Titan Gas and Power | Best Oil Lesson Of Harvey: People Hoard

It's not only generals who are constantly fighting the last war, it is also most policy makers and researchers. After the Iranian Oil Crisis (1979/80), nearly every oil crisis study was aimed at the problem of hoarding, because in 1979/80, there were periods where inventories grew by 3 million barrels a day, a major reason for the price increases that occurred. My 1986 M.I.T. paper, "Fighting the Last War: Preparations for the Next Oil Crisis," argued that the type of hoarding that occurred during the 1979 Iranian Oil Crisis was due to specific conditions that were unlikely to recur.

Since then, such hoarding has not been a problem for the international oil industry; in cases like Hurricane Harvey, when the impact was limited to the Houston area as drivers feared gasoline shortages and rushed to fill their tanks. This was not much different from what happened in 1973/74 and 1979, when government regulations created localized shortages that lead to widespread panic buying.

A couple of decades ago, John Sawhill, speaking at a Harvard session, talked about the gasoline lines in 1973/74 and how his boss, William Simon, the Energy Czar, was advised not to shift supplies to, for example, the New Jersey Turnpike as it would just move the shortage around. But when the political pressure became too much, he announced, in time for the Friday evening news, that the government would be sending emergency supplies. By morning, the gasoline lines had disappeared as consumers became less worried about not finding gas. Apparently, no shipments were ever sent. [This is based on my recollection of his talk; I have no written record of it but believe it to be accurate.)

Which highlights an often-overlooked aspect of oil crises, namely the hoarding compulsion and the role of uncertainty. Hoarding is often treated as irrational behavior, but on the individual level, it can be quite rational. People on a lifeboat with an uncertain rescue try to stretch out their food; consumers fearing gasoline shortages rush to fill up their tanks. That, in turn, creates gasoline lines and removes millions of barrels of gasoline from retail storage (gas stations) to consumer storage (vehicle tanks). This can overwhelm the retail sector's ability to replenish inventories as well as cope with the surge in customers.
[After the Iranian Oil Crisis, Ellen Burton measured the storage capacity in consumer vehicles and demonstrated hoarding behavior for her M.I.T. economics Ph.D. The short-term shift, if done on a national level, can be about 25 million barrels in a few days, at the extreme.]

At the industry level, the hoarding that occurred in 1979/80 was unusual and reflected, again, the role of uncertainty. The rise of the Ayatollah Khomeini to power in Iran restored some of Iran's oil production, but also brought forth a torrent of concern about the spread of radical Islam and/or the intensification of Shi'a-Sunni conflicts in the Arabian/Persian Gulf region. The November 1979 seizure of the Grand Mosque in Mecca by radicals seeking the overthrow of the Saudi government seemed to confirm these fears, and the war of words (and small-scale clashes) between Iran and Iraq did, in fact, culminate in war in September 1980. Supply uncertainty was well founded.

There was a microeconomic element as well, which few are aware of anymore. Many companies that lifted oil in OPEC nations had their oil supply contracts canceled or the volumes cut sharply, or in a few cases, expiring contracts renewed at lower volumes. This caused the large oil companies to cancel their third party sales to large consumers and independent oil companies, Japan being the worst hit. As a result, oil companies not only scrambled for new supplies, but were reluctant to release any supply they had, for fear they wouldn't be able to replace them. Spot market volumes, small pre-crisis, all but dried up for the same reason. Inventories soared at a time of rising prices and supposed shortages (see figure).

OECD Oil Inventory Surge During Iranian Oil Crisis

Since then, the global spot market has grown substantially to where it is unlikely that any but the biggest crisis would cause it to dry up, but the primary factor is the level of uncertainty, which stimulates hoarding. Governments have, to some extent, used strategic reserves to reassure buyers, which has helped, but the occasional insistence that only physical shortages, not fears of physical shortages, would lead to releases of stocks ignores the important role that the strategic reserves have in reducing the hoarding impulse.

SOURCE: Forbes Energy | Michael Lynch, CONTRIBUTOR | https://www.forbes.com/sites/michaellynch/2017/09/...