Much Ado about the Strategic Petroleum Reserve

Last week, the news was full of reports of Congress calling for the president to stop filling the Strategic Petroleum Reserve. Congress' argument was that it is irresponsible to take oil off the market to fill the SPR when crude and gasoline prices are so high. The counterargument was that failing to top up the SPR would at best save consumers pennies on the gallon, and at worse have no effect on crude or gasoline prices, while simultaneously putting the nation at risk in the future.

All this left us with three questions: 1) What exactly is the Strategic Petroleum Reserve? 2) How is it used?; and 3) Will this action make any difference in the grand scheme of things?

The Strategic Petroleum Reserve

The SPR was established in 1975 after the oil crisis of 1973-1974. It is made up of specially created storage facilities in salt domes along the Gulf Coast. Despite the fact that Fox News shows pictures of giant steel tanks in Texas, we're talking about underground salt domes 2,000 to 4,000 feet below the earth's surface. As it was originally conceived, the SPR was built to hold 500 million barrels to be released only during times of extreme market panic (like a protracted OPEC stalemate, Armageddon or cancelling "Lost" before we find out who Jacob is). Since that time, the capacity of the SPR has increased to 727 million barrels - 58 days of supply at our nation's current rate of consumption.

In 2005, President Bush signed the Energy Security Act of 2005, paving the way for the expansion of the SPR's capacity to 1 billion barrels. The digging for this expansion should be completed sometime within the next eight years or so.

The U.S. is not the only country in the world that has a government commodities reserve; we just have the largest one - we think. Getting accurate, conclusive data about the world energy market is a hard thing to do. Estimates and projections frequently differ among various international agencies, if you can get any information at all. As Eduardo Lopez of the International Energy Agency said:

"China appears to be creating a strategic stockpile of oil, but has never acknowledged it."

For the countries that are members of the IEA (think OECD countries), the picture of government-controlled stockpiles looks something like this:

Other members of the IEA may have strategic reserves in their countries, but they are industry-controlled, rather than government-controlled. (Yes, even though you can't see the red - Portugal and Slovakia do have small government-controlled strategic reserves.)

Withdrawals

The most recent, significant drawdowns of the SPR occurred in 1991 because of the Persian Gulf War, and then again in 2005 because of oil supply disruption during Hurricane Katrina. In 1991, 17.3 million barrels were released (sold). In 2005, after Hurricane Katrina, 30 million barrels were offered for sale, but only 11 million barrels were sold to five companies through a bidding process.

Any oil sold to companies is repaid in kind by the companies at a later date, along with a premium so that the SPR ends up ahead on the transaction as far as inventory is concerned. By the way - all of the oil released after Hurricane Katrina has been replenished.

Other drawdowns can, and do, occur, usually for temporary supply disruptions so small they don't make much of a splash on the front page. Refill occurs quickly and the nation goes right along with nary a hiccup.

Deposits

Filling the SPR's additional capacity tends to occur through royalty-in-kind transfers. Companies that lease oil rights from the federal government for drilling on the Outer Continental Shelf are required to pay the government a fee of equivalent of 12.5% to 16.7% of the oil produced there. Those payments can take the form of barrels of crude oil or the monetary equivalent, whichever the government requires. These RIK transfers are what Congress was calling to be suspended, because they do, quite literally, keep U.S. oil on the market.

Current Status

The government keeps a close eye on the inventory of the Strategic Petroleum Reserve - and you can too. This handy little site gives daily updates as to the number of barrels and their breakdown (either sour or sweet). As of May 16, the SPR contained 702.7 million barrels of oil with 39.93% sweet and 60.07% sour. The amazing thing is the oil that resides in the SPR was bought for an average price of $28.42 per barrel. Ah, the good ol' days.

Congress decided that the best thing they could possibly do with their collective time was drafting and then passing a bill halting the filling of the SPR until the price of crude drops below $75 - presumably "hell freezes over" is politically incorrect language. The president, though against the idea, said he wouldn't veto the bill and the Department of Energy (the guys who actually deal with oil on a day-to-day basis) said that they would not sign any contracts to receive oil between August and December of this year.

Should be a big deal, right? But despite the nonstop crawl at the bottom of CNBC, the market didn't even blink.

This was such a nonevent to the market it seemed invisible - as it should be. Based on current estimates, we get the equivalent of 70,000 barrels per day of oil from our RIK transfers.

Adding 70,000 barrels per day into the market makes virtually no difference. At best, the EIA estimated that it could bring the price of crude down $2 a barrel - that would assume that there is not a single thing going on in the world but the addition of those barrels.

But these seem not simple times. The price of crude continues to go up, not because of any real, hard news such as massive supply disruptions, but seemingly just because the political environment suggests it can. The addition of a few measly barrels just can't stand up to the kind of momentum that the market seems to be feeling. Our call is that it's going to take a major demand change to slow the ever-progressing upward trend - or a few more Sugar Loaf discoveries that even the supply optimists aren't counting on.

So what's the big deal? In the end, Congress gets to look like they're heroes to the American people, trying to do something to ease Americans' pain at the pump. Hey, whaddya know, they're all senators, and it's an election year. The Senate voted 97-1 on this, with the only dissenter (Allard, R-Colo.) heading for retirement.

Everyone gets to look like they stood up to the president, add another sound bite to their nightly gigs and the market goes merrily on its way. Don't you just love being an investor in an election year?

Comments

[Jack Yetiv:]

The SPR contains much more than a 58-day supply because it cannot be pumped at the rate of 12.5 million barrells per day (which is basically our daily import rate).

As I recall, it can only be pumped at half that rate or less, meaning it would last 4 months instead of 2. It would also mean we would have to conserve majorly if all of our imports were interrupted.

Of course, the reality is that even with a major supply disruption in the Middle East, Canada, Mexico and Venezuela--our major import sources--would keep on pumping.

Of course, oil would spike tremendously in the case of a big disruption, so conservation would be forced on Americans via the price of oil-based products.

Jack

2008 May 21 09:14 AM

[AFK:]

Even though you claim there is little correlation between the oil going to the reserves and the market price, the chart you reference tells a very different story. For the past few weeks we have seen Oil prices climb based on supply estimates. You indicate that the recent government report shows a decline in crude supplies which resulted in the oil prices topping $130 a barrel. The website shows that the amount of crude shipped to the Strategic reserves in MAY increased 2.5 times that of April and 8 times as much as in other months. To me that shows a direct correlation and intentional market manipulation. In this overinflated market, what happened 3-4 years ago is likely to be amplified considerably as shown in teh recent reserve transfers and their affect on supplies.

2008 May 21 11:55 AM

[jackooo:]

If the Bush administration opened Alaska to drilling, which they just did with leases being signed last week before the polar bear being listed as endangered, do you think oil would drop in price?
If those wells started producing tomorrow, instead of 8 years from now, what would Exxon or Chevron sell the oil for in dollars?
Not for $40/barrel. Not for $100/barrel. They would sell it for the most they could get for it. The extra capacity would be a blip on the world market so the supply would be nil.
Now. If the leases were sold by the govrnment and had a clause in it that said you sell it to only the USA at cost plus a percentage then that would work. But to helter skelter sell them leases to drill and then they sell the oil to other countries at top dollar while ruining the ecological system with pollution and the destruction of lands, well it doesn't make "cents" to me.

2008 May 21 12:40 PM

[Texbuz:]

The SPR Program commenced due to the threat of the Russians during the cold war. Not the current problem of competition for a diminishing supply world wide for crude oil. It was planned and put into operation on a FAST TRACK concept.

Salt domes were well known suitable structures for storage and several voids in the salt domes existed enabling fast action for storage and close to the Gulf Coast refiniers as well as pipelines serving the Gulf Coast and Mid-Continent regions as well as Gulf Coast import terminals. The SPR Program was conceived in the interest of National Security due to extensive saber rattling.

Now that the Cold War is a distant memory the SPR Program is still a vital assest as now potential interruptions will be due to the inability to provide an uninterrupted supply due to the emergiing markets world wide and the diminishing supply of oil for the volume of oil that our economy requires under our current patterns of useage. The inventory concepts in the capitalist society is to be "Just in Time" and that is now often about 15-20 days.

The problem with expanding the SPR Program based on the Gulf Coast Salt Domes is short sighted. The use of hard rock storage facilities closer to the Mid-Continent Refineries is vital as the pipeline capacity to the Mid-continent is historically inadequate in times of short supply.

There are no crude oil pipelines serving the East Coast refineries from domestic crude oil supplies. All crude oil serving the east coast refiners comes in by ocean going tankers.

Current Salt Dome Storage facilities requires the use of fresh water is remove the oil from the salt caverns and in the process the salt caverns are enlarged and eventually will collaspe. To avoid the collaspe the current design provides for only four withdrawals. Not a long term concept that we now are faced with.

The SPR design and location of storage concentrated on the Gulf Coast during the Cold War short term potential problem full filled a potential threat but inadequate for a program that is now needed to provide back-up for a world wide increase in demand and a diminishing supply of crude oil. That will last for decades until massive energy alternatives are conceived and put into operation

Therefore hard rock caverans located near the east and west coast refineries is a must. Besides the fact that a one billion barrel reseserve for the Gulf Coast refineries and zero for the w
West and East Coast is not in the national interest.

Diversification is a basic guideline.

2008 May 21 06:20 PM