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John Manfreda

John Manfreda

John majored in Pre-Law at Frosburg State Universtiy and received his MBA at Trinity University. He has co-authored The Petro Profit report and dividend stock…

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Does Selling Oil From The Strategic Petroleum Reserve Make Sense?

Does Selling Oil From The Strategic Petroleum Reserve Make Sense?

Recently, some members of Congress have made a proposal for the government to sell 101 million barrels of oil from the Strategic Petroleum reserves (SPR), as a means of raising $9 billion dollars so the country’s highway trust fund could be funded over the next three years.

This sale would take place in the 2018-2025 timeframe. There are several reasons this proposal does not make sense. But before we discuss why, one first has to know why the SPR came into existence.

How the SPR Was Founded

The idea of the government stockpiling oil reserves was first proposed after the Suez crisis of 1956. President Eisenhower suggested that the U.S. should purchase lower cost foreign oil, and then store it in exhausted wells. Many believe that this idea came to him because of what he experienced during World War II when General Patton ran out of gas, and Eisenhower had to overcome the challenge of allocating supplies between a furious Patton, and an inflexible Montgomery.

Related Lack Of Alternatives Sees EU Sign New Russian Gas Deals

Eisenhower thought that a stockpile might not improve the domestic health of the U.S. oil industry, but it would at least ease some of his national security concerns. But, Eisenhower couldn’t garner any support for this idea, and the special committee formed to evaluate the idea of a government stockpile concluded that this idea was impractical. (For more of this history, see The Prize, by Daniel Yergin).

Even though Eisenhower’s idea was viewed as impractical in the 1950s, his idea was vindicated in the 1970s. This vindication came in form of an OPEC oil embargo in 1973-74, when OPEC refused to sell oil to the U.S. and its allies. This embargo prompted the U.S. government to create a strategic reserve stockpile in 1975, so it could combat potential oil shortages, and provide the U.S. military with fuel, if its supply chain was disrupted.

But like all government programs, revenue taxes, or material stock piles, their use always gradually drifts away from its intended purpose; and the SPR isn’t any different. Despite the obvious reason the SPR was created, if you look back on its past sales, it is quite obvious that the SPR is now being used for purposes other than those intended.

In 1996-97 there was a non-emergency sale. In 2011, there was another market sale of 60 million barrels ostensibly to make up for lost supply coming from Libya. While that sounds valid on the surface, the details don’t support the premise. In terms of supply, increases in production from Saudi Arabia already made up for the loss of crude coming out of Libya. In fact, there are people who believe that the 2011 SPR sale was done to scare speculators from going long in the oil market, thus decreasing the price of oil. Related: The Biggest Red Herring In U.S. Shale

The truth may be difficult to pinpoint, but the mere fact that the justification was murky points to a growing detachment from the SPR’s core mission of meeting national security needs.

Should the SPR be used to fund the Highway Trust Fund

With that historical context in mind, the latest proposals in Congress seem foolhardy for a couple of reasons.

First, such a move would essentially end a core piece of American energy policy that has been around for decades. Congress is no longer even trying to pretend that SPR sales are related to national security. The SPR was formed for emergency purposes only, and treating it like a piggy bank to fund highway construction undermines that policy.

The second reason relates to U.S. treasury solvency. Currently, out total debt is greater than our GDP, and this metric doesn’t include the future off balance sheet liabilities of the U.S. government. Generally when it comes to economic stats, government economic statistics are overstated, and government balance sheet liabilities are understated. This means that the GDP is smaller than what we are told, and the debt is larger than what is being reported. The U.S. simply can’t afford to keep living beyond its means and elevated transportation spending could make the problem worse. If the government doesn’t have the money to fund highway transit, then maybe it shouldn’t.

A third reason to not sell the SPR is because of where oil markets might be heading. Currently, the price of oil is trading near around $45 dollars per barrel, after having touched six-year lows last month.

(Click to enlarge)

With so much of the U.S. oil industry unable to breakeven at these prices (see chart), tapping into the SPR could depress oil prices even further, and could exacerbate the current problems in the U.S. energy sector. The oil markets are in the process of adjusting, and an SPR sale would distort and delay that balance. Related: Two Big Oil And Gas Finds In Unexpected Places

What this means for future oil prices

Governments have a historical track record of selling assets at the bottom of the price cycle, and purchase materials at the top of the price cycle. Government sales of SPR came in 1996-97, which was a cycle low. Gordon Brown, the Prime Minister of England sold 400 tonnes of gold in the years 1999-2002 which was a cycle low for gold, and in 2007-2008, the U.S. government made a large purchase to fill the SPR with a mix of sweet and sour crudes of oil (see Petromania, Daniel O’Sullivan, P.105). And now they are talking about selling oil when it is trading at multi year lows.

Based on the history of government material purchases and sales, governments generally buy at the top of the market and sell at the bottom. This is why I believe as an investor, this event is a sign that a bottoming out process is currently taking place within the oil market, and in the next couple of years, higher oil prices will return.

By John Manfreda for Oilprice.com

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Leave a comment
  • David Hrivnak on September 09 2015 said:
    No! Not sure how one could be more clear as the need is still there.
  • Lee James on September 09 2015 said:
    Let's see, if we sell from our strategic oil reserve, we get to buy high and sell low!
  • drew2 on September 09 2015 said:
    First of all the SPR was primarily created to offset a decrease in supply whether it be by OPEC cutting production, or whatever. It really wasnt created for military use even though that was a side effect. So this was setup because we depended so much on foreign oil so they would fill it while it was cheap and then use it if they ever got cut off again. At least for now, it is not relevant. We can produce enough oil to supply ourselves now in a quick hurry if something happens. So the SPR is less relevant. That being said it is always good to keep some in storage in my opinion. But to release some is not a big deal either. I have no problem with releasing enough to punish speculators. Those are the people driving up the prices when we are awash in oil. So I dont totally agree with the guy in this article, but when he starts talking about the debt and GDP, I couldnt agree more. lets dont do what we cant afford.
  • RJS on September 15 2015 said:
    Same song, different day. Wonder what they will really do with the money from the sale of SPR??

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