Budget 2018: Trump’s Oil Dump?

Well folks, we now have A New Foundation for American Greatness. Or, by its less grandiose name: the budget for fiscal year 2018. Or, more technically: President Trump's proposed budget for fiscal year 2018. The White House unveiled the $4.1 trillion proposal on Tuesday, and as you might expect, people found things to like and dislike. It now goes to Congress, and while we won't be holding our breath on its passing any time soon-it may not at all-some parts could impact certain sectors if they took effect. For example: the proposal to sell off half of the Strategic Petroleum Reserve (SPR). The SPR is a relic, and we think its waning importance is a timely reminder of the market's problem-solving prowess-especially compared to other institutions like government.

Plans for a national oil reserve didn't arise in the 1970s, but the 1973 - 1974 oil embargo prompted action. The SPR became official US policy after President Gerald Ford signed the Energy Policy and Conservation Act (EPCA) in December 1975. The SPR, created to be a counterweight to Middle Eastern oil, is authorized to hold up to one billion barrels of petroleum. The US has dipped into the reserve a handful of times, from national emergencies (Hurricane Katrina in 2005) to globally coordinated efforts to keep supply steady (Libya violence in 2011). Today, the SPR has a capacity of 713.5 million barrels and currently holds 687.7 million barrels of crude in Louisiana and Texas.

The proposal to reduce the SPR by half has prompted fierce debate. Proponents call the reserve archaic, while opponents rail against the supposed national security risk. However, many specifics are missing. The pace of the selling and the magnitude-i.e., whether this includes reductions Congress already agreed to-isn't clear. The current budget proposal estimates selling off 344 million barrels of oil would generate $500 million in fiscal year 2018 and raise about $16.6 billion over the next 10 years. While these are some yuuuge-sounding figures, analysts note this would be only a tiny fraction of daily traded volumes or daily US output.

For illustrative purposes, imagine if the SPR sold off half its current capacity over the next three years, equivalent to adding approximately 300,000 barrels of oil per day to global supply. According to the Energy Information Administration, the US produced an average of 8.9 million barrels of crude oil per day (MMbd) in 2016. If all levels remained the same, this hypothetical SPR selloff would increase US supply by about 3% over three years. Again, this is all hypothetical, but even under more aggressive selling scenarios, the impact on overall supply probably isn't significant.

While we are always skeptical of straight-line math projections of the distant future, the SPR's outdatedness highlights the Energy sector's transformation over the past four decades. The recent surge in US production via the shale oil boom is a big contributor to a world currently awash in oil. OPEC and its allies have resorted to self-imposed production cuts (which they just extended) to try and maintain a floor under oil prices, with little success. That is a far cry from the US building up a reserve in 1975 to insulate itself from OPEC's whims and the supply shortages they threatened.

Granted, things could always change. As recently as 2010, most folks were worried peak oil had arrived and the world's reserves would soon be tapped out. Few knew about hydraulic fracking and its industry-changing impact. Maybe at some point a larger strategic reserve makes sense again. Yet while it's near-impossible to know how the Energy sector will look a decade from now, oil supply is currently abundant-and a SPR selloff would only add to that. Amusingly, selling oil reserves in this current market environment is akin to selling low-not unlike former UK Chancellor Gordon Brown's decision^[i] to sell half of the Treasury's gold reserves from 1999 - 2002, at the bottom of gold's 1990s slump and right before gold prices took off for the rest of the Aughts. Unsurprisingly, politicians aren't exactly great market forecasters.^[ii]

While the SPR and other budgetary items are all interesting and potentially impactful, they also aren't set in stone. The budget lets the president lay out his administration's priorities, but Congress holds the purse strings. The legislative branch has ignored past presidents' budgets-both Obama and Bush 43 had theirs rejected, too. Considering Democratic and Republican lawmakers are already opposing Trump's proposal, the budget probably won't breeze through Congress. Gridlock will likely lead to watering down or outright rejection of the more controversial budgetary ideas. While folks may bicker about Washington's inability to get anything done, we expect stocks shouldn't mind at all: Gridlock has persisted in the Beltway for several years now, and the bull market has charged higher throughout. So while budgetary tidbits make for plenty of headline fodder-and certain parts like the SPR could have broader sector implications-we think investors shouldn't bank on any proposals becoming reality just yet.