Public and Private Storage of Oil

I've been thinking and studying a lot about storage and commodity markets, mostly with regard to food commodities.  A grad student, Nam Tran, is neck deep solving stochastic dynamic programing models.  I'm pretty optimistic something good will come out of his dissertation--he's focusing on rice markets and the price spike in 2008.

Anyway, the theory for oil isn't all that different.  In the news we're seeing a lot about the US strategic oil reserve.  Obama is thinking about selling some of our reserves.  Would this be a good idea?

The thing to recognize is that the recent price spike is coming from private markets building up their own reserves.  Reserves have gone up about 4% since early January, perhaps a bit more depending on what the next report says. Markets are speculating that there may be an actual disruption of supply in the future.  If that happens, prices will spike, and so it makes sense to store a little more in anticipation of that possibility.  If that speculation is rational, markets are responding in a reasonable and efficient manner to a potential supply shock.  If the speculation is irrational--if too much is being held off the market given the potential threat to supply--a release of pubic inventories may make sense.

It does look to me like Lybia's share of the oil market is too small to pose much of threat to supply.  Other countries could easily make up a lot of the difference, and likely will in order to capitalize on higher prices while anticipating that disrupted supplies will come back online.  But then problems in the Middle East could spread much further.  This doesn't seem like the kind of uncertainty one pin down very precisely in an objective manner.  Moreover, prices haven't gone up that much.  Yet.

On the other hand, I have a hard time seeing the general point of our strategic oil reserve.  I don't know that it serves much if any social good.  This is because it's hard for me to see the market failure in private speculation and storage.  While speculative bubbles seem to have occured in other places, I haven't seen any good evidence to support their existence in commodity markets (except maybe precious metals--a very different thing).  Actually, commodity prices appear to behave in near textbook economic fashion.  So, if the US is going to dump its public reserve and get out of the oil speculation business, now seems about as good a time as any.

One good thing about recent news: the more information they provide about what they will do and the circumstances in which they will do it will help private markets store more efficiently.


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