An Expensive Oil Reserve* – Watching America

*Editor’s note: On March 4, 2022, Russia enacted a law that criminalizes public opposition to, or independent news reporting about, the war in Ukraine. The law makes it a crime to call the war a “war” rather than a “special military operation” on social media or in a news article or broadcast. The law is understood to penalize any language that “discredits” Russia’s use of its military in Ukraine, calls for sanctions or protests Russia’s invasion of Ukraine. It punishes anyone found to spread “false information” about the invasion with up to 15 years in prison.

Analyst Aleksandr Frolov discusses what the U.S. refusal to buy 6 million barrels of oil for its Strategic Petroleum Reserve means for the global oil market.

The Biden administration has withdrawn its proposal to buy 6 million barrels of oil for the Strategic Petroleum Reserve, thus halting a steady stream of solicitations to replenish some of the state oil reserves sold from 2021 to 2023. The reason is predictable: Oil has become more expensive.

At the end of 2021, the U.S. experienced a wave of public discontent over the sharp rise in gas prices. From the point of view of an ordinary American, the situation at that time looked as follows: Under Donald Trump, gas prices fell to about $2.17 per gallon, rising to about $3.01 per gallon under Joe Biden.

In reality, neither president had anything to do with these changes. In the U.S., according to the Energy Information Administration, about 50% of the retail price of gas is made up by the price of crude oil. Roughly another quarter corresponds to refining costs. Obviously, in 2020, when oil was at its cheapest, gas was also more affordable. Conversely, in 2021, when the global oil market was recovering, gas prices increased. However, the public did not care much about such subtleties.

Meanwhile, during the midterm election campaign, the Biden administration had to take action to reduce gas prices. It acted strangely if not excessively, deciding to sell 50 million barrels from the Strategic Petroleum Reserve — 1 million barrels per day. This could not affect the market in any way, and it didn’t. But Biden could safely say that he had done his best.

Then came February 2022, when political tensions between Russia and the U.S. escalated against the backdrop of the special military operation in Ukraine. Washington began issuing threats and imposing sanctions against the Russian oil and gas industry, promising to halt Russian oil production and exports. The threats were so convincing that panic gripped the global market. Attempts to calm the markets down by promising that Russian oil would soon be replaced by supplies from Saudi Arabia and the United Arab Emirates did not achieve the desired effect. Besides, both Saudi Arabia and the United Arab Emirates were astonished by such statements, knowing they would not replace Russia on the global market.

As a result, faced with the unstoppable rise in gas prices, Washington had to announce the sale of an additional 180 million barrels from the Strategic Petroleum Reserve. Given that the sale was scheduled to be completed by November, there was no doubt in the U.S. that the Biden administration opened the strategic oil coffers just so the Democrats could get more votes. Relevant questions were even asked during press conferences, following which the Biden administration extended the sale until December 2022 to deflect suspicions of the unscrupulous use of strategic oil reserves.

During the sale, the Strategic Petroleum Reserve shrank from about 617 million barrels to 371.6 million barrels by early 2023. In January, Washington officially announced attempts to purchase oil for the reserve at $70 a barrel, urging its oil producers to be reasonable. However, nobody wanted to sell oil below the market price.

Further attempts to replenish the Strategic Petroleum Reserve were made in late spring and summer. The American authorities awarded two contracts to supply about 6.2 million barrels to the reserve. Half of this volume, purchased at $73 per barrel, was meant to be supplied in August and the rest (at $72 per barrel) in September.

Furthermore, the U.S. intended to continue a steady flow of purchases of 3 million barrels each month until the end of the year. However, by the end of July, the volume of the Strategic Reserve had further decreased to 346.76 million barrels. That is, Washington sold another 25 million barrels from the reserve to the global economy after the beginning of the year without prior notice.

The contracts awarded to date do not cover even a third of the volume of oil in the reserve sold in 2023. In fact, the sale, which should have lowered the oil market price, decreased the reserve by about 270 million barrels.

In other words, even if Washington had continued to replenish its oil reserves at the current pace, by the end of the year, it would have been able to replenish them by only about 30 million barrels. But this slow pace was understandable, as too much buying could lead to a significant increase in global demand over supply and, consequently, to higher prices.

Meanwhile, efforts by Russia, Saudi Arabia and other members of the Organization of the Petroleum Exporting Countries began to reap the benefits, agreeing to cut production to remove the excess supply that had been decreasing prices — the range of $70-75 per barrel was deemed inadequate for the industry’s needs. Now, the optimal price is estimated to be between $80 and $95. Such prices will ensure that economically justified supplies meet the current demand. Moreover, these prices will allow the oil reserves to be replenished and will address future needs. In other words, it is not enough solely to produce oil, but it is also necessary to invest in the exploration of new reserves to avoid future shortages.

OPEC is, of course, very sympathetic to the Biden administration’s past attempts to influence the global oil market through intervention. It also understands the political struggle in the U.S., which is why the Biden administration jeopardized the stability of the global oil industry in the first place. But supplies to the market should not be allowed to outstrip the demand.

So, having noticed the growth in prices, the Biden administration was forced to postpone the launch of forthcoming solicitations for further oil reserve purchases. The decision was correct — after all, why would the Democrats disgrace themselves for the second time in a year, which would in turn allow the Republicans to hold all the cards? Obviously, with West Texas Intermediate prices within the range of $80-81 per barrel, there are no producers willing to sell oil at $70-73. And Washington does not want to pay more because earlier, it was announced that the Strategic Petroleum Reserve replenishment would cost about $70 per barrel to keep a healthy profit margin on the previous sales at $90 per barrel.

However, the problem for the Biden administration is that the presidential election is a year away. The price of gas in the U.S. will rise along with oil prices. And this is an important factor in the internal political struggle. Therefore, in contrast to March 2022, Washington will try to avoid making any bold statements which could destabilize the market even further. But at the same time, the U.S. will try to discreetly put pressure on market participants to increase oil production to bring down the prices. And if this does not help, a new large sale may begin at the turn of the first and second quarters in 2024. However, U.S. oil reserves are not infinite.

The author is deputy director of the National Energy Institute. The author’s opinion may not necessarily reflect the views of Izvestia’s editorial board.