Increasing the Supply of Oil Won't Decrease Gas Prices in America

In my previous PolicyMic post, I examined some of the factors that help determine crude oil prices, which rise and fall in rough approximation with the price of gasoline. When these prices rise precipitously, it is almost a certainty that in the U.S., the opposition party will blame the president; or at least call upon him to enact measures to alleviate the situation. A recurring plea is for the president tap the nation’s strategic petroleum reserves. The hope is that an increase in supply will result in a decrease in price.

To see how well this strategy works, recall the last time the strategic reserves were tapped — all the way back on June 23, 2011. Obama announced the release of 30 million barrels of oil from the nation’s reserves, in conjunction with another 30 million tapped by the International Energy Agency. This move was widely panned among financial experts as unnecessary, with one oil analyst noting, “There’s been weakness of demand and I don’t see what the release of 60 million barrels of oil adds to the market.” 

The timing was indeed curious, as the price of a barrel of the benchmark West Texas Intermediate (WTI) crude had already fallen from $115 in early May to $95 in late June. Reaction to the announcement in the oil markets was predictable, as WTI fell further for three straight days before reversing course all the way back up to $100 in late July. Thus, just one month after tapping the strategic reserves, the price of WTI was actually $5 higher.

Still others insist that the answer to rising oil and gas prices is to expand onshore and offshore drilling. Some Americans seem to think that if only the U.S. produced more oil, the increase in supply would yield cheaper oil and gasoline prices. However, because crude oil is traded on international exchanges, domestic supply and demand cannot be considered in isolation from global context. For example, an OPEC embargo would not only affect the price of oil exported from those countries, but all oil, including WTI, which is as beholden to global macroeconomic developments as any other brand. Put simply, the amount of crude oil extracted from new drilling in the U.S. would have to be so substantial as to significantly impact crude supplies globally, not just domestically. The prospects for this scenario are not promising. According to a 2009 report by U.S. Energy Information Administration, expanding offshore drilling would shave off a mere three cents per gallon of gasoline by the year 2030.   

Some commentators like to point out that when George W. Bush lifted the ban on offshore drilling in July 2008, the price of oil subsequently plummeted from a record high of $147 per barrel to $33 by January 2009. In reality, the collapse in oil prices was due to a severely overbought market, and the growing sense that something was horribly amiss in the financial services sector after the bursting of the real estate bubble. As 2008 proceeded and the direness of the economic picture became clearer, asset prices around the world fell as investors correctly anticipated a global credit squeeze and a contracting economy. 

Since hitting that bottom of $33, oil stands at $107 as of this writing. Much of that has to do with the plain fact that the economy is in better shape than it was in 2008. As was pointed out in the last piece, economic growth tends to yield higher oil prices. Another factor, however, is the policies of the Federal Reserve under the last two presidential administrations. Two rounds of quantitative easing coupled with zero interest rate policies have helped fuel this three year-long climb in asset prices across the board. For that story, stay tuned for part three.

Photo Credit: WHO 2003