Thank god for elections! With the 2022 midterms imminent, President Biden has decided to release more oil from the nation’s Strategic Petroleum Reserve to put downward pressure on gasoline prices. He’s no dummy, Biden. He has clearly made the connection between gas prices—still fairly high, at around $3.85 per gallon—and the electoral prospects of the incumbent party, which happens to be his own.
But another Biden move may be more important. The Energy Dept. plans to purchase oil to replenish the reserve at prices ranging from $67 to $72 per barrel and sign contracts with producers locking in the price two or three years in advance.
Normally, the government purchases oil for the reserve at market prices, timing the purchases so that taxpayers get a good deal. If it sells oil from the reserve when market prices are at $100 per barrel, for instance, and replenishes when market prices are at $50, the program operates at a nominal profit.
Government contracts for future purchases would set a kind of price floor for oil, letting producers know they’d be able to sell some oil to one buyer at a known price, even if the market price is lower. The government might end up overpaying, relative to the market price, but it could still buy at a lower price than it sold the barrels it is replacing. The Biden administration has been selling oil since May, with market prices ranging from $78 to $120. So replacing those barrels at around $70 would still be a bargain for taxpayers.
Why guarantee a fixed price? Up till now, oil producers have readily cranked up supply as prices rose, with no government assist needed. Producers would cash in as long as prices remained high, but the added supply often sent prices lower, which was a kind of a built-in corrective. But that dynamic has changed. Punishing oil-industry losses in 2020 and the move to renewables have made drillers and their investors a lot more cautious about adding capacity, especially if it costs a lot of money. Nobody wants to finance new infrastructure if the payback period is long and demand might dry up before the returns are in.
Tighter oil supplies and this new reluctance to add capacity explain a lot of this year’s spike in oil and gasoline prices. As prices have risen, U.S. drillers have very cautiously been producing more, with production inching up from a bottom in 2020. But the monthly pace of production growth is about 30% slower than it was from 2017 to 2020, when prices were far lower. That reflects the industrywide trend of returning profits to shareholders instead of plowing cash flow back into infrastructure. Drillers don’t really want to grow anymore, given the pressure on the industry to shrink.
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The Biden locked-in price is supposed to let producers know there will be at least one large purchaser willing to pay a set price that should allow them to earn a profit, even if market prices are low. “We think that’s an important signal for producers,” a senior Biden administration official told reporters on October 18. “The strategic petroleum reserve will be an important part of helping moderate price flows not only when prices are going high, but when prices are going low.”
That’s a fairly radical move for Biden, given that he came into office promising a green energy revolution and practically pledging to put the fossil fuel industry out of business. The Biden White House won’t spin it this way, but the price guarantees could let some oil producers sell to the government at $70 per barrel when the market price might be, say, $50 or $60. That’s because of the contracts locking in those prices two or three years in advance. So in the future, it might look like the government is overpaying, as a sop to the fossil fuel industry.
But the purpose is to encourage more production by removing some of the risk that added supplies will lower prices so much that drillers lose money. Energy historian Gregory Brew points out that U.S. oil producers can earn a profit at market prices ranging from $48 to $69, depending on location. The Biden team seems to have chosen price targets for contracted purchases that would allow mostly all U.S. producers to earn a profit. Under the new policy, the government could still purchase oil at market prices, and it could offer contracted prices below the $67 to $72 range if market conditions warranted that.
If drillers know they’ll able to sell at least some of their future product for a profit, they’re less likely to worry about overproduction and more likely to add capacity. Market prices could still be lower than what the government pays, and consumers would benefit from those lower prices, passed on to them through cheaper gasoline and other energy products.
This is a back-door subsidy to the fossil-fuel industry, which might send environmentalists into fits of rage. But the turbulent energy markets of 2022 have made very clear that most countries, including the United States, lack an effective bridging strategy to get to the point, decades from now, when there’s enough renewable energy to meet everybody’s needs. We have nowhere near enough renewable energy right now, and we’ll be very depending on fossil fuels for a long time. Private-sector energy firms are behaving rationally by shaving capacity and focusing on short-term profitability, given the longer-term threat to oil and gas. There’s a role for government when the private sector fails to meet the public need, which is what’s been happening this year.
Biden has also threatened to block U.S. firms from exporting oil and gas prices if domestic prices get too high, as a way of encouraging them to produce more and get U.S. prices down. A block on exports would probably be counterproductive. With foreign markets closed to them, U.S. drillers would probably produce less, which could end up raising domestic prices by even more. It’s a good bet Biden knows this and is bluffing about shutting off exports, allowing him to seem tough on the industry at the same time he’s offering a bit of stealthy aid. Biden is the bad cop; the Energy Dept. is the good cop.
The oil and gas industry is still unlikely to consider Biden a pal. Earlier this year, the American Petroleum Institute outlined a variety of things Biden could do to boost production and lower prices, such as speeding up permitting and allowing more drilling on land and in waters under federal control. Biden hasn’t followed any of that advice. Instead, he’s offering less-visible inducements that might work behind the scenes. The only thing he wants voters to notice is lower pump prices.
Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @rickjnewman
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