Risk analysis of the Strategic Petroleum Reserve: theory and preliminary estimates

This paper describes how modern developments in the analysis of risks associated with public investment can be applied to questions of the desirability and optimal size of a Strategic Petroleum Reserve (SPR). Some preliminary quantitative results and directions for further research to refine the results are presented. It is assumed throughout that investment in an SPR is a proper function of government because of social costs and benefits of oil inventory management that are not included in private calculations of profit and loss. In this paper we assume that world oil prices, in normal and disrupted periods, depend on the level of US oil imports; that to make possible releases designed to hold down prices during a disruption, stocks during normal periods must be larger than the levels private traders will hold; and that the requisite additional stocks are acquired through direct government purchase for an SPR. A simple two-period framework, stockpile policy is described that is optimal in terms of expected value maximization. This is the standard framework for analysis of optimal stockpile size and involves ignoring issues of attitude toward risk. The opposite extreme of what might be called the price diversification benefits of the SPR is analyzed.more » It is assumed that the level of stocks has no influence on oil prices and evaluates the risk premium associated with stocks of any given size. These two perspectives are considered jointly and the optimal size of the SPR is examined, given both risk attributes and price effects. 14 refs., 4 tabs.« less