In 2008, given the economic brought about by soaring energy prices, the Air Transport Association (ATA) and other organizations pursued legislation to halt the filling of the nation’s Strategic Petroleum Reserve (SPR). Subsequently, ATA and others have sought a structural change in federal policy governing the use of the SPR. Doing so would not only boost commercial inventories but also help reverse the market psychology of financial players who bet on a tightening of oil markets. The following Q&A provides a rationale for pursuing this change in policy and addresses some related FAQs.
Q: How would a sensible SPR policy work?
A: In the event of any global petroleum-supply disruption (or combination of disruptions) that exceeds, in the aggregate, 200,000 barrels per day and is expected to last at least seven days, the Department of Energy (DOE) must immediately make available SPR inventories in an amount substantially equal to the expected supply disruption, not to exceed 20 percent of the amount of inventory in the SPR at that time. DOE should be allowed to replenish the SPR no faster than on a pro rata basis over the following 12 months. DOE should consider using the proceeeds from the sale of SPR barrels to invest in enhancing U.S. supply.
Q: How much oil does the SPR hold?
A: As of July 15, 2008, the SPR held 706.2 million barrels of crude oil, of which 40 percent is highly valued light sweet crude. At today’s consumption rate, the SPR inventory could supply the United States for approximately 34 days, and that assumes no domestic production and no imports. But physical limitations mean that it can supply no more than 4.4 million barrels per day, regardless of how many barrels it contains at any given time.
Q: How does that compare to U.S. commercial stocks?
A: As of July 4, 2008, U.S. commercial crude oil inventories totaled fewer than 293 million barrels, roughly 14 days of domestic supply, less than half the inventory of the SPR.
Q: Has the size of the SPR grown substantially?
A: From January 2001 through July 2008, the Bush administration added more than 165 million barrels. While the administration argued that filling the SPR represented a small fraction of global supply, this addition actually amounts to more than half of the nation’s current commercial inventory of crude oil. These stocks were unavailable to the commercial marketplace at a time when oil was trading close to $150 per barrel.
Q: Where do U.S. commercial stocks stand versus a year ago?
A: As of July 4, 2008, commercial crude oil inventories were 58.6 million barrels lower than one year earlier.
Q: Should the government release oil from the SPR?
A: The SPR was established in 1976 in response to the growing instability of the Persian Gulf oil supply, and to address the threat to oil imports in the event of a war with the Soviet Union. It has been used only sparingly. Today, supply disruptions often come in smaller chunks (e.g., Nigeria, Venezuela, Mexico, North Sea) but collectively are meaningful. What many people fail to appreciate is the relevance of the SPR as a market signal. By filling the SPR at times when commercial supplies are tight, the government signals to the market that it is worth paying a premium to fill the SPR because trouble looms. Conversely, if the government were more willing to make barrels of crude oil available upon the threat of disruption, it would have the effect of calming the markets.
The impact of any U.S. SPR release would be bolstered if done in coordination with the International Energy Agency (IEA), as was effectively done in response to Hurricanes Katrina and Rita. According to a March 2001 agreement, IEA net oil importing countries have a legal obligation to hold emergency oil reserves equivalent to at least 90 days of net oil imports of the previous year. IEA member countries hold some 1.4 billion barrels of public oil stocks, for which the maximum daily drawdown rate for the first month is 12.9 million barrels (9.6 million barrels of crude oil and 3.3 million barrels of products). In response to the damage inflicted on oil installations in the Gulf of Mexico by Hurricane Katrina, on Sept. 2, 2005, IEA member countries agreed within one day to make available to the market two million barrels per day of oil for an initial 30 days.
Q: Is a release necessary?
A: At times it is, and now would be a good time, especially given the massive flows of institutional funds into energy commodities. But more broadly, we should rethink the rules governing the SPR to make the oil more readily available to the marketplace. That is, even if barrels were not released, just the fact that they were available for sale or time-trade, if a commercial party were interested, would help mitigate spikes in advance of real or anticipated disruptions.
Q: What is the right number of barrels to release?
A: Since commercial inventories have fallen more than 58 million barrels versus their prior-year level, a release of at least 58 million barrels is in order, effective immediately, at the maximum feasible pumping rate. That would represent a modest release – less than 10 percent of the Reserve.
Q: Is the quality (e.g., density, gravity) of the barrels important?
A: Yes. In making barrels available to the marketplace, priority should be given to light (low-density), sweet (low-sulfur, low-acid) barrels, for four reasons. First, among the most pronounced supply disruptions over the past year has been the loss of barrels from Nigeria, which exports predominantly light, sweet crude oil to the United States. So the availability of such crude from the SPR would squarely address our biggest disruption. Second, the growth in product demand is currently concentrated in middle distillates such as diesel, heating oil, kerosene and jet fuel and it is much easier for refineries to maximize the output of those products when using light, sweet crude as the input. Third, associated with growing demand for diesel is the expanding worldwide regulatory push for low-sulfur products. It is much easier to generate low-sulfur products when starting off with low-sulfur crude oil. Fourth, all U.S. refineries are capable of processing light, sweet crudes, whereas only a fraction are capable of processing more complex, heavier crudes. Processing heavy, sour crudes requires more sophisticated construction, including steel composition to withstand the oil’s higher acid content.
Q: Don’t we need all that oil for national security?
A: ATA believes that having strategic reserves is good policy. The question, though, is how much oil to keep on hand, especially given our need to alleviate the economic crisis our country already faces. Many of those who advocate an SPR exceeding 500 million barrels base their case on a complete loss of imports as well as a complete loss of domestic production. As stated earlier, the maximum pumping rate of 4.4 million barrels per day means that, no matter how full, the SPR is not capable of meeting 100 percent of the nation’s daily crude oil requirements. For example, at 706.2 million barrels, it would take approximately half a year to fully transfer the contents of the Reserve into commercial inventories.
According to the Energy Information Administration, the United States imports 9.8 million barrels of crude oil per day, of which approximately 2.4 million barrels comes from Persian Gulf countries. If the SPR were needed to replace completely our imports from the Persian Gulf, the current SPR inventory would provide approximately 294 days of coverage. If, as suggested above, the government were to release 58 million barrels to replenish diminished commercial inventories, the remaining 648 million barrels would still provide 270 days of coverage in the case of a loss of imports.
Q: Would releasing barrels help lower the price of oil?
A: Given a certain level of demand, increasing commercial supplies could only help alleviate upward price pressure. While the magnitude of the impact is a subject of healthy debate, we know that the price was lower when commercial inventories were higher. Equally important, the risks associated with inaction far exceed the risks associated with a release of oil from the SPR. On Jan. 16, 1991, under authority from President Bush, Secretary of Energy Watkins ordered the drawdown of 33.75 million barrels of oil, equivalent to a drawdown of 1.125 million barrels per day. He observed, “By drawing on our strategic stocks, the U.S. is working in close cooperation with its partners in the International Energy Agency (IEA). Our purpose is to take precautionary action early and, in doing so, counter any possible disruption of supplies from the Persian Gulf.” As the U.S. action was joined by similar stock drawdowns from 13 other nations, including Germany and Japan, Watkins added, “Acting collectively, the U.S. and its allies intend to reassure the world market. Consumers should not have any concerns about the availability of petroleum and petroleum products. The SPR was envisioned for exactly the situation we have today. Now is the time to begin taking advantage of the investment we have made in it.”
Q: Wouldn’t the economic impact of an SPR release be short-lived?
A: While the immediate impact likely would be temporary, a release also could have longer lasting impacts in two ways. First, the government’s willingness to embrace a policy that recognizes price aberrations and their impact on the nation as a reason for releasing reserves should dampen speculation in the market. Second, the government can then uses the resultant revenues to invest in expanding the domestic energy supply from all sources. As a matter of policy, whether receiving royalty checks for access to federal lands or revenues from selling/leasing oil to commercial parties, we as a nation should use those revenues to bolster national energy security, including a wide portfolio of domestic energy resources.
Q: How much money are we talking about?
A: Let’s suppose the government sold 58 million barrels of crude oil at $140 per barrel. That’s $8.1 billion in federal revenues that could be used to develop new domestic energy supply.
Q: Isn’t a release a blatant example of market intervention?
A: In some respects, yes, but the government was already intervening in the market by taking tens of millions of barrels out of it at ever increasing prices in order to fill the SPR. Government involvement in markets should be the exception, not the rule. However, there are circumstances when involvement is appropriate, especially when the broader economy is at risk (e.g., Bear Stearns, AIG, Citi, FreddieMac, FannieMae). In previous years, the government chose to subsidize ethanol production through an array of measures. The government now must address how the oil crisis is impacting the broader economy and U.S. national security. A release from the SPR would make Americans better off. By removing barrels from commercial inventories at a time when commercial stocks are low, the U.S. government was inherently altering the normal functioning of crude oil markets.
Q: Wouldn’t the impact of a release be offset by a cut in OPEC output?
A: Retaliatory or other offsetting measures are always a risk. But given that a properly structured release would be designed so as to replenish depleted U.S. stocks and given that the Saudis have publicly commented on oil’s current overvaluation, the risk in this case is relatively low. Moreover, at today’s prices, if an oil-producing nation were to cut back on production, it would forgo critical revenues needed for its domestic economy.
Q: Can the SPR be drawn down in economic crises?
A: The Energy Policy Act of 1992 permits a drawdown of the SPR when a reduction of supply would raise prices to a level likely to “cause a major adverse impact on the national economy.” It is true that we have not experienced a traditional supply disruption as a result of an embargo, war or hurricane. Yet, we have been experiencing a series of smaller, less visible supply disruptions around the globe, which, when viewed collectively, are meaningful.