Releasing Oil from Reserves—Posner

Becker is right to emphasize the role of demand and supply elasticities (how price responds to changes in demand and supply) in the startling fluctuations in the price of oil and oil derivatives such as gasoline, to deemphasize the role of speculation in those fluctuations, and to point out the social utility of speculation. 

If the responsiveness of supply to an increase in demand is sluggish, price will rise steeply in the short run, to ration the limited supply among the clamoring demanders—and it will rise especially cheaply if the demanders would rather pay a high price than do without. If demand falls, price will plummet if supply is sluggish, because supply will not fall proportionately to demand—there will be oversupply. An exogenous increase in supply will cause price to drop sharply because inelastic demand implies that price must fall very far to attract purchasers for the additional demand, and thus clear the market. Increased demand or reduced supply will also have sharp effect, though in the opposite direction. So the dramatic fluctuations in oil prices that Becker documents do not require the assumption of nefarious activities by speculators. 

And, as Becker also points out, those activities are not, in general, nefarious. Without speculation, the only information about values would be supplied by the actions of suppliers and consumers and others in the chain of distribution from producer to ultimate consumer. With speculation, information is often supplied by persons and firms that buy or sell on the basis of their opinion of how prices will change. 

Yet speculators can destabilize markets. Speculators are interested in price changes, and know that price changes are driven in part by other speculators. In an asset-price bubble, speculators (and others) buy in the expectation of rising prices, and may believe that the asset is actually overpriced yet they keep buying because they think that other market participants believe (erroneously) that it is still underprice. 

The decision of the United States and other countries that have governmental oil reserves to release a total of 60 million barrels of oil (half of it from the Strategic Petroleum Reserve, which is what the U.S. government’s reserve supply of oil is called) could be a shrewd speculation on oil being overvalued. If it is overvalued, prices will fall, so by selling now the countries will receive more income than if they waited. The sale itself, by increasing supply, will reduce the price of oil; these countries are net importers of oil and so would benefit from lower oil prices. 

But this is implausible; there is no reason to think oil overvalued. The current high prices reflects the loss of about a million barrels a day of Libyan oil because of the civil war in that country. The reduction is small as a percentage of world output, but the low elasticity of supply enables a small reduction in supply to have a big impact on price. By the same token, the modest release from the reserve—two million barrels a day for 30 days—may have a dramatic though short-term effect on oil prices, an effect that would be extended if we and other countries continued to release reserves. Our Strategic Petroleum Reserve contains more than 700 million barrels, so we could release a million barrels a day for a year and still have almost half the current reserves. 

But what is the point of reducing our reserves? They have after all value as a hedge against catastrophic hits to oil supply, such as were caused by Hurricane Katrina and the BP Gulf of Mexico mishap. One possibility is that it is another short-term stimulus measure, such as “cash for clunkers” and the various mortgage-relief programs. The effects of these measures is slight, because businesses and consumers realize that they are short term and so merely alter the timing of purchases rather than increasing aggregate spending. But with the 2012 elections approaching, the Administration has an incentive to create even short-term bursts of prosperity. Consumers are extremely conscious of gas prices because of the frequency with which gasoline is purchased and the frequency with which the retail prices changes, which increases consciousness of gas prices relative to other consumer products. Hence a sudden, sharp drop in gas prices as a result of an increased supply of oil can create a feeling, but only a transient one, of improved economic prospects.

Comments

[Jack]

Pradeep? I'd hoped to spur you into sallying forth with descriptions of your (magical?) model for? growth? wealth? happiness? But nada....... just more whining and (silly?) extrapolations of GDP growth in the emerging nations.

Not sure if you studied much history or econ, but there were decades in our adolescent era when our nation's GDP outstripped virtually all of the other nations. Why was that? On the crest of the industrial revolution we were building this great nation perhaps in a similar manner as India and China are, belatedly, doing.

Today? We're largely a mature economy with more productive capacity, more retail, more cafes, and more of most things than we've demand for. So....... start up a new restaurant chain? Mebbe if you've a VERY hot idea and execute perfectly, but you've got to take your customers from all the chains you've heard of that are scratching for their own biz.......... or like Starbucks, closed a few thousand. Get the idea? While an infant Microsoft might grow 30% per year, a gargantuan, mature MSFT is unlikely to achieve such a pace............. and, truth be known? need not.

So.......... as above, a hearty "good on ya!" and your hardworking countrymen for achieving, your much needed, rapid growth rate. But as for your premature gloating and anticipation of "burying us" even the most casual of historians know how that one turned out. Cheers and best in your pursuits.

[Pradeep Despandee]

Indeed, how about we revisit these comments in 10 years and see how the apparently new American mentality of "Mediocre? Don't worry we'll take care of you" works out.

[Martin]

Pradeep,

actually the new American motto is:

“Less productive than Pradeep and Junquin? Can’t compete? Let’s vote to take wealth away from Steve Jobs in a futile attempt to keep a standard of living that is 6 times Pradeep’s and Junquin’s”. No incentives to do better. Just redistribution!

As if the Steve Job’s have collectively enough money to significantly prop up the standard of living of 90% of Americans (or just 50% for that matter) who are now transitioning to European levels of incentives to excellence. You could bump the marginal tax rates on the most productive all the way to 70% and still you would not be able to balance the current budget, not to mention that you would set the US on a perpetual 1 to 2 percent growth path to economic extinction.

Justifiably, the developing world has little patience or interest in the Nth human attempt at socialism. Now the American version. Americans actually think they’ve discovered something new! Paul Krugman says so!

The middle class will get what it deserves. European level VAT tax of 20-25% on everything that it buys, high tax rates for the middle class too (unlike the US where top tax rates kick in at about 7 times average income, in Europe they just kick in at 2) $8/gallon gas just like in Europe, a host of excise taxes making everything more expensive, just like in Europe, and, more importantly, an average growth rate of 1%-2% driving the country to economic extinction, just like Europe.

Pradeep’s analysis of the fundamental trends is correct. Those are the overriding trends of the early 21st century: The developing world moving away from central planning, America adopting it. End result, parity with three billion people in averagedom.

[Jack]

Pradeep? "Mediocrity?" Is that your best shot????? And here I thought you had a cogent theory to pass on.

While, we, or any nation can surely do better, what nation builds better cars, heavy equipment, aircraft and many other things?

As for "socialism?????" How so? Currently we devote less of our GDP to the public sector than most other nations, with the only increase being that of having to service the D E B T ginned up by Reagan, HW and Bush Jr hewing to the ridiculous notion of lowering taxes and going on wild spending sprees. (Details available upon request.)

Having posted NO theory as to how we, or any other nation, can do a lot better, can we assume you're just another whining right winger overly imbued with Limbaugh schtick?

Martin: It looks as though you too are suffering from the same whack right mythology. Do you REALLY "feel" that pursuing the ALL FOR THE RICH agenda replete with the negligent regulation and oversight that took us from where we were as President Clinton departed and passed off a balanced budget and low rate of unemployment to where we find ourselves today will........... eventually "work" if only pursued for another few DEBT amassing, nation tanking decades?

As for your (seeming) confusion on European tax policies, I'd urge you to add up what we pay PLUS what is extorted from us by our medical "insurance" parasites, along with the many other services that are included in the Euro tax bill. OK?

High fuel prices??? Truth is they pay the same world price we pay but with the (intelligent) difference of having diverted some of their income tax burden to NON-RENEWABLE resources, as we SHOULD have done when President Carter urged such a policy back when the first oil crisis warning bell rang. What the Euros have reaped with their "high fuel cost" policy are nations less than half as dependent on oil (per dollar of GDP) as our far more wasteful nation.

"Central planning???" Where? How so? Do "we" really want to allow oil companies to cut corners and then pass on the costs of multi-billion buck "clean up" charades? What "central planning" is it that you object too?

[Observer]

Martin:

Turn off the radio---you are less fact based than Pradeep and TANSTAAF.

1) Distribution of income is always and solely a political question.

2) But for education how does one make a person or a group of people "productive?"

3) Exactly where are we socialist, other than in agriculture?

[Matthias]

Not related to Strategic Oil Reserves, but,

I wholeheartedly agree with Pradeep’s cardinal and overriding assessment about where America is fundamentally headed. With Americans abandoning their founding principles in large numbers, the result is inevitable.

He is correct in essentially characterizing Americans as simpletons who are oblivious to what has set them apart from the rest of the world in the past 100 years and propelled them to a prosperity above any other country in the world. Namely, self-sufficiency and thus, abstention from the indolence inducing and innovation draining politics of mandatory compassion (are really a whole 50% of Americans so bad off compared to the rest of the world that they need the compassion of paying no income tax?). If the concepts of equality were to be applied globally, all Americans would belong to the privileged class and be forced to pay tax to countries like India and China. But no, the average American with his top 10% standard of living worldwide wants to get some money from the top 1% and thus is set to bring American prosperity to an end.

Perhaps it is an inconvenient fact, but the policies of mandatory compassion inevitably lead to the cruel outcome of group economic decline and marginalization. The human that will offer a significant percentage of his/her abilities to serve society at large, as opposed to his/her family, has not yet genetically transformed, at least not in sufficient numbers to create a prosperous, internationally competitive society. The best hope of creating such a new human race lies in something else that promoters of mandatory compassion typically despise: Genetic engineering… of the human race that is :-)

With so many Americans oblivious to their exceptionalism, the country is now past the tipping point and inevitably headed for decline as Pradeep correctly points out, no matter how many tricks Paul Krugman can convince a naïve population that macroeconomic manipulation can accomplish.

Sit back, relax, and watch the decline unfold. Sign up for ObamaCare when it comes into effect. Just don’t be the last fool left working. Let the folk that are motivated by working for the community pull the cart for a while (lets see how hard they pull and if the cart goes anywhere). The steamroller following behind at an 8% growth pace carries 3 billion people.

[Jack]

Mathias: Would I be right in assuming you're another overly imbued with the whack right agenda as pumped 24/7 on talk radio and Fox, who's yet to open an econ text?

If not, could you cite a few (accepted) econ principles supporting your ALL FOR THE RICH "trickle down" fantasies? Thnx!

[Jack]

Mathias: Nearly forgot! The (mythical/unsustainable) "8% growth rate" of the emerging nations do NOT pose a threat to the US economy nor its std of living. Some will recall our wisely standing up the economies of Europe, Japan, Korea, and others after WWII that they might PURCHASE our abundant foodstuffs and other exports instead of having to give them away to prevent worldwide famine -- and likely another war. Cheers! and best for Independence Day.

[Jack]

Ha! Observer! Indeed! The current crop of CEO's and "rare management talent" must be lazy indeed to require 500 working folks chipping in there hard-earneds to make a pile large enough to give the wastrels enough incentive to get up with their alarm rings........... or fly the "corp?" jet back from the most recent sports event.

How about TRYING incentives for working folk? After a 25 year hiatus it may well be the new "new thing!"

[Observer]

Matthias:

Matthias:

Is the Dept of Agriculture "indolence inducing?"

You say that 50% of American's don't pay income taxes---you are dull---all employee FICA taxes are income taxes. Additionally the economic effect of FICA taxes falls on employees.

These taxes are used for all Gov't purposes. And, the Economy doesn't known a FICA tax from any other tax collected by the IRS.

Consequently, we have the most regressive income tax structure in the world.

As for American exceptionalism, whatever that is, the standard of living of 98% of Americans has been frozen for 35 years, while the income of the top .5% has skyrocketed. Why has that happened?

Learn a few facts

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[Kirsten]

And what happens after we release the oil? At some point we need to do something about the fact that oil is a non-renewable resource. Maybe we should start facing the real issue here - we are going to run out of oil and major changes need to happen because of this.

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