The Fuse

Strategic Oil Reserve Gets Short-Changed in Political Debate

by Matt Piotrowski | September 08, 2016

The U.S. government’s Strategic Petroleum Reserve (SPR) has been a hot political topic a number of times since its inception in the mid-1970s after the Arab Oil Embargo. Because of the economy’s sensitivity to high fuel prices and global outages, the SPR was set up to cushion against severe supply disruptions on the global market. It has been tapped on four major instances: in 1990-91 during the first Gulf War; in 2000, to reduce tightness in the U.S. Northeast heating oil market; in 2005, to make up for outages from Hurricane Katrina; and in 2011, to offset disruptions in Libya.

Last year, the reserve got caught in the middle of budget wars, with a number of policymakers—arguing that the reserve has lost its importance due to the rapid rise of shale oil—seeking to raise funds by selling oil out of the SPR. The debate prompted questions about the appropriate size of the reserve and how it should be preserved and modernized as a critical component of the country’s energy security portfolio.

Last year, the reserve got caught in the middle of budget wars, with a number of policymakers—arguing that the reserve has lost its importance due to the rapid rise of shale oil—seeking to raise funds by selling oil out of the SPR.

In the end, Congress in its Bipartisan Budget Act mandated 58 million barrels of sales from the reserve from fiscal year 2018 to fiscal year 2025 to pay for federal spending. The Act also authorized that a small portion of sales modernize the SPR by dealing with eroding infrastructure and changes in the U.S. oil market. Generating enough revenue necessary to pay for the modernization would require sales of roughly 40 million barrels. Besides the Budget Act, Congress also scheduled crude sales of 66 million barrels from the SPR from 2023-25 as part of a transportation bill. In all, the sales would total a drawdown of 164 million barrels. The SPR currently holds 695 million barrels.

SPR needs to be modernized to be effective

The controversy over the SPR will surely heat up now that the Department of Energy (DOE) has published its Long-Term Strategic Review of the U.S. Petroleum Reserve and the Obama administration has asked Congress to allow the sale of 8 million barrels to begin the overhaul of the reserve. Despite authorizing the revamp, Congress has not yet appropriated the money for it.

Since the SPR is contending with aging infrastructure and the logistics of the U.S. oil market have changed drastically, modernizing the reserve is essential.

Since the SPR is contending with aging infrastructure and the logistics of the U.S. oil market have changed drastically, modernizing the reserve is essential. One major problem has been equipment corrosion from bad weather. Another issue is bottlenecks: Overfilled pipelines in the Midwest as a result of the country’s shale boom make it more difficult for the SPR to feed refineries if a disruption occurs. Moreover, the reversal of the Ho-Ho pipeline several years ago, which now moves shale oil from Texas to Louisiana refineries, complicates matters further. If crude oil from the SPR needs to be distributed in case of a global supply crisis, there would be “displacement of domestically produced oil and/or Canadian imported oil,” the DOE said. In other words, the pipelines would have to be cleared to make way to move oil from the strategic stockpiles. The report noted that in order for a release of SPR oil to be successful, it would have to include loading volumes on tankers and shipping them to the necessary destinations.

“The changing patterns of U.S. oil imports mean that the magnitude and geographical location of an international oil supply disruption can affect the capacity of the SPR to deliver oil to its customers and the ability of the U.S. to meet its obligations…in the event of IEA collective action in response to a global supply disruption,” the DOE said.

Downsizing the SPR compromises energy security

While the upgrading of the SPR will be contentious because it requires prompt availability of funds, the size of the reserve going forward could be even more of a testy issue. The DOE report says that the ideal size for the SPR is between 530 million to 600 million bbl, or a month’s worth of demand—the U.S. currently consumes around 20 million barrels per day. The DOE argued against trimming the reserve below 530 million barrels, pointing out the SPR would lose its drawdown authority. The Energy Policy and Conservation Act of 1975 stated that stock levels must remain above 500 million barrels even after a release is made.

On the one hand, a slimmer SPR makes sense given that the oil market has changed significantly this decade with the rise of shale and expectations that U.S. oil demand has leveled off. The U.S. has sliced crude imports by more than 25 percent from their peak and commercial stocks recently reached records. Moreover, just last year, Congress lifted the 40-year ban on crude oil exports. The country is saturated with oil.

The U.S. is still vulnerable to wild price swings prompted by outages in unstable producer countries, particularly those in OPEC, and imports roughly 8 mbd.

On the other, however, the U.S. is still vulnerable to wild price swings prompted by outages in unstable producer countries, particularly those in OPEC, and imports roughly 8 million barrels per day. Even with shale output, which has declined in the past year and a half and represents only 5 percent of global supply, the U.S.’s exposure to global prices could grow. In fact, a supply crunch looms. In a recent report from HSBC, the bank’s analysts warn of a tight market emerging next year and point out a number of factors that could lead to higher prices. For one, spare capacity is expected to shrink to just 1 percent of supply and demand, “leaving the market far more susceptible to disruptions than has been the case in recent years.” Secondly, demand is poised to rise by more than 1 mbd, with major forecasters such as the EIA and IEA saying demand will growth for at least the next 25 years. Third, more than 80 percent of global production is in decline and the annual decline rate is roughly 3.5-4 mbd. Lastly, new discoveries have become more limited, with exploration success rate falling to a record low of 5 percent last year.

In the DOE report, besides arguing for a smaller SPR, the government agency failed to make the case for more regional petroleum product reserves. Currently, only the Northeast has strategic stockpiles of heating oil and gasoline in case of emergencies. Analysts at Clearview Energy Partners said they were “struck by the fact that the report did not advocate for additional regional petroleum product reserves,” but pointed out that they are “something of a touchy subject on Capitol Hill.” The Obama administration created a 1 million barrel gasoline supply reserve in the Northeast in 2014 after Hurricane Sandy caused fuel shortages. But Congress responded by limiting presidential authority to set up any more regional reserves without congressional consent. Establishing regional reserves would diversify the emergency supply base away from the Gulf of Mexico and crude oil.

SPR still a critical part of energy & national security

“In today’s uncertain and dangerous geopolitical environment, the SPR is our most immediate defense against oil supply disruptions and price spikes.”

Reducing the size of the SPR does not make sense, particularly with policy makers using it as a “cookie jar” to pay for other initiatives. In fact, the explosion of shale has brought about a false narrative that the energy security situation has been solved and the SPR has lost its relevance. It remains a potent weapon for both energy and national security. U.S. Navy Admiral Dennis C. Blair (Ret.), former Director of National Intelligence and Commander of U.S. Pacific Command, eloquently stated the vital importance of the SPR in testimony to Congress last year: “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.”

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.”

 

 

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