Why is the US cutting its oil reserves?

In the second quarter of 2022, when the price of Brent Crude oil was around $120 a barrel, figures from the Organisation for Economic Cooperation and Development revealed the largest ever drawdown from the SPR, of 240 million barrels.

Of these, 180 million barrels came from the US by the end of the year, and 60 million barrels came from the rest of OECD's states, which are often described as a rich nation's club.

China and India, the second and third largest oil consumers and major importers of Russian oil weren't involved in this historic drawdown, raising more questions than answers about it.

Low levels of oil inventories can have major consequences for major oil-importing nations — especially in times of crisis — from unforeseen supply interruptions to the impact of full-blown natural disasters. The lower the level, the fewer days of demand it can cover.

The US alone uses 9 million barrels of gasoline a day, the highest in the world. A low SPR makes the country more exposed to potential economic shocks via potential energy shortages and economic and industrial paralysis.

Interest rates and oil markets

The main reason for the large drawdown may be to try to lower oil and gasoline prices.

Indeed, the summer of 2022 saw an unexpected decline in domestic gasoline demand in the US,  although seasonal demand is at its peak at this time of year.

But the drop in gasoline prices wasn't the result of record withdrawals from the strategic storage, but of falling consumer demand at a time of inflation.

Oil prices fell steadily in the second half of 2022 – from $120 per barrel, to below $80 by the end of the first half of 2023 – as global central banks raised interest rates to curb inflation.

This was accompanied by growing concern about a global economic slowdown, led by financial concerns. A lack of balance in oil markets does not appear to be the main driver of lower oil prices.

The pace was being set by the stresses and strains on wider financial markets, and their implications for the global economy. These were the definitive concerns, and they were the clear result of the tighter monetary policy coming in from major central banks, led by the interest rate hikes by the US Federal Reserve in its battle to tame runaway inflation.

With financial markets factored in this change in conditions, it roiled futures markets in oil and energy, where speculators exploit price moves, while the moves in prices for physical commodities were not as dramatic.

The political angle

Prices for physical delivery contracts did fall — which could have been an ideal time to build up stockpiles, including the SPR.

When around 180 million barrels were withdrawn, average prices were between $90 and $95 a barrel. The White House indicated that it planned to top up reserves at around $70.

But contradictory statements were issued by the Department of Energy: it said the replenishment of the SPR could take several years, but then it changed its position and announced that the US could immediately refill its strategic oil storage as soon as the third quarter of 2023 at low prices if this is beneficial to taxpayers.

In March, the price of West Texas Intermediate Crude fell to $67 a barrel, and still, the US did not start to refill the SPR, while it continued to raise interest rates. Just as the drawdown has not pushed prices lower, replenishing the SPR might not necessarily mean higher oil or gasoline prices.

Reluctance to refill

Why is the US reluctant to buy oil to refill its oil reservoirs? Is it a shortage in liquidity? Or is a further decline in oil prices expected? Or is there concern that the buying required would trigger a price rise after any such move was announced? How much would the move boost demand at a time of relatively lower prices?

There are several explanations, but the real reasons may be political rather than purely economic — especially for Democrats.

Buying oil in large quantities will boost oil demand, raise prices, give a boost to demand and reduce US oil exports while the US is trying to offset some of the decline in Russian oil exports due to economic sanctions.

US oil exports in 2022 saw a record 3.6mn bpd due to increased demand from Europe, rising supply of US production, and the flow of crude oil from the SPR. In contrast, oil producers have been struggling to export their oil, according to data from the US Energy Information Administration.

The Independent Petroleum Association of America wants the SPR to be re-stocked; it considers the depletion of that reserve to affect the markets of oil or its refined products a major mistake, calling on policymakers to oppose all non-emergency oil sales.

It may be that calculations over oil prices correlate to political factors as much as economic ones.

What happens in the oil markets, at times, seems to be affected by more than straightforward supply and demand. Prices can move contrary to market fundamentals.

They cannot be fully isolated from economic conditions, and remain exposed to what happens with the dollar, the currency prices are set in, at a time when interest rates are rising.