Perhaps no national security strategy reinforces the ability of the US to defend itself and maintain reasonably normal economic activity during a disruption in oil supply more than the Strategic Petroleum Reserve (SPR). The Department of Energy calls the emergency crude oil reserve, created in 1975 in response to the Arab oil embargo 2 years earlier, "the nation's first line of defense against an interruption in petroleum supplies."
Since 1985, SPR has been tapped twice to supplement supply and minimize economic damage during an oil shortage: in 1991 (during operations Desert Shield and Desert Storm in Kuwait) for 21 million bbl, and in 2005 for 11 million bbl (after Hurricane Katrina). DOE plans to expand SPR storage capacity to 1 billion bbl by 2018 from the current 727 million bbl.
SPR uses four underground salt caverns along the Gulf Coast holding 724 million bbl of federally owned oil. This strategic supply, which is enough import cover for nearly 60 days, has a maximum drawdown rate of 4.4 million b/d for 90 days. Fig. 1 illustrates the significance of this amount in satisfying US oil requirements—including the ability to maintain national defense.
RIK program
Since 1999, SPR oil generally has been filled with crude acquired by the government through the royalty-in-kind (RIK) program in use on federal offshore leases. A recent decision by the interior secretary to phase out the RIK program will return SPR purchases to a cash basis.
Sales of SPR occur at the discretion of the president. They begin with notices of sale outlining the details, after which prospective buyers submit bids, which are subject to DOE review. The time between a presidential decision to release SPR oil and physical entry of the oil into the market is about 2 weeks.
In May 2008, the federal government suspended SPR fill, the rate of which had been about 70,000 b/d, in an effort to reduce prices. The futures price for light, sweet crude on the New York Mercantile Exchange at the time was above $120/bbl. The SPR suspension occurred under a law that prohibited further additions to the stockpile until the price fell below $75/bbl.
In his 2007 book, The Strategic Petroleum Reserve: US Energy Security and Oil Politics, 1975-2005, Bruce Beaubouef confirms SPR drawdowns mitigate the economic damage of a disruption in oil supply in four basic ways. Drawdowns, according to Beaubouef:
• Help stabilize and lower oil prices by discouraging excessive speculation, panic buying, and hoarding.
• Reduce inflation, wealth transfers, loss of industrial output, and "consequential economical damage" by mitigating price increases.
• Play a key role in mitigating and reducing, and perhaps preventing, the type of socioeconomic damage that occurred in the 1970s by alleviating oil shocks.
• Allow the US economy time to adjust, recover, and operate more closely to predisruption levels by helping to replace lost supply.
SPR issues
The SPR, however, faces several issues, some of which have been in effect since the program's inception.
One of those issues is uncertainty. Oil ShockWave, a scenario exercise developed by Securing America's Future Energy Future and the National Commission on Energy Policy, in 2005 examined the implications of and possible responses to an oil shortfall, finding that SPR offers "some protection against a major supply disruption." But it said the protection is "limited in both scope and duration."
Participants, a group of formerly high-ranking federal officials, verified that it was "extremely difficult" to reach consensus on when SPR is appropriate for use. The decision to withdraw crude from strategic storage is difficult and somewhat controversial, as the inventory is ambiguously meant to be tapped during a "severe energy supply interruption."
For example, Oil ShockWave participants were uncertain as to whether high prices by themselves constituted the type of emergency SPR is intended to help assuage. Further, the use of the reserves could confirm oil traders' fears of a major crisis, causing prices to increase rather than decrease.
There was broad agreement, however, that SPR could help the US response to an oil shortage by offering some short-term relief. An overall lack of experience in the use of SPR makes a drawdown imperfect and uncertain.
That oil is a global commodity sold on an international market also creates problems for the SPR. Supply disruptions anywhere raise prices everywhere. Therefore, there is concern that unilateral US action, by drawing upon SPR to reduce prices, would benefit consumers worldwide but would be paid for largely by American taxpayers.
Like events after Hurricane Katrina, any use of SPR would have to be coordinated with similar actions by other consuming countries. Still, the effects of globally coordinated inventory withdrawals might be offset by output cuts by producing nations. And there is no guarantee that SPR oil made available will find buyers.
The Congressional Research Service reports there are too many factors involved to predict the effect of an SPR drawdown would have on oil prices.
Oil quality is another issue. According to the Government Accountability Office (GAO), 40% of the oil in SPR is classified as "light sweet crude," and 60% is classified as "light sour crude." These oil grades are not optimum feedstocks for the many US refineries that have been upgraded to process heavy oil.
GAO concluded SPR use could decrease domestic gasoline production by as much as 11% and diesel production by 35%. Of the approximately 5.6 billion bbl of oil that US refiners ran to distillation units in 2006, GAO reports an estimated 2.24 billion bbl (40%) was heavier than that stored in SPR.
Recommendations
These issues suggest recommendations for managing the SPR.
• Store heavier oil. To ameliorate problems of compatibility with US refineries, a DOE study indicated that SPR should have at least 10% heavy oil. An added benefit of increasing the heavy-oil share of the storage volume would be lower per-barrel costs of purchased crude.
• Base SPR purchases on dollar-cost averaging. GAO suggests "filling SPR by acquiring a steady dollar value of oil over time rather than a steady volume of oil over time as has occurred in recent years."
The constant-quantity path of repeatedly purchasing the same monthly amount is a detriment in times of high prices and makes SPR filling more vulnerable to market volatility. Dollar-cost averaging, on the other hand, offers DOE a monthly allowance, meaning more oil can be bought when prices are low and less when they are high.
• Reexamine procurement. Oil companies participating in the RIK program, until it phases out, should be given more flexibility to defer their SPR deliveries when filling would substantially tighten the market or when a price decline is expected. The companies could then provide additional barrels when deliveries resume (DOE has permitted some delivery deferments in the past). Further, GAO notes the evaluation of bids has been more adequate for cash purchases than for RIK exchanges. Cash purchases are generally seen as more transparent and cost-effective.
Pivotal role
SPR drawdowns will continue to play a pivotal role in protecting America's national security. In fact, SPR is the most functional energy security policy tool at hand in the US. It helps maintain the country's petroleum-based economy by making an oil crisis a short-term phenomenon.
Despite a recent decline, DOE's Energy Information Administration projects global demand will jump from 86 million b/d in 2010 to 107 million b/d in 2030.
With some exceptions, major producers are decreasingly dependable and cannot be expected to assuage the effects of a large supply disruption. Physical supply from strategic storage can abate market panic in an emergency.
Drawdown issues must be resolved.
Bibliography
Beaubouef, Bruce, The Strategic Petroleum Reserve: US Energy Security and Oil Politics, 1975-2005, Texas A&M University Press, 2007.
Congressional Research Service, The Strategic Petroleum Reserve: History, Perspectives, and Issues, http://fas.org/, Sept. 19, 2008.
Energy Information Administration, International Energy Outlook, US Department of Energy, May 2009.
Secure Energy, Oil Shockwave: Oil Crisis Executive Simulation, www.secureenergy.org, 2005.
US Department of Energy, Inspection Report: Review of Security at the Strategic Petroleum Reserve, June 2005.
US Government Accountability Office, Strategic Petroleum Reserve: Options to Improve the Cost-Effectiveness of Filling the Reserve, Feb. 26, 2008.
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