Regional heating oil reserve a solution with its own problems

May 22, 2000
President Bill Clinton on Mar. 18 proposed the establishment of a heating oil reserve for the US Northeast region.

President Bill Clinton on Mar. 18 proposed the establishment of a heating oil reserve for the US Northeast region.

He proposed that it be incorporated as part of the reauthorization by Congress of the Strategic Petroleum Reserve, although he reserved the right to act under his existing authority. Authority for the SPR expired at the end of March, and its reauthorization is part of an omnibus energy bill introduced into Congress last week (see related story, p. 27).

Although Pres. Clinton gave no details, he appears to be calling for the establishment of a 2 million bbl distillate reserve to be located at leased terminals in the Northeast. The 2 million bbl figure was estimated by the US Department of Energy in June 1998, in the "Report to Congress On the Feasibility of Establishing a Heating Oil Component to the Strategic Petroleum Reserve," as the amount needed to cover the 7-10 day period required to move additional supplies of products from the Gulf Coast to the Northeast.

Clearly, the spike in the price of heating oil this past winter triggered demands that the government take action to prevent a repeat, and the president's proposal is an attempt to respond. But there are strong reasons not to rush into it, especially given the potential for perverse effects on overall supply.

Reserve authority

Legal authority for the SPR is provided for under the Energy Policy Conservation Act (EPCA) which expired at the end of March.

EPCA also provides the authority for the president to establish product reserves, including, in this case, a heating oil reserve.

However, the current law restricts the use of the crude oil reserve, and any product reserve as well, only to instances of supply disruption, as determined by a presidential finding. Under EPCA, the president must find that a drawdown is required by a "severe energy supply interruption" or by obligations of the US under its participation in the International Energy Agency. The 3-week, weather-triggered event in the Northeast would not have met this condition.

The temporarily high prices ensured a supply-demand balance while, as described later, setting in motion industry responses that quickly brought prices back down. Until the president made his proposal, the most likely prospect had been that Congress would simply extend the current provisions of EPCA, as it did once before in October. But new legislation possibly broadens the conditions under which a heating oil reserve, or any strategic reserve, can be used. The broader the conditions for use of the proposed heating oil reserve, the greater the risk of perverse effects.

Risks involved

At the beginning of this year, distillate stocks in the US Northeast amounted to about 35 million bbl (28 million bbl in the Mid-Atlantic region and 9 million bbl in New England), an amount toward the lower end of the normal range but still viewed as adequate.

The total of these commercial stocks in place was about 18 times the proposed level of the 2 million bbl Northeast Heating Oil Reserve. The government reserve would become a factor in calculating winter price risks for holders of these inventories. The more aggressive the potential use of the government reserve, which political pressures are likely to intensify, the greater the skewing of risk toward the downside and the greater the disincentive for the private sector to hold inventories. After all, while the government would be capping the upside risks, the downside risks, which have materialized all too frequently, would remain. Thus, a government reserve, especially if perceived as easily triggered, could potentially lead to no net gain in inventories, perhaps even a reduction.

Price spike

The price spike this past winter, while painful for consumers without price protection plans, did plant the seeds of its own demise. At the onset of the price spike (the week ended Jan. 21), distillate imports averaged about 150,000 b/d.

Three weeks later, imports surged to over 500,000 b/d, and 2 weeks after that, to over 700,000 b/d. This was a significantly faster industry response than the 4-7 weeks estimated as the response time to a price spike by DOE in its 1998 report. An aggressive use of a government reserve to hold down prices would hold down the supply response as well, potentially prolonging the problem. Any trigger mechanism for the reserve would involve the setting in advance of a specific price (or a price differential vs. crude) at which reserves would be released.

This price, known to all participants in the market in advance, sets a cap on how much would be paid for additional commercial supplies from foreign and domestic sources. This would negatively impact the incentive to obtain new supplies during periods of greatest need.

It should also be kept in mind that this winter's surge in imports, and the subsequent downturn in heating oil prices, was accomplished despite growing concerns about worldwide crude supplies and low levels of inventories in all major consuming regions.

Supply constraints

As Petroleum Industry Research Foundation Inc. pointed out in a recent report, the episode revealed potential constraints in meeting peak demand for overall energy in the Northeast, particularly peak demand for natural gas-and not just heating oil.

Indeed, oil is the region's safety valve at times of peak demand and served that role again, although at a high price. Pres. Clinton alluded to this issue when he noted in his statement of Mar. 18 that DOE is studying "ellipsethe effects of interruptible natural gas contracts on the home heating oil market in the region."

By looking to Congress and not using his existing authority to establish such a reserve, the president is allowing more time for careful assessment of the proposal. This is certainly needed in view of the risks and complexities involved.

As the president said in response to a related question about use of the SPR, he wanted to avoid "taking shortsighted and risky steps now we might regret later."

The same caveat applies to the heating oil reserve.

The Authors

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Larry Goldstein is president of PIRA Energy Group and president and a member of the board of the Petroleum Industry Research Foundation Inc. (PIRINC), NewYork. He has been a member of the Petroleum Advisory Committee of the New York Mercantile Exchange and a contributor to studies by the National Petroleum Council. He served as a board member and treasurer of the Scientists Institute for Public Information.

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Ronald B. Gold is a consulting senior adviser to PIRA Energy Group and a consulting vice-president of PIRINC. He retired from Exxon Corp. at yearend 1997, where he was company economist and manager of the Energy Outlook division for Exxon Co. International. Gold also has worked for the US Treasury Department, Office of Tax Analysis, and was an assistant professor of economics at Ohio State University. Gold has an undergraduate degree from Brooklyn College, City University of New York, and an MA and PhD in economics from Princeton University.

Adapted from the PIRINC March 2000 report,"What Happened to Heating Oil?"

Senate bill would limit US oil dependence to 50% by 2010

US Sen. Majority Leader Trent Lott (R-Miss.) has filed an omnibus energy bill that includes placing a limit on US oil import dependence to 50% by 2010.

The bill was drafted by a 10-senator task force headed by US Sen. Frank Murkowski (R-Alas.), energy committee chairman (see Watching Government, p. 28).

Murkowski disclosed details of the legislation earlier this month at the annual meeting of the US Energy Association, which coordinates US participation in the World Energy Council and sponsors energy partnership programs with foreign nations.

Bill's details

Murkowski said the measure would limit US oil import dependence by increasing domestic energy supplies and conservation.

The US Secretary of Energy would be required to report annually on the nation's progress toward meeting the 50% goal. US dependence on foreign petroleum currently is about 56%.

The bill would open more federal lands to exploration, provide royalty relief for exploration in US frontier areas, and allow exploration on the Arctic National Wildlife Refuge Coastal Plain in northeastern Alaska.

Like a bill the House recently passed, it would reauthorize operation of the Strategic Petroleum Reserve (SPR), create a heating oil stockpile in the Northeast US, and provide fiscal relief to keep marginal wells in operation when low prices make them uneconomic to operate.

The legislation would not allow SPR drawdowns unless the Secretary of Defense certifies that a national security emergency justifies them. It also contains provisions for home weatherization tax credits in the Northeast, energy conservation measures, and measures to facilitate more natural gas use.

Murkowski said the bill would be referred to his committee and the Senate finance committee.

The senator said the energy committee will begin marking up a retail electricity decontrol bill May 17, and, "Surprisingly enough, there's quite a bit of agreement on many of the issues."