NCPA - National Center for Policy Analysis

SOCIALIZED OIL CAN'T REPLACE MARKET SENSE

December 14, 2007

To many Americans, the proposal to raise money by selling the U.S. Strategic Petroleum Reserve (SPR) to private enterprises may sound a bit like saving money on premiums by canceling a life insurance policy. Yet this type of thinking overlooks the market's ability to anticipate future supply needs, says Robert P. Murphy, senior fellow with the Pacific Research Institute.

To see how all this works, suppose there were no government-run SPR and that tensions with Iran suddenly escalated:

  • Analysts would forecast huge spikes in the spot price of oil in the event of military strikes; depending on the likelihood of this happening, prices on oil futures as well as more exotic derivatives would constantly adjust with every development in the standoff.
  • Investment banks issuing call option contracts would hedge themselves by buying oil futures, raising the "futures price" of oil.
  • This in turn would cause oil producers to slow current output, as they devoted more of their reserves to futures contracts rather than the spot market.
  • At the same time, those most pessimistic about the geopolitical future would literally stockpile barrels of oil, anticipating massive price spikes if and when oil from the Middle East stopped flowing.

All of these factors would contribute to a jump in the current spot price of oil, leading consumers to economize on current use, says Murphy.  In short, everyone would behave exactly as we would want them to.

Private analysts and professional investors -- with their own money on the line -- would do a much better job forecasting possible supply interruptions.  So long as the government stays out of the way, and doesn't threaten "windfall profits taxes" on those who prepare for another OPEC embargo, the feds don't need to take on yet another expensive job they will inevitably bungle, says Murphy.

Source: Robert P. Murphy, "Socialized Oil Can't Replace Market Sense," Investor's Business Daily, December 13, 2007.

 

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