DOE: small distillate stockpile best option

Aug. 3, 1998
The U.S. Department of Energy has concluded that a federally controlled "regional petroleum product reserve" would make economic sense only under a very narrow set of conditions. The DOE study was commissioned 2 years ago after increases in world oil demand boosted heating oil prices and cut distillate inventories. Several congressmen from New England asked DOE to study the merits of a federal refined products stockpile in the U.S. Northeast.

The U.S. Department of Energy has concluded that a federally controlled "regional petroleum product reserve" would make economic sense only under a very narrow set of conditions.

The DOE study was commissioned 2 years ago after increases in world oil demand boosted heating oil prices and cut distillate inventories. Several congressmen from New England asked DOE to study the merits of a federal refined products stockpile in the U.S. Northeast.

The study concluded the benefits of a government stockpile of heating oil in the Northeast would exceed its costs only if the reserve were relatively small (about 2 million bbl), located in leased terminals, and filled by trading crude from the government's Strategic Petroleum Reserve (SPR) for the distillate product.

It said that storing distillates in dedicated salt caverns at the SPR sites on the Gulf Coast would improve the cost/benefit characteristics, but products would take 7-10 days to reach consumers in the Northeast.

A larger product reserve, sized at around 6.7 million bbl to meet the worst weather contingencies, would not be attractive, based on the cost-benefit analysis, unless it were constructed entirely within the existing SPR sites.

Moreover, the study said, the positive economic benefits would be achieved only if the government adopted the policy of releasing the entire volume of the product reserve at the point heating oil prices reached a predefined "trigger price."

It said a more conservative policy of releasing only enough products to bring wholesale prices back down to a predefined "ceiling price" would not provide sufficient benefits to offset the reserve's costs.

The U.S. currently stores only crude oil for emergency purposes, principally to protect the U.S. from import supply disruptions.

The SPR holds 563 million bbl at four sites that are accessible to most refining centers in the country.

Findings

The DOE study started with the premise that the U.S. refining industry cannot be profitably built to a size sufficient to supply seasonal demand for distillate and gasoline from current production, so stockbuilding is required during off-peak seasons for drawdown during periods of heavy demand.

"When inventories fall below planned levels due to very heavy demand, prices rise, and incremental supply is provided either with imports or through increased production from domestic refiners," the study said.

The study examined past instances of very heavy demand and found that, generally, inventories have been sufficient to meet demand above normal levels through the normal workings of the market.

"Looking at a recent winter event, the exceptionally cold December of 1989, the study also concluded that suppliers are responsive to price signals and can import additional stocks of heating oil in 4-7 weeks, albeit after an exceptional price rise in the case of December 1989," DOE said.

"The benefit of a Regional Petroleum Product Reserve (RPPR) would be to protect the economy from the sudden price spikes that signal the demand for additional supplies."

The study also noted heating oil markets in the Northeast are financially linked to other middle distillate products such as jet fuel, kerosine, and diesel fuel, and thus a heating oil price increase has a spillover effect on consumers of other oil products in the northeastern states.

The study concluded that the cost of a 6.7 million bbl RPPR, sized to meet the worst weather contingencies, would exceed its benefits to northeastern states unless it is located at the SPR sites in the Gulf-but it could not be moved quickly to alleviate an unexpected distillate shortage in the Northeast.

It said a hybrid configuration, with 2 million bbl of leased storage in the Northeast and 4.7 million bbl in SPR caverns, would solve the responsiveness problem and would be cheaper than leasing 6.7 million bbl of storage in the Northeast, but the costs would exceed expected benefits unless the government adopts an aggressive drawdown policy.

DOE said the expected benefits of a 2 million bbl RPPR in leased terminals in the Northeast would approximate or exceed its costs, provided that those costs could be reduced by trading SPR crude oil for distillate fill.

"Basing the smaller RPPR in the SPR caverns in the Gulf Coast area would further improve its cost-benefit characteristics, but it would take time to move the products to Northeast markets."

DOE said that consumer cost savings were not included in the macroeconomic benefits calculations because they are generally viewed as transfers within the U.S. economy, but they would total as much as $24-99 million (in inflation-adjusted 1996 dollars), depending on the size of the reserve and its drawdown policy, over the 20-year lifetime of the RPPR.

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