FROM THE OFFICE OF PUBLIC AFFAIRS

Mr. Chairman, Mr. Boucher, Members of the Committee, this testimony addresses the President's decision to swap 30 million barrels of oil out of the Strategic Petroleum Reserve for replacement next fall.

Let me begin by noting that the overall prospects for the U.S. economy are very good today, despite the current conditions in world petroleum markets. One clear confirmation of this fact comes from the latest consensus economic forecast released last week by the Blue Chip panel of some 50 economists at major businesses, financial institutions, and economic research organizations. The consensus view is that U.S. economic growth will remain strong in the near term, and inflation will remain moderate. The Blue Chip forecasters expect real GDP growth to average 3.3 percent during the second half of this year, and 3.4 percent (fourth quarter to fourth quarter) during 2001. They forecast CPI inflation at 2.9 percent for the second half of 2000, slowing to 2.6 percent next year.

In addition, the Blue Chip panel released last week their semi-annual update of the outlook for the next 10 years. Once again, the picture looks strong. The consensus forecast of the Blue Chip economists is that real GDP will grow by at an average annual rate of 3.3 percent from 2002 through 2011. This is up from 3.1 percent in the ten-year forecast compiled last March and 2.7 percent in the October 1999 forecast. Inflation is expected to remain tame, with the CPI rising at an average annual rate of only 2.6 percent over the ten-year horizon.

Turning specifically to the issue of the swap from the Strategic Petroleum Reserve, the Administration believes that this policy has a sound economic rationale.

Use of the SPR in response to low inventories of crude oil was a policy option that had been on the table most of the year. But in the several weeks before the swap announcement, the world oil market became considerably more unsettled. The price of oil surged by more than $3 a barrel to its highest level since the Gulf War. We saw anecdotal reports of anticipatory purchasing that seemed to be generated by the expectation of a further price rise.

Most important, domestic stocks of both crude oil and refined products were at an unusually low level. There was growing concern that we might not have sufficient inventories of home heating oil to ensure a smooth supply through the winter. In the Northeast, in particular, stocks of distillates are down by about half from last year's levels. All told, the tightness of the petroleum markets left very little room to absorb any further shocks, raising the risk of very unfavorable developments in the months ahead.

The deterioration of market conditions led the President to take a prudent, precautionary step to reduce the risk of shortages of home heating oil this winter. The President ordered that about 5 percent of the SPR be made available for the swap, leaving the other 95 percent in reserve for possible future use. We anticipated that this measured action would have several favorable effects:

• First, and most directly, the swap would increase the supply of crude oil and boost oil inventories.
• Second, the swap would increase the supply of home heating oil this winter. Although domestic refineries were operating around 96 percent of capacity in July and August, we expected that capacity utilization would decline in the early fall, as it usually does, at the conclusion of the period of peak demand for gasoline. In fact, that decline in utilization has now occurred - and with utilization around 91 percent, refineries have the capacity to refine oil from the SPR.
• Third, the swap could reassure markets that there would be no disruption in the supply of oil, thereby adding confidence to what could potentially have been a difficult situation. By rebuilding inventories, we can reduce the likelihood of shortages and spikes in the price of heating oil and other refined products this winter.
• Fourth, by using SPR reserves for an exchange rather than an outright sale, we will have a larger Strategic Petroleum Reserve next fall than we have today, leaving us with an enhanced energy security in the long run.

While it is too early to observe any increments to inventory levels, the behavior of the oil market since the swap announcement suggests that we are on the right course:

• The markets reacted to reports that an exchange was imminent. The 1-month futures price of West Texas Intermediate dropped more than $3 per barrel on rumors of the pending announcement, and then by more than $1 per barrel on the announcement of the President's decision. Moreover, the price continued to head downward over the following six calendar days, for a cumulative decline over that period of more than $2 per barrel. Overall, from the day before to six days after the President's action, the one-month futures price of WTI dropped by about $7 per barrel.
• Importantly, the one-month futures price of heating oil also declined during this same period, taking very much the same profile from day to day as crude oil prices. While the objective of the policy was to address potential issues of supply disruptions and shortages, we cannot lose sight of the fact that in markets, shortages - and potential shortages - are reflected as higher prices. Likewise, alleviation of shortages - and reductions in the risk of shortages - are reflected as reductions in prices.
• Since that time, a portion of the oil price decline has been reversed. This partial unwinding appears to be due primarily to additional concerns about instability raised by recent world events such as the turmoil in the Middle East, a hurricane threatening production in the Gulf of Mexico, an early cold snap in the Northeast, and Venezuelan oil workers going on strike.
• It is noteworthy that, notwithstanding those world events, crude oil prices remain several dollars a barrel below where they were before the SPR swap announcements. In addition, the 1-month futures price of home heating oil is also well below its level a month ago, despite substantial volatility arising from these market forces. These readings suggest that the SPR swap is viewed by market participants as having reduced the pressure in petroleum markets and the risk of shortages this winter.

In summary, we believe that the swap has given market participants, and U.S. citizens generally, a measure of confidence they would not otherwise have had that the Federal government is ready and willing to move aggressively to address issues of supply disruptions. In a market as tight and unsettled as the world oil market is today, every additional measure of confidence is extremely valuable. Mr. Chairman, we believe that the U.S. economy is in better shape today because the President undertook a SPR swap.

Thank you.