the size of the strategic oil reserve from 700 million barrels to 1.5 billion barrels. The Bush administration plans to start purchasing 100,000 barrels of oil per day.
The result has been predictable, with the futures price of oil jumping from $50 to $54 per barrel between Jan. 19 and Jan. 24. Not only will these government purchases increase oil demand, they will also provide new storage capacity needed to re-corner the market.
One last piece of evidence concerns Hurricane Katrina and the oil loan program. Following Katrina, Gulf of Mexico oil production was interrupted, causing shortages of crude for refineries. The administration's response was to loan crude to refiners who were to pay it back in-kind. That was a huge gift to refiners, who got the oil they wanted and then made a killing on the processed gasoline that was in short supply after Katrina. The proper way to handle the situation would have been to auction the oil, in which case taxpayers would have got the windfall disaster rent (excess profit) resulting from Katrina. This is because refiners would have been willing to pay a high price knowing that gas prices were high.
If government had auctioned the oil, it could have chosen when to buy it back. Instead, companies paid it back in-kind in late 2005 and early 2006, and these repayments tightened market demand and also freed up private storage capacity, thus facilitating further cornering of the market.
Every price blip in the oil market calls forth explanations in terms of Chinese demand, more violence in Nigeria's delta region, cold weather, threats from Venezuela's president, Hugo Chavez, or heightened tensions over Iran's nuclear program. The strategic reserve is the perfect vehicle for subterfuge corruption because its transactions can be cloaked in the veil of national defense. But a motive exists and the circumstantial evidence is troubling.
Congress must investigate the strategic oil reserve; how it has been managed and what its purpose is. The recently announced expansion serves no real national security function (though that will be the justification) and will only drive up oil prices.
One last factoid. A recent working paper posted by the International Monetary Fund documented that oil prices in the United States appear to be politically manipulated, falling prior to elections. If you are an economist, you ask how that is done. The answer is the strategic oil reserve.
Thomas I. Palley, an economist, runs the Economics for Democratic and Open Societies Project (www.thomaspalley.com <http://www.thomaspalley.com>).
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