Order Code RL32358
CRS Report for Congress
Received through the CRS Web
The Strategic Petroleum Reserve:
Possible Effects on Gasoline Prices
of Selected Fill Policies
April 19, 2004
Robert Bamberger
Specialist in Energy Policy
Resources, Science, and Industry Division
Robert Pirog
Analyst in Energy Economics and Policy
Resources, Science, and Industry Division
Congressional Research Service ˜ The Library of Congress
The Strategic Petroleum Reserve: Possible Effects on
Gasoline Prices of Selected Fill Policies
Summary
The Strategic Petroleum Reserve (SPR), authorized by the Energy Policy and
Conservation Act (P.L. 94-163), was originally intended to provide a domestic stock
of crude oil to be used in emergency situations when the supply of crude oil to the
United States is disrupted. In November 2001, President Bush ordered that the SPR
be filled to its current capacity with royalty-in-kind (RIK) oil, the government’s share
of oil produced from federal leases. In the face of high prices for crude oil and
gasoline, the policy has been challenged as a contributing cause of higher prices.
Some policymakers have been urging suspension of RIK deliveries to the reserve for
the remainder of 2004, arguing that it would help to lower the cost of gasoline.
This report examines the factors that are currently influencing crude oil and
gasoline prices, and reviews the extent to which prices might be correlated with SPR
fill policy. If RIK oil was released to the market, gasoline prices might be affected.
Since crude oil is a raw material in the production of gasoline, a reduction in the
price of oil might pass through to the price of gasoline. To the extent that the
capacity to refine additional barrels of crude directed to the market exists, and the
diverted RIK oil is not offset by reduced crude oil imports, consumers might benefit.
However, the amount of RIK oil, relative to the total market, is small, and when
coupled with other market dynamics, the effect of changes in SPR fill policy on crude
and product prices could be only minimal.
Conditions in the gasoline market, including strong demand, high refinery
capacity utilization rates, fragmented regional gasoline specifications, scarce, high
cost imports as well as low current inventory levels point to the continuation of high
gasoline prices even if oil prices decline somewhat. Although the price of oil
influences, and is a component of, the price of gasoline, a complex interaction of
many factors determines price.
A drawdown of the SPR — in addition to a deferral of RIK fill — is a further
policy option, but not analyzed in depth here. Benefits might vary, depending upon
the ability of refineries to absorb additional crude, and the amount of additional crude
made available. However, if one considers that refining capacity is already strained
and unlikely to benefit from extra crude supply, any softening in oil prices from a
drawdown would be unlikely to be passed along in full to consumers. This report
will not be updated.
Contents
SPR Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Oil Markets and Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Gasoline Markets and Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
The Strategic Petroleum Reserve: Possible
Effects on Gasoline Prices of Selected Fill
Policies
The price of gasoline reached nominal record levels in March 2004. The price
of crude oil surged to over $38 per barrel, before receding during the first week of
April 2004. During the week of April 5, prices rose to $37 per barrel on news of a
broadened insurgency in Iraq. These high prices have raised concern among
consumers and policy makers. Crude oil prices are an important component of
gasoline prices, but not the only one. Conditions within the gasoline market itself,
including strong demand, as well as supply restrictions, are also adding upward
pressure to the price. This report analyzes one strategy that has entered public debate
as a strategy to mitigate gasoline prices: the diverting of scheduled deliveries of
royalty-in-kind (RIK) oil to the SPR.
SPR Background
Congress authorized the Strategic Petroleum Reserve (SPR) in the Energy
Policy and Conservation Act (EPCA, P.L. 94-163) to help prevent a repetition of the
economic dislocation caused by the 1973-74 Arab oil embargo. Physically, the SPR
comprises five underground storage facilities, hollowed out from naturally occurring
salt domes, located in Texas and Louisiana. Although authorized to a level of one
billion barrels, current storage capacity is 700 million barrels, and current fill levels
are approximately 650 million barrels.
Until 1995, Congress appropriated funds for purchase of SPR oil, and what was
then known as the Defense Fuel Supply Center contracted for deliveries. Crude oil
from Mexico and the United Kingdom accounted for roughly 65% of purchases from
1978 to 1995. Volumes and fill rates varied over the years, reaching a peak
exceeding 300,000 barrels per day (b/d) during the Reagan Administration. The
urgency attached to the SPR program during the 1980s and 1990s often tracked
broader energy concerns. Periods of volatility in energy prices drew a focus on SPR
fill policies. During times of relatively low prices and adequate supply, the SPR fill
rate declined, or was even suspended. Congress and the Clinton Administration
agreed to suspend purchases after FY1994.
From 1995 until the latter part of 1998, sale of SPR oil, not acquisition, was at
the center of debate. There were three sales of SPR oil initiated during 1996, totaling
28.1 million barrels. The first of these sales was for the purpose of financing the
decommissioning of the SPR storage site at Weeks Island. Other sales were directed
by Congress for the purpose of budget deficit reduction. By the late 1990s, following
a reduction of the annual federal budget deficit, and a major drop in crude oil prices,
there was new interest in replenishing the SPR to further energy security objectives,
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and as a possible means of providing price support to domestic producers who were
struggling to keep higher-cost, marginal production in service. Secretary of Energy
Bill Richardson requested that the Office of Management and Budget (OMB) include
$100 million in the FY2000 budget request for oil purchases. The proposal was
rejected.
When OMB turned down the Department of Energy’s (DOE’s) request to fund
purchases for SPR oil in FY1999, DOE suggested as an alternative that a portion of
the royalties owed to the government from oil leases in the Gulf of Mexico be
accepted “in kind” (in the form of oil) rather than as cash payments. The Department
of the Interior (DOI) was reported to be unfavorably disposed to the royalty in kind
(RIK) proposal, but a plan to proceed with such an arrangement was announced on
February 11, 1999. The intention was to replace the 28 million barrels sold in the
mid-1990s. It was estimated that, at a rate of 100,000 b/d, it would take about 10
months to replace this volume. At its inception, the RIK plan was greeted by the oil
industry as a well-intended and helpful first step.
The initial contracts were signed at the end of March 1999 with Texaco, Shell,
and BP-Amoco for a total of 3.5 million barrels, and they provided for an adjusted
volume of oil reflecting the quality differential between the oil to be delivered and
the oil produced from the lease tracts. Competitive bids were invited for a second
round, and contracts were awarded in mid-June 1999 for an additional 9.3 million
barrels.
The terrorist attacks on the United States on September 11, 2001 accelerated
interest in acquiring crude for the SPR. Some thought that, depending on the nature
of the U.S. response and potential reprisals, the possibility existed that a politically
driven interruption in oil exports bound for the United States might occur. On
November 13, 2001, President Bush ordered the filling of the SPR to its full capacity
of 700 million barrels, relying on RIK oil. During 2002, nearly 40 million barrels of
oil were delivered to the SPR, some of which was oil returned under the terms of a
“swap” in the fall of 2000.1
Deposit of 40 million barrels into the SPR during 2002 was criticized in a report
released on March 3, 2003, by Senator Levin, prepared by the minority staff of the
U.S. Senate Permanent Committee on Investigations. The study argued that this
increment of SPR fill had been a major contributor to oil price increases during that
1 Stocks of home heating oil were low as the end of summer 2000 approached, and there was
concern about the fresh pressure that escalating crude prices, colder weather, and anticipated
refinery maintenance might have on home heating price and supply during the winter. On
September 22, 2000, President Clinton announced a swap of 30 million barrels of oil from
the SPR, and contracts were awarded on October 4, 2000. Interested parties bid to borrow
quantities of not less than 1 million barrels. Contracts were awarded on the basis of how
much oil bidders offered to return to the SPR.
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year.2 A number of industry analysts dismissed the study, arguing that the quantity
of SPR fill was not significant enough to have driven the market.3
However, in light of tightness in world oil markets and increasing prices (due
in some measure to an interruption in roughly 1.5 million b/d in oil exports from
Venezuela), the Bush Administration agreed to delay deliveries scheduled for late
2002 and the first months of 2003. The Administration had intended to accept a total
of 3.9 million barrels of RIK crude oil during April 2003, an average of 130,000 b/d.
On March 4, 2003, DOE delayed delivery of all but 15,000 b/d. With the end of the
military phase of the war in Iraq and little effect on oil markets, deliveries of RIK oil
were resumed in the spring of 2003, as was delivery of oil still owed from the swap
in 2000.4 In early August 2003, Senator Levin reiterated his charges in a letter to
Secretary of Energy Abraham, requesting that DOE suspend purchases for the SPR
until crude oil prices declined.5
On March 11, 2004, during debate on the FY2005 budget resolution, the Senate
called for a suspension of deliveries and a sale, instead, of 53 million barrels of RIK
oil.6 Proceeds (estimated at $1.7 billion) would be used for deficit reduction and
increased homeland security funding for states. The Administration has indicated that
it is continuing with RIK fill, and on March 24, 2004 announced the signing of
contracts for the delivery of 18 million additional barrels. In this instance, and during
the remainder of the contract, the DOE will be furnishing slightly more than 100,000
b/d to the signatories and receiving a slightly lower volume of higher quality crude oil
in return. Deliveries of RIK crude oil to the SPR are currently scheduled through
October 2004 and are to vary from month to month, ranging between 1 to 6 million
barrels.7
Oil Markets and Price
Determining whether the cancellation, delay, or market sale of the scheduled
delivery of approximately 25 million barrels of RIK crude oil to the SPR between April
2004 and October 2004 will have an effect on gasoline prices requires analysis of the
link between the price and supply of crude, as well as the link between crude oil and
gasoline prices in U.S. markets.
2 U.S. Congress. Senate. U.S. Strategic Petroleum Reserve: Recent Policy Has Increased
Costs To Consumers But Not Overall U.S. Energy Security. Report prepared by the
Permanent Subcommittee on Investigations. Committee on Governmental Affairs. S.Rept.
108-18. March 5, 2003. p. 2.
3 See, for example: Petroleum Industry Research Foundation, Inc. The SPR, the Royalty in
Kind Program, and Oil Prices. August 2003.
4 Obligations to the SPR from the “swap” were completely covered by January 2004.
5 Platts Inside Energy, August 11, 2003: p. 3.
6 This is roughly the volume of oil yet to be delivered to the SPR to reach capacity.
7 T h e c u r r e n t d e l i v e r y s c h e d u l e m a y b e m o n i t o r e d a t
http://www.fe.doe.gov/programs/reserves/ under the link for “Current Inventory.”
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Net imports of petroleum to the United States averaged an estimated 11.2 million
barrels per day (mbd) during 2003, while total daily petroleum consumption exceeded
20 million barrels.8 While daily volumes will fluctuate, scheduled deliveries of RIK
oil to the SPR between April and the end of October 2004 will average roughly
125,000 b/d. If diverted to the market, this would represent less than 1% of U.S.
demand for oil. The amount of oil potentially entering the market, relative to the size
of the market, is the reason that some analysts discount the practical importance of
altering the planned SPR fill.9
Other analysts have made broader assertions that stockpiling and policies
governing drawdown of the SPR — along with strategic stocks held elsewhere in the
world — have added to the price of oil in world markets. In a statement before a
California panel discussion on gasoline prices, Philip Verleger estimated that SPR fill
policy had raised crude oil [prices between $5-$10/barrel by the end of 2003.10
The March 2003 study by the minority staff of the Permanent Subcommittee on
Investigations, of the relationship between SPR fill policy and price argued that the
addition of 25 million barrels to the SPR during late 2001 and early 2002 contributed
to oil price increases. During a one-month period in mid-2002, the study concludes,
crude oil price increases stemming from deposits to the SPR imposed an additional
energy price burden on consumers ranging between 500 million and one billion
dollars.11 The study predicted that maintenance of the Administration’s fill policy
would contribute to higher prices in 2003 as well.
Consistency between links in the oil supply chain, from the oil market, to the
refineries, to the gasoline market, might also be important in determining the extent
to which oil, and ultimately gasoline, prices would be affected by rescheduling RIK
deliveries to the SPR. For example, if refining capacity were not readily available to
process released oil, because refineries were near maximum capacity, the result might
be that U.S. imports of crude oil would decline as refiners substitute RIK oil, yielding
no additional new product supply on the market.
The other side of these arguments is that in a tight oil market, even a relatively
small change in supply could have a disproportionate effect on price. The Organization
of Petroleum Exporting Countries (OPEC) however, asserts that the market is not
experiencing supply tightness. They point to plentiful supplies of heavy, sour crude,
8 U.S. Department of Energy. Energy Information Administration. Monthly Energy
Review. March 2004.
9 American Petroleum Institute, “API Update to Congress on Fuel Supplies, Market
Conditions.” April 2, 2004.
10 Goldman-Sachs Commodities Weekly, January 16, 2004, p. 5. Philip K. Verleger, Jr.,
“Statement for Attorney General Lockyer’s Panel Discussion on California Gasoline
Prices.” March 11, 2004. Verleger asserts that SPR policy since the fall of 2001 has resulted
in increases in crude oil prices of as much as $8 per barrel.
11 U.S. Congress. Senate. U.S. Strategic Petroleum Reserve: Recent Policy Has Increased
Costs To Consumers But Not Overall U.S. Energy Security, p. 2.
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the type sold by many OPEC producers, while recognizing the market for light, sweet
crude oil is tighter.12
Isolating the effect of any single causal factor in the workings of the oil market is
difficult. The market is characterized by complex multi-causality that reflects both
long and short run influences. Daily market price perturbations suggest that it is likely
that any change in energy policy, including one on SPR fill rates, could have some
immediate effect on the price of crude oil, due to the price sensitivity of spot and near
term futures prices to changing expectations. Whether the initial price response would
last long enough to translate into a change in gasoline prices for consumers would
depend on whether the underlying demand and supply fundamentals were tipped in the
direction of excess supply. But, it would also be difficult to separate out the effect of
other developments during the same period that also may have had some bearing on oil
and product prices.
The events of March 31, 2004, provide a good example of the complex, and
sometimes contradictory, short term effects of changing market forces on price. On
March 31, 2004, the price of oil, measured by the May delivery, light, sweet crude
futures contract traded on the New York Mercantile Exchange (NYMEX), closed lower
by $0.49 per barrel, or a decline of about 1.5%, at $35.76. On the same day, OPEC
ministers, meeting in Vienna, reaffirmed their intent to lower their production limit to
23.5 million barrels per day on April 1, a decline of 1 million barrels per day, which,
if effective, might tighten oil supply and push prices upward. However, other factors
also affected the market that day. The EIA announced that stocks of crude oil held by
refiners unexpectedly rose by 5.7 million barrels, to 294.3 million barrels, for the week
ended March 26, the highest value attained since August 2002. This news seemed to
offset the OPEC actions, yielding the fall in price.13
Longer term demand and supply factors also filter into the price setting process.
The persistently high price of crude oil in 2004, above the stated OPEC target price
range of $22 to $28 per barrel, has been widely attributed to demand growth that has
exceeded forecasts, especially in the United States and China.
Expectations and psychological factors also play a role in price formation. When
the Senate passed a bipartisan sense-of-the-Senate resolution (sponsored by Senators
Levin and Collins) to the 2005 budget resolution that would direct the government to
cancel delivery of RIK oil and divert 53 million barrels to the market, the price of crude
oil futures fell $0.59/barrel. The futures price then rose $0.40/barrel only a week later
on the day that the administration announced that it intended to keep filling the SPR
as planned, even though prices were at a near record high level. How much of these
price movements should be attributed to the Senate action or the Administration
response is arguable in light of the many other factors cited here that may bear on daily
movements in market prices.
12 Oil Daily, “Opec Looks Set to Stick to April Target.” Vol. 54, No. 61, March 31, 2004.
p.1.
13 Some also argue that speculation plays some part in the movement of crude and product
prices, and that these observed prices may not always be a strict measure of current or
anticipated supply.
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A drawdown of the SPR — in addition to a deferral of RIK fill — is a further
policy option, but one not analyzed in depth here. Depending upon the ability of
refineries to absorb additional crude, and the volume of the drawdown, the benefits
might vary. However, it could be argued that refining capacity is already strained and
unlikely to benefit from a deferral in SPR fill. Thus, in this circumstance, any
softening in the price of crude from a drawdown is unlikely to be passed along in full
to consumers.
Gasoline Markets and Price
According to the Energy Information Administration (EIA), crude oil accounts for
approximately 40% of the cost of gasoline at the pump.14 The remaining components
of the price per gallon are federal and state taxes (about 30%), distribution and
marketing costs (about 13%), with refining costs and profits accounting for a variable
residual. Along with the price of crude oil, refining profit margins and costs have been
volatile in recent years.15 Conditions may now exist in the gasoline market that would
tend to keep prices high, independent of crude oil prices.16
Since no new refinery has been built in the United States in over 25 years,
expansion of capacity to meet growing product demand has come from incremental
expansion of existing facilities and increasing the rate of capacity utilization. Over the
past decade, capacity utilization, on average, has been greater than 90%. The most
recent data for 2004 show the normal seasonal dip in capacity utilization as refiners
prepare for the summer driving season and perform scheduled maintenance, with
capacity utilization averaging 90.6% in January and 89% in February 2004, higher
values than the 87.2% and 87.3% for January and February 2003.17 High utilization
rates imply very little flexibility in the system to expand production if a bottleneck
appears anywhere else in the supply chain or if market supply of crude oil increases.
If RIK crude oil entered the market and did not displace supply from other
sources, and if refinery capacity were available to produce more gasoline for the
market, it is likely that consumers would gain. Increased supply would likely help
reduce price, and this additional supply could be used to replace high cost imported
gasoline.
Adding to the tightness in regional gasoline markets is the specialized nature of
gasoline specifications. In 2003 there were 20 different gasoline blends marketed in
14 Energy Information Administration, “Primer on Gasoline Prices.” September 2003. p 2.
15 See CRS Report, RL32248, Petroleum Refining: Economic Performance and Challenges
for the Future, March 1, 2004, for a more complete analysis of the refining industry.
16 For a more detailed treatment of the factors and dynamics affecting gasoline prices, see
CRS Report RL32343, Gasoline Price Surge: Revisited Crude Oil and Refinery Issues, by
Lawrence Kumins and Robert Bamberger.
17 Energy Information Administration, “Weekly Petroleum Status Report.” March 31, 2004.
Table 2, p. 2.
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the United States to meet air quality standards.18 This variety of gasoline blends makes
it difficult to transfer product from areas of available supply to those in shortage.
Importing fuel also becomes more expensive because a foreign refinery has to tailor a
relatively small run of product for a regional U.S. market. In some cases, relatively
small product volumes and lower profit expectations may induce foreign refiners not
to invest in the processes necessary to produce specific blends for U.S. regional
markets. If this outcome were to occur it might mean localized price spikes and
shortages.
Imports of finished gasoline and blending components now account for about 10%
of total gasoline supply on the U.S. market.19 Because of more stringent requirements
on sulfur content, additives such as MTBE, and vapor pressure, finding supplies of
imported gasoline on the international market that meet U.S. and state fuel
specifications, and that are available at prices less than or equal to domestic supplies,
has been difficult. As a result, it may be that the more expensive import component
of gasoline supply is raising the price of gasoline in the U.S. market. This could
happen if the price of gasoline is determined by the cost of acquiring the incremental
supply necessary to meet market demand and avoid market disruptions.
Low inventories of both crude oil and gasoline products have also influenced
near- term futures prices, as well as prices faced by consumers. Total motor gasoline
inventories have been declining in recent years. It has been estimated that a minimum
stock level of 185 million barrels of gasoline is needed simply to keep the distribution
system running. However, gasoline stocks averaged about 211 million barrels in 2002.
They declined further to about 202 million barrels on average in 2003, a 4.5% decline
from the 2002 level. Data for the first three months of 2004 shows an additional 0.6%
decline compared to the first three months of 2003.20 Although U.S. motor gasoline
supplied to the market has averaged about 9 million barrels per day, an inventory level
of slightly above 200 million barrels translates into available supply of less than two
day’s consumption when the necessary volumes required to keep the system flowing
are factored into the analysis.21
Conclusion
Crude oil is an input into a production process that yields motor gasoline as a
retail product. For the suspension of RIK deliveries of crude oil to the SPR to have an
effect on gasoline prices this oil would have to alter the demand and supply balance in
the production process. At least two obstacles exist that might prevent the RIK oil
from having a significant effect. First, the amount of oil is small, less than 1%, of U.S.
requirements, and even less of the world market. If any other oil producer chose to
reverse the effect of the RIK oil on the market, that could be accomplished with an
offsetting reduction in supply. Second, refineries in the United States, the link between
18 D.J.Peterson and Sergej Mahnovski, New Forces at Work in Refining, Industry Views of
Critical Business and Operations Trends, RAND Science and Technology, 2003, p. 26.
19 Ibid. Table 8, p. 14.
20 Ibid. Table 4, p. 6.
21 Energy Information Administration, “Petroleum Supply Monthly.” Table S4. p. 17.
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the crude oil and the gasoline markets, are operating at nearly full capacity, making it
unlikely that additional supplies of crude oil, in the form of the RIK volumes, could be
refined and distributed as a net increase in motor gasoline.
High crude oil prices in the world market are influenced by political as well as
economic forces. The high gasoline prices facing U.S. consumers reflect those high
world crude oil prices and are sustained by a number of conditions in the gasoline
market. The high utilization rate of refineries, the fragmented specification of regional
gasoline blends, the low inventory balances, and the scarcity and high cost of
conforming imported gasolines suggest that the gasoline market might remain tight
even if additional crude oil appeared on the market.