Bush Weighs Critical Decision on Oil Reserves

Two thousand feet below the Texas and Louisiana Gulf Coast, the U.S. government is building a stockpile of crude oil already large enough to make up about three years’ worth of lost imports from Iraq.

Now, as President Bush prepares for a possible military offensive to oust Saddam Hussein, he faces a critical decision that jinxed his father’s administration: Should he keep the emergency oil in the ground until supplies run short? Or should he open the tap immediately to keep prices from soaring and the economy from sinking?

“It’s hugely, hugely important,” said Adam Sieminski, global oil strategist for Deutsche Bank in London. “It could be the difference between $80 oil and $30 oil.”

Bush’s father waited until six months after Iraq invaded Kuwait in August 1990 to declare his intention to utilize the Strategic Petroleum Reserve. By that time, oil prices had doubled and the economy was headed for recession.

Although the current Bush administration has stepped up deliveries of crude oil into the reserve’s underground salt caverns, industry analysts say oil markets might panic if war began without an immediate and unequivocal pledge to draw down the reserves.

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Unresolved Debate

Their concern reflects an unresolved policy debate dating back to the energy crises of the 1970s. One camp says the government should wait for clear evidence of a supply shortfall before turning to the strategic reserve. The other argues that Washington should act preemptively so that oil traders won’t send prices through the roof and consumer confidence into the cellar.

Energy Secretary Spencer Abraham has indicated the administration would prefer to hold off in the absence of a “major supply disruption.”

The head of the International Energy Agency, the Paris-based organization established in 1974 to coordinate the energy policies of the United States and other industrialized nations, has endorsed a similar approach.

If the outbreak of war cuts off Iraq’s oil exports, which have been averaging about 1 1/2-million barrels a day, IEA Executive Director Robert J. Priddle said he would like to give other OPEC oil producers an opportunity to honor recent promises to make up the difference.

“We would prefer not to intervene in the market. If the suppliers can meet the needs of their customers, we’d like to leave them to do that,” Priddle said. “If for any reason that didn’t happen, or if the market wasn’t sufficiently reassured by what they heard, we have the capacity to make ... much more than 1 1/2 million barrels per day, and we can do it fast.”

The capacity to act is clearly there. The International Energy Agency’s 26 member nations, including the U.S., hold 1.3-billion barrels of oil in strategic reserves, in addition to 2.6 billion barrels of crude oil and refined products held by private oil companies. That’s equivalent to 114 days of oil imports, Priddle said.

The 26 countries could draw as much as 10-million barrels of crude oil a day from strategic reserves for a month or so, with maximum output gradually declining as more and more tanks were drained.

The organization says the current stockpile would have been sufficient to cover the worst supply shortfall in history: the six-month, 5.6-million-barrel decline in daily production during the Iranian revolution of 1978-79.

Equally important, Priddle said, is the improving relationship between IEA countries and OPEC oil producers, particularly Saudi Arabia. When the IEA was formed in response to the Arab oil embargo, the atmosphere was highly confrontational. Now, Priddle can pick up the phone and talk supply with the Saudi oil minister.

The 10 members of OPEC besides Iraq have enough spare capacity to boost production by as much as 4.9-million barrels a day, far more than Iraq currently exports, and Priddle said officials in Saudi Arabia and other OPEC members have promised to make up any lost output.

The United States, meanwhile, can take unilateral advantage of its own strategic reserve. After the Sept. 11 attacks, Bush announced plans to increase reserves from about 550-million barrels to its maximum capacity of 700-million barrels by 2005.

The reserve now holds a record 595-million barrels. That’s enough oil to cover about 1,200 days of lost imports from Iraq, or 66 days of total U.S. imports. The reserve could be drawn down at a maximum rate of 4.1 million barrels a day for three months; so far this year, U.S. imports of Iraqi oil have averaged 483,000 barrels a day.

One senior administration official, speaking on condition of anonymity, declined to speculate on possible war scenarios but said that as for tapping the reserve in an emergency, “we’ve ruled nothing out.”

The official said, however, that the Bush administration is opposed to using strategic oil reserves to manipulate market prices in the absence of a significant shortage, as the Clinton administration did two years ago in response to complaints about rising fuel oil prices.

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Decisive Action

In the view of some experts, it’s not just the number of barrels in the ground that will matter if the United States launches a military offensive in Iraq. It’s also the willingness to act immediately and decisively to avert a supply shortfall.

Sieminski said the president should announce a drawdown at the same time he tells Americans that U.S. troops are on their way to Baghdad. “The futures markets are not going to wait for reassurances from the kingdom of Saudi Arabia or OPEC or President Bush or Robert Priddle,” Sieminski said.

“They debated this for six months in 1990,” he added. “We know that waiting six months was a bad idea. So is waiting six days any better? Or should you give it about six hours?”

America’s strategic stockpile may be fuller than ever, but the nation’s import habit has increased too, and global inventories are at historically low levels, Newport Beach energy economist Philip K. Verleger Jr. said. It wouldn’t take much, he said, to spook oil traders into bidding up the price first and asking questions later.

“It’s a psychological effect,” Verleger said. “Because stocks today are so very low, if there’s a problem and governments don’t respond immediately, it could be catastrophic. Once the price starts to escalate, trade freezes, and then it takes a much bigger response to stop something.”

Many economists say the doubling of oil prices to about $40 a barrel after Iraq’s Aug. 2, 1990, invasion of Kuwait helped push the U.S. economy into recession -- a downturn that may have cost the elder Bush his job. When the U.S. and other IEA nations finally announced plans to tap strategic reserves on Jan. 17, 1991, the price dropped $10 a barrel overnight.

One reason for the delay was reluctance by some presidential advisors to intervene in the marketplace, even though the crisis had reduced world oil production by 4.3 million barrels a day.

Robert E. Ebel, energy program director at the Center for Strategic and International Studies, said he thinks the United States and other IEA nations learned from that experience and are unlikely to repeat it. “We always want to act in concert with our friends and allies,” he said. “They were a little reluctant 10 years ago to take that step. I think they’re ready now.”

Still, there’s a fine line between prudent reserve policy and counterproductive price manipulation, which can reduce the incentive for oil companies to hold their own inventories.

“Looking backward with 20-20 hindsight, it’s easy to say that Bush did too little too late in 1990,” said Ed Porter, research manager at the American Petroleum Institute in Washington. “But it’s very hard in the midst of a developing crisis to try to do something preemptively.”