How US strategic oil reserve might fill Iran gap

How to hit Iran hard and, at the same time, avoid a rally in oil prices?

The question is keeping western policymakers awake because it seems impossible to achieve the first without triggering the second.

The new US and European Union sanctions targeting Tehran’s oil exports would surely hit the country’s economy and, conceivably, force a change of course over its nuclear programme. But they are also likely to push oil prices up, hurting the west.

Philip K. Verleger, a veteran oil economist and a visiting fellow at the Peterson Institute for International Economics, has proposed an imaginative – and most likely controversial – solution to the problem: Washington should release a significant chunk of its strategic petroleum reserve (SPR) because, according to his estimate, it is holding much more oil than is necessary.

The US, along with many European countries, Japan, South Korea and a few other industrialised nations, has a large strategic petroleum reserve to meet supply interruptions. The reserve, built in the 1970s, has been used three times: during the 1990-91 Gulf war, in 2005 after hurricane Katrina struck the oil-rich Gulf of Mexico and last summer during the war in Libya.

Under an international treaty signed in 1974 the US needs to maintain a certain amount of crude oil reserves. But as domestic consumption plunges and production surges, the requirement under the treaty has fallen.

In a paper circulating in policymaking circles in Washington, Mr Verleger estimates that only five years ago the US reserve barely met the minimum level required. But today, the stockpile, at 690m barrels, is roughly 280m barrels too big.

The international treaty obliges the US to hold enough crude to meet 90 days of imports, but he estimates that the US stocks cover in reality 173 days of net imports.

“This oil could be sold as surplus government property, just as the US has disposed of surplus stocks of other commodities in the past,” Mr Verleger argues.

The sale of the 280m barrels surplus over, say, one year will provide nearly 770,000 b/d, more than enough to compensate for the impact of the sanctions against Iran and provide a cushion to European and other nations to seek alternative supplies.

“This strategic use of our SPR will increase the effectiveness of sanctions on Iran and ease the adjustment difficulties that confront our allies.”

The proposal is not without its problems. Reducing the size of the SPR, for example, would leave the US more exposed to a supply interruption in the future.

Also, selling the reserve down would only help smooth the impact of the sanctions if Iran does not shut the Strait of Hormuz. Amounts released from the reserve would not be able to cover the shortage if Iran retaliated by closing the body of water through which one-third of the world’s seaborne oil trade passes.

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Copyright The Financial Times Limited 2012.