US Stockpiles Oil to Avoid Price Shock

Published on Saturday, August 3, 2002 in the Guardian of London

US Stockpiles Oil to Avoid Price Shock
by Julian Borger in Washington

Beneath the gently curving coastline of Texas and Louisiana, vast underground caverns are being filled with crude oil as part of Washington's war preparations that could be as important as the Pentagon's military blueprints.

The caverns were once subterranean pillars of salt, but the salt has been dissolved and sucked out, leaving gigantic sealed reservoirs which for the past quarter century have served as the US strategic petroleum reserve (SPR). Last November, when the Bush administration began to think about extending its "war on terror" from Afghanistan to Iraq, the president ordered the reserve to be filled to its 700 million barrel capacity.

This vast tank is intended to insulate the country, and the world economy, from oil price shocks of the sort experienced during the Gulf war in 1991. The ensuing slump cost the first President Bush his job.

Since the presidential directive in November, crude oil is being poured into the caverns at the rate of 150,000 barrels a day. According to a US energy department schedule, it will continue filling up at that rate for the rest of the year.

Adam Sieminski, an oil analyst at Deutsche Bank in London, said that US purchases for the SPR have accounted for half the total increase in demand for oil around the world this year, helping to buoy the oil price up at $25 a barrel.

The big question is whether the SPR can prevent the oil price shooting up to $50 or $60 in the event of a Gulf war, and reversing the US economy's faltering recovery.

That recovery is arguably already endangered by the US government's return to deficit spending largely as a result of its $355bn (about £227bn) defense budget for 2003, approved by the Senate this week. That would be further bloated by contingency spending on a war. The Gulf war cost about $80bn in today's dollars but 80% of that was paid for by US allies. This time, no one else is going to foot the bill.

The defense deficit will put upward pressure on inflation and interest rates, but its impact could be dwarfed by a serious oil shock. The likelihood of that will depend on the success and speed of a US invasion.

If Saddam Hussein is toppled in a speedy strike, the only physical impact on the market would be a temporary interruption in Iraq's one million barrels a day supply under the UN oil for food program, which could be easily compensated for by drawing down the US reserve, which can supply over four million barrels a day for three months.

President Bush's father also turned to the SPR to mitigate the impact of the Gulf war, but many analysts believe he left it too late, announcing his intentions in January 1991, at the start of the coalition air campaign but several months after the invasion of Kuwait. The oil market got jittery and the price per barrel rose temporarily to $40. Most observers say the current administration will signal its intention to draw down the SPR ahead of any military action.

Richard Cooper, a former CIA analyst who is now a Harvard economics professor, said the US might not even have to use much of its reserves.

"World demand is weak at the moment, and there's a lot of excess capacity, particularly in Saudi Arabia, but also in other countries. And I think that any shortfall from Iraq would, in relatively quick order, be made up by production elsewhere," he said.

However, Saddam could strike at other oilfields, terminals or tankers in the Gulf. Conceivably, he could block Saudi Arabia's exports of eight million barrels a day.

With that in mind, Mr Sieminski said, the US has sounded out the Germans and Japanese about using their reserves in coordination with the SPR. Together, they could pump nine million barrels of oil a day on to the world market, at least for a month.

However, there was an even worse "nightmare scenario". A prolonged conflict could trigger serious unrest across the Gulf and ultimately bring down pro-western regimes such as the Saudi royal family.

The emergence of a hardline Islamic state and the long-term interruption of Saudi oil, representing nearly a third of the world's known reserves, could send the energy market into a panic.

"In that case, you'd have very expensive oil, and the world economy would be in a lot of trouble," Mr Sieminski said.

© Guardian Newspapers Limited 2002