Should we Prepare for Oil Price Spikes Ahead?

This graph shows the development of oil prices...
Oil Prices (Brent) over 10 years in Dollars and Euros via Wikipedia

Now that the Obama Administration and the International Energy Agency have teamed up to release 60 million barrels of oil from strategic reserves in a politically timed move to drive down oil prices what should we anticipate the reaction and counter reaction to those moves will be?

Short Term Gain, Long Term Pain?

If the politicians wanted a ‘feel good’ press release experience from their action they got it as global oil prices fell 5.5% the first day but by the second day they had begun to creep back up slightly as the markets digested the true significance of the action and speculated on what it meant for the future.

To put the action taken in context, the 30 million barrel release from the U.S. strategic petroleum reserve (SPR) is about 4% of total reserve but those reserve levels are high with 727 millions barrels of oil on hand.  So President Obama had the reserve capacity to take this action but needed to decide whether the big bang short term impact of releasing the reserves to bring down prices was worth the risk of a big bang counter reaction that might pike oil prices even higher at a future time.

The calculus for the Europeans is about the same since the IEA’s 30 million barrel release represents about 5% over total reserves, but the IEA has made unexpected oil releases in the past and on three separate occasions the result was a counter reaction of higher oil price spikes down the road.

The question is ‘do you feel lucky’?

For economists and corporate executives these are long term strategy decisions, but for politicians these are short-term choices revolving largely around when the next election will be, what bad can happen between now and then, and how can to divert accountability for this problem to others. For consumers the result is often higher retail prices since the typical market action for falling wholesale prices is to reduce prices slowly while wholesale price spikes result in rapidly increasing retail price response.

The Europeans have a more legitimate short term worry from the disruption of Libyan oil but cheating on production quotas is historically common among OPEC and non-OPEC market participants.  Given relatively weak demand due to the weak recovery the short-term disruption seemed manageable.  The EU could actually improve that situation if it got off its hands to step-up action by NATO to unseat Col Gaddafi rather than dither and drag out the conflict.  But cheating alone by oil producers will likely be enough as oil prices stay high or creep higher.

Higher Risk of Oil Price Spikes

The bottom line for politicians responsible for this strategic petroleum release action is not likely to be very satisfying.  Oil prices will not go down measurably at the gas pump or stay down long enough to improve consumer confidence or make a positive impact on the economy.  But price volatility will increase and the risk of even higher prices from worry and speculation about the impact of future supply disruptions given smaller reserves could actually make things worse.

Back to consumer confidence for a minute, the lack of confidence is one of the biggest factors in holding down growth.  It is caused by uncertainty about the policies being used by politicians and their impact on business and job creation.  In the US, the huge federal deficit, the huge uncertainty over health care policy and costs, the threat of higher taxes, higher inflation and more regulation in financial, investment, environmental and employment areas is causing business to hoard cash and hunker down.  It is discouraging consumers fearful for their jobs, with houses with negative equity as home prices fall, and fear of loss of health insurance and of rising inflation starting with those gasoline prices.

If politicians want economic growth and improved consumer confidence they must deal with these uncertainties in real and constructive ways to unleash investment, encourage consumer spending and stabilize housing prices.  Political stunts like the SPR release avoid the real problems and add even more uncertainty and volatility in an already nervous market environment. It is both economic and political malpractice.

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