The Fuse

UPDATE: Reform SPR Policy, But Do It Wisely

by Matt Piotrowski | October 08, 2015

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In a hearing this week on Capitol Hill, energy security experts cautioned lawmakers against policy changes to the Strategic Petroleum Reserve (SPR) that would heighten U.S. vulnerability to an oil supply disruption. U.S. Navy Admiral Dennis C. Blair (Ret.), former Director of National Intelligence and Commander of U.S. Pacific Command, testified before the Senate Committee on Energy and Natural Resources, joining other experts in urging Congress to evaluate, preserve and modernize the SPR as a critical component of the nation’s energy security portfolio, rather than sell the oil as a funding source for other initiatives.

Blair argued that SPR plays an important role in insulating the U.S. economy from increasingly volatile and unpredictable global oil market, adding that Congress should ensure the SPR has the necessary infrastructure and technology to bring oil to market quickly in the event of emergency.

“Given the current state of geopolitical affairs around the world, it would be foolhardy to draw down the immediate protection we have in the face of potential oil supply disruptions and price spikes.”

“Given the current state of geopolitical affairs around the world,” said Blair, “it would be foolhardy to draw down the immediate protection we have in the face of potential oil supply disruptions and price spikes.” He continued, “In today’s uncertain and dangerous geopolitical environment, the SPR is our most immediate defense against oil supply disruptions and price spikes. However, it is only one part of a comprehensive energy security strategy to reduce America’s dependence on oil. We need increased efficiency and fuel diversity in the transportation sector. A strong energy policy is imperative to improving our national security.”

The Government Accountability Office has recently suggested that the Department of Energy reevaluate the size of the stockpile, and lawmakers have introduced a bill that would sell 101 million barrels of oil from the reserve to earn about $9 billion over 9 years. The funds could help pay for road construction and other infrastructure.

Energy Secretary Ernest Moniz argued that “The SPR remains an extremely powerful and valuable energy security tool,” that provides a valuable insurance policy against global supply disruptions. His assessment was supported on both sides of the aisle. Senator Lisa Murkowski (R-AK), committee chairwoman, urged that the SPR “is not an ATM for new spending or a vestige of our national energy policy.” Senator Elizabeth Warren (D-MA) expressed similar sentiments, arguing, “Mandating massive, inefficient and inflexible selloff of the Strategic Petroleum Reserve years in advance is just one more bad idea for how to finance government.”

However, Moniz and others argued in their testimonies that although the SPR should not be used as a “cookie jar” for government spending, modernization is badly needed. Admiral Blair’s recommendations to the committee included the funding and completion of deferred maintenance of the SPR, dedicated marine loading capacity for SPR oil, updating release criteria to clearly define when to sell oil from the reserve, and establishing a plan to right-size and upgrade the SPR for the long term.

In a similar vein, Jason Bordoff of Columbia University’s Center on Global Energy Policy argued while it may be prudent to study the “size, compositions, location, and use of the SPR” in light of current oil market dynamics, any revenues from sales of the SPR should first be allocated towards ensuring the reserve remains effective in the event of an emergency.

The following story was originally published in July 2015

There’s been a lot of discussion lately about a possible diminished role for the U.S.’ strategic crude stockpile now that the country’s imports have declined dramatically since their peak ten years ago and domestic production has boomed. Although imports have fallen and prices are more than half year-ago levels, U.S. consumers are still vulnerable to supply disruptions and market volatility, and it is unclear what the optimal level of the Strategic Petroleum Reserve (SPR) needs to be in order to offset major disruptions, now and in the future.

Against this backdrop, it is crucial to assess the SPR’s necessary size, its exact role in offsetting supply disruptions and dampening price fluctuations in the global oil market, what infrastructure improvements are needed to use the reserve as effectively as possible, and whether the country’s emergency stockpile should be expanded to include petroleum products such as gasoline and diesel.

It is crucial to assess the SPR’s necessary size, its exact role in offsetting supply disruptions and dampening price fluctuations in the global oil market, what infrastructure improvements are needed to use the reserve as effectively as possible, and whether the country’s emergency stockpile should be expanded to include petroleum products such as gasoline and diesel.

The problem is, no comprehensive assessment has been put together to examine these issues, and without such an analysis, it is problematic to go forward with any changes to the SPR.

Right now, the SPR, set up in 1975 in the aftermath of the Arab Oil Embargo, holds some 695 million barrels of crude oil in salt caverns in Texas and Louisiana, and is authorized to store up to one billion barrels. There have been four major sales from the reserve: in 1990-91 during the first Gulf War; in 2000, to reduce tightness in the U.S. Northeast heating oil market; in 2005, to offset crude outages from Hurricane Katrina; and in 2011, to rebalance the global market amid disruptions in Libya.

The Government Accountability Office (GAO) weighed into the conversation last year, arguing that in light of “changing market conditions,” the role of the SPR ought to be reassessed, recommending that the Department of Energy (DOE) reconsider the size of the stockpile. When commenting on the report, the DOE said it agreed with the GAO recommendations, but so far the agency has yet to issue its own analysis. The government’s quadrennial energy review, released in April, made suggestions for modernizing the SPR, but still the DOE has not done a definitive study.

The GAO, citing data from the International Energy Agency (IEA), said that as of last year when it put together its report, the SPR held up to 106 days of net imports, with private commercial stocks holding another 141 days, pushing the country’s total to 247 days, well above the 90 required by the IEA.

It is tempting to conclude that given the current environment, a smaller SPR would make sense, but that’s not necessarily the case.

It is tempting to conclude that given the current environment, a smaller SPR would make sense, but that’s not necessarily the case.

“There needs to be a thoughtful analysis of the SPR,” said Bob McNally of The Rapidan Group, an independent oil market consulting firm. “But just because imports are down and production is up, doesn’t mean we should sell off SPR oil.”

Tighter market down the road?

One main argument against reducing the size of the SPR is that prices could eventually snap back very sharply or that the decline in imports could reverse course. Indeed, the oil market can turn around quickly. Just a little over a year ago, prices were above $100 per barrel while the Islamic State was gaining ground in Iraq, a deal with Iran over its nuclear ambitions was still well off, there were major outages in Libya, and Saudi Arabia held almost all of the world’s spare capacity.

“There could even be a case to make that the SPR should be bigger,” said McNally. “Global spare capacity is tight, geopolitical risk abounds, and the U.S. economy remains vulnerable to price shocks no matter how little we import.”

There could even be a case to make that the SPR should be bigger.

While oil markets are certainly bearish for now and prices could fall further throughout the rest of the year and into 2016, a tighter market down the road is not out of the question. Global spare capacity is right now very low, at less than 2 mbd, or only about 2 percent of total supply. Commercial inventories have ballooned amid loose supply-demand balances, but higher-than-expected demand increases, slower production growth as a result of an extended period of weak prices, and more unanticipated supply outages could cause stocks to slim down and boost prices once again.

The big question for the U.S. in regards to the role of the SPR and declining imports is the sustainability of the country’s shale boom, the main factor in slicing dependency on imports from overseas. Since 2008, crude output has almost doubled to 9.6 mbd and has proved resilient in a lower price environment, but there is no guarantee growth will continue. The Energy Information Administration (EIA), for instance, says in its long-term reference forecast that U.S. crude oil production will peak early next decade before going into a steady decline, a development that would increase the need for imports. The agency sketches out other scenarios based on variations in price and changes in production from tight oil formations, reflecting how uncertain the U.S. outlook is. In a couple of scenarios, the EIA projects imports bottoming out in the coming years, but then rising again, possibly reaching close to 9 mbd by 2040, up from just above 7 mbd now, making U.S. consumers and the country’s economy even more vulnerable to supply shocks and price volatility.

Push on Capitol Hill for clarity

Policy makers on Capitol Hill have been pushing for an objective, thorough assessment on the SPR in order to go forward with legislation on possibly changing its size and how it’s used. A group of House members, led by Fred Upton (R-Michigan), the Chairman of the Committee on Energy and Commerce, sent a letter earlier this year to Energy Secretary Ernest Moniz, seeking clarity on the DOE’s future plans for the strategic stockpile.

“Significant changes to the national energy landscape over recent years make a long-term strategic review especially critical at this time,” the lawmakers wrote.

Significant changes to the national energy landscape over recent years make a long-term strategic review especially critical at this time.

Key questions on the future of the SPR

Key issues for the DOE and legislators to consider before changing SPR policy include:

  • How big should the SPR be?
  • How large does a supply disruption have to be to trigger a release?
  • Will the U.S. move alone in SPR releases, or will it act in coordination with other consumer countries?
  • What price level should prompt a release?
  • Should products such as diesel and gasoline be an integral part of the country’s emergency stockpiles?
  • What changes are needed in the SPR’s distribution network, particularly pipelines?
  • Should the government allow SPR crude to be exported to dampen effects of a supply disruption outside the U.S.?

The executive branch has used its discretion to order SPR releases at critical times, whether the reason was to counteract lost supply due to weather (Hurricane Katrina), war (the Gulf War), or an outage in an unstable country (Libya). Moving forward, there needs to be more clarity about the SPR’s size and role before any quick changes are made.