Would reducing SPR demand help oil prices?

Did the state holiday bunny come to your house? Here is something she left me in the headlines of the C-J (Bush asked to delay adding to oil reserve to help gas prices):

Americans could save as much as 25 cents a gallon on gasoline if the U.S. government held off buying more oil to be saved for a national emergency, nearly three dozen House Democrats say.

...

That could increase the amount of oil on the market and perhaps reduce prices.

Such a move, they said, "can have temporary benefits that would go a long way towards helping American families who are being squeezed, and also stimulate the economy."

There's disagreement among economists about how much impact -- if any -- such a move would have.

Count me among the skeptics.

Using the formula for demand elasticity (short run e = .10), information from the rest of the article (and the only question confirmed), and mixing apples and oranges applesause (oil quantities and gas prices), the effect of totally suspending SPR purchases is less than a penny on the price of a barrel of oil gallon of gas:

• e = .10 = (dq/dp)/(p/q)
• dq = 12.3m over 6 months = 0.0683m/day
• q = 20.7m/day
• p = $3.25
• dp = $0.00107

Given the short run elasticity of .10, U.S. gas/oil consumption would need to fall by almost half to nudge gas prices down by $0.16/gallon.

Corrections to my mistakes and unprovoked attacks on my character will appear shortly in the comments section (and now I need to put on my state holiday bonnet and get ready for the state holiday service at a private, non-secular spiritual institution).

Comments

[Rick McGrath]

John,

Since the discussion is about a reduction in government demand, shouldn't we be using a supply elasticity? Demand shifts left, we slide down to the right along supply, and the change in price is determined by the elasticity of supply. Do you have a supply elasticity estimate?

I hope your non-secular activities were enjoyable. I engaged in extended non-secular activities last night then slept in. The rapidly-reproducing secular icon brought baskets for the kids and a quart jug of malted balls for me. Yippeee!

[John Whitehead]

Rick,

I'll do it similar to how Mankiw does crowding out. Separate the demand into the private and public demand. Reducing government demand increases the supply to the private market moving us down the private demand curve.

Does SC have a state holiday tomorrow? If so, enjoy!

We have a state holiday tomorrow and then Memorial Day celebration on Tuesday. Sweet!

[Sam Clifford]

These Democrats are trying to score political points rather than propose something that's actually going to take the edge off high petrol prices for families. High oil prices are here to stay and the solution for America's families is to drive less.

[Rick McGrath]

So Mankiw's method gives an upper bound on the price change by assuming supply is perfectly inelastic. The daily purchase is the proverbial drop in the bucket, 1/3 of one percent reduction in purchases.

(Thanks for ignoring the mis-statement. I did mean moving down to the left along supply, but that doesn't change the discussion at all.)

I'm in Savannah, GA. We don't get a wink-wink non-religious holiday tomorrow. Instead we had spring break for St. Patrick's when a hundred thousand or so of our dearest and closest friends came to town and got drunk.

Does Sam score extra points by ending his post with "drive less?" I'll have to find away to do that in the future.

Enjoy the days off.

[John Whitehead]

Rick,

Right, Ga not SC, I knew (sorry about) that. Must be the chocolate buzz.

Supply would still be downward upward sloping in the gas market. When I think of crowding out, I shift the demand curve for loanable funds to the right. But Mankiw, and others, shift the supply curve to the left as the government siphons some of the supply out of the market.

In the same way, imagine that the government stops siphoning some of the oil out of the private oil market with fewer SPR purchases. This would shift the private supply curve to the right ... and we can use demand elasticity to make inferences about the expected price change.

Drive less!

[Web]

It’s great that more people are focusing on making better environmental choices. Plus technology is making it more economical now, and that’s what people really notice. Wind energy, solar power, hybrids and zap EV’s, our choices are good. There are now electric cars being sold everyday, you just plug it into a regular power outlet. When people test drive them they say it’s far more fun to drive an EV.

[bartman]

John, your analysis makes no sense to me. This "crowding out" business is nonsene, and a needless complication. If the DOE stops purchasing for the SPR, the demand curves moves to the left. So, the appropriate elasticity is the price elasticity of supply. That's Econ 101. BTW, -0.1 (I always include the minus sign) is a large value for price elasticity of demand for gasoline. Most studies find numbers in the -0.04 range. And I'm not sure what you mean when you say the gas supply is downward sloping. It is very much upward sloping.

The supply curve is assumed to be very steep near the current equilibrium point for crude oil, so in theory, an inward movement of the demand curve could cause a fairly large drop in price. In theory. In reality, the SPR has been augmented by about 30,000 bbl/day over the past year. That's 30,000 out of 85 million bbls/day of global demand, or 0.04%. And that's not really the appropriate market, since spot prices are largely determined by futures markets, and futures markets trade well over 50 times the volume of physical oil. So the SPR purchase volume is in the parts per million range.

Another factor that non-economists tend not to realize is that SPR purchases are basically fully foreseeable public knowledge, and if they changed, producers would know, and adjust their production acccordingly. For example, 30,000 bbl/day is 0.3% of Saudi production, a production cut they wouldn't even notice - it would be swamped by daily noise.

So I agree, the SPR purchase is overblown. Of course, I think the SPR is a needless waste, but that's another discussion altogether.

[John Whitehead]

bartman,

Thanks for your comments. Here are some replies:

Of course i know that supply slopes upward. I've changed the obvious typo.

BTW. A better estimate of demand elasticity is 0.26.

You spend a lot of time disagreeing with my methods but end up agreeing with the result. There might be two appropriate ways of modeling the demand and supply of the oil/gas market with SPR purchases (similar to the fact that there are two ways of modeling the loanable funds market with government borrowing)?

Free your mind of its shackles!

[bartman]

John, I work in the electrcity business, where demand response is modeled as a change in the supply curve. (They do that because it's simpler than trying to model a sloping demand curve - if demand is a constant, solution algorithms are much simpler.) It strikes me as totally wrong, and not needed in today's world of high powere computers, but that's the way it is. So, yes, I am fully aware that demand change can be modeled as a change in the form of the supply curve. I just think that it is methodologically flawed, and needlessly complicating.

I used to work as a professor of economics, and I know how hard it is to get students to understand the basics, so I tend to have a fairly strong reaction when people try to overcomplicate things, and try to make changes in consumer behavior show up in the supply curve. The supply curve is about, and only about, the aggregate of the producers' minimum willingness to accept, and the demand curve is about, and only about, the aggregate of the consumers' maximum willingness to spend. I'm a bit of a fundamentalist about that, unapologetically, and whenever I see people who should know better, such as other economics professors, muddying the issue for no good reason, I'll say so, in no uncertain terms. Up is up, and down is down, and I don't need to free my mind of the few things I know for sure... :-)

Please don't take it personally, I'm really not that much of a jerk. But lucid pedagogy is important to me, and, IMO, should be to all of us interested in trying to educate the public in economic basics. That's all.

[John Whitehead]

bartman,

The complication was adopted due to the availability demand-side elasticity estimates and the reference to the loanable funds market (an analysis which I don't prefer, i'd rather shift the demand curve when government borrows more) was a plea to let me get away with it!