Stocks of Oil: Security and Price Effects

Stocks of Oil: Security and Price Effects

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March 21, 2017
Stocks of Oil: Security and Price Effects
In January 2017, almost 1.2 billion barrels of crude oil, or
reserves could be held either publicly, as in the United
about 60 days of consumption, were held as stocks, or
States, or privately, as in most other IEA member countries.
inventories, in the United States. This In Focus examines
the ownership and potential uses of these oil stocks while
Defining the target quantity of petroleum reserves in terms
also examining their relationship to important issues of oil
of net imports meant that the required quantity could
security and oil price determination.
change over time as the nation’s trade position on the
international oil market evolved. By 2006, U.S. net imports
Oil stocks in the United States are owned by both the public
had risen to over 10 mmb/d. The trend of increasing
and the private sectors. The Strategic Petroleum Reserve
petroleum import dependence began to reverse by 2010 as
(SPR) established by the Energy Policy and Conservation
U.S. production of light, tight oil began to increase and
Act of 1975 (P.L. 94-163) currently holds about 692 million
consumption stabilized at around 19 mmb/d. By 2016, U.S.
barrels of crude oil, with an authorized capacity of 1 billion
oil production reached almost 9 mmb/d and net imports of
barrels. The key purpose of the SPR is to provide the
petroleum decreased to about 4.9 mmb/d.
United States with a measure of oil security in case of
supply disruptions, both domestic and international,
Figure 1 shows that the net import coverage of SPR has
although it also has linkages to oil price determination.
changed over time as the quantity of oil in the SPR, as well
as U.S. production, consumption, and net imports have
Private sector crude oil stocks totaled over 500 million
changed.
barrels in January 2017. These stocks are held by numerous
oil industry firms at refineries, bulk terminals, and in
Figure 1. Import Coverage Provided by SPR
pipelines. The purpose of these stocks is to insure the
1980-2015
continuous operation of the refining industry which
transforms crude oil into petroleum products used by
consumers. In recent years, private oil stocks have reflected
changing oil prices as well as affecting oil prices and price
expectations.
The SPR
The embargo on the sale of oil to the United States by the
Organization of the Arab Petroleum Exporting Countries
(OAPEC) in 1973-1974 had psychological as well as some
physical effects on how the United States viewed oil issues.
Although U.S. crude oil production had peaked in 1970 at
about 9.1 million barrels per day (mmb/d), oil consumption
had increased to almost 15 mmb/d by that time, resulting in
a widening gap to be filled by imported oil. By the time of

the embargo, only four years later, U.S. production had
Source: EIA.
fallen to about 8.3 mmb/d and consumption had risen to
Notes: SPR stocks divided by last year’s net imports of crude oil and
over 16 mmb/d, suggesting that crude oil import volumes
petroleum products.
would continue to increase.
The current value of SPR net import coverage of over 140
The SPR was created to provide security against
days has raised questions concerning whether the size of the
interruptions in U.S. access to imports from the world oil
reserve should be reduced. Some view the oil in the SPR as
market. Recognizing that the U.S. refining industry
a national security asset, unlikely to be restored if sold off.
maintained adequate domestic capacity to satisfy demand
Others see the SPR as a potential funding source for other
for petroleum products, the decision was made to hold the
high priority programs.
reserve in the form of crude oil, rather than petroleum
products.
Since 2015, several laws were passed by the 114th Congress
which required the sale of oil from the SPR, with the
The International Energy Agency (IEA) was also formed in
proceeds to be used largely for program funding. The
the aftermath of the OAPEC actions. The IEA facilitated an
Bipartisan Budget Act of 2015 (P.L. 114-74) authorized the
agreement among member countries to hold stocks of oil, or
sale of 58 million barrels of oil from the SPR over the
petroleum products, equivalent to 90 days of net imports to
period FY2017 through FY2025. In addition to sales
provide security against future supply interruptions. Oil
revenues to be deposited in the U.S. Treasury, $2 billion is
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Stocks of Oil: Security and Price Effects
to be used to modernize and maintain SPR facilities. The
Once excess oil has made its way into storage, the
21st Century Cures Act (P.L. 114-256) authorized the sale
management of those oil stocks becomes related to the
of 25 million barrels of SPR oil for health care related
futures price of oil. Oil futures contracts, and hence prices,
expenses. The Fixing American Surface Transportation Act
are written for one or more months into the future. The
(P.L. 114-94) authorized the sale of 66 million barrels of
basic futures contract obligates the owner of the contract to
SPR oil from FY2023 through FY2025.
buy, or sell, a given quantity of oil at a specified price.
In total, this legislation will reduce the SPR by 149 million
Oil stock management depends on the relationship between
barrels by 2025, a 21% reduction in SPR inventories. While
the current spot price of oil and the futures price. Two
all of this legislation includes restrictions to prevent a fall
possibilities exist. Backwardation refers to a price
below the 90 days of net import coverage threshold, it is
relationship where the current price of oil is higher than the
possible that further reductions could be in the offing.
futures price. This price relationship offers little, or no,
incentive to store oil. In addition to storage costs,
While providing oil security, the SPR also is related to oil
backwardation suggests that holding oil will result in
prices. Withdrawals can be ordered by the President when it
economic losses on future sales compared to sales in the
is determined that economically threatening disruptions in
current period.
the oil market are taking place, or are likely to occur. As in
2011, when SPR releases provided a calming effect on the
Contango, on the other hand, is a situation where the
oil market after disruption of Libyan supplies, releases from
current price of oil is less than that of oil purchased in the
oil reserves can tend to balance shortages in the short term
future. This means that anyone with access to oil storage
and provide psychological support to the market and
facilities can buy oil at the current, spot price; hold the oil
stabilize oil prices.
in storage; and then sell the oil in the future for a profit. Of
course, the carrying cost of holding oil must be smaller than
Private Oil Stocks
the difference between the current and future price. For
Private holdings of oil stocks, unlike SPR inventories, are
example, if the storage cost of oil were $0.40 per barrel per
held in widely dispersed facilities across the country by a
month, and the contango price spread were $0.65 per barrel,
large number of firms. Although the private sector currently
storing 100,000 barrels of oil for one month could yield a
holds about 534 million barrels of crude oil in storage, it
profit of $25,000. If the cost of oil is taken to be $40 per
does not provide a level of oil security proportional to that
barrel, storage could yield a return of 6.25% in a month,
of the SPR. A certain amount of oil held in the system is not
given available storage capability and idle cash balances.
likely to ever be drawn upon. For example, in the case of oil
in pipelines, some quantity may be considered as “pipe
Contango can also be thought of as an outcome resulting
fill,” oil required to keep the pipeline system operable.
from excess production relative to market demand.
Contango is based on the idea that current surpluses of oil
The level of private oil stocks is closely related to the
have driven the current price to low levels and that the
production of oil as well as changes in the price of oil.
market will tend to balance, or move toward a zero surplus
Management of these stocks can also affect the price of oil.
position in the future.
These effects are limited by the storage capacity of the
system as a whole, but that capacity can be augmented or
An oil market with prices in contango encourages near
reduced.
term, current purchases of oil. This behavior can either
strengthen or weaken contango. More demand for oil, other
The most basic reason for increasing, or decreasing,
things equal, should put upward pressure on current prices,
privately held oil stocks relates to quantities of oil
but if that oil is merely put into storage, rising reported
produced. If global production is greater, or less than,
inventories might act to reduce the current price. The
current consumption needs, private stocks of oil will either
relative strength of the two effects depends on specific
rise, or fall, respectively.
market conditions.
While there are a large number of oil prices depending on
Conclusion
the API specific gravity, sulfur content, and location of the
Both public and privately held oil stocks have important
oil, the key reference oil price in U.S. markets is that of
roles to play in providing security in times of oil market
West Texas Intermediate (WTI). Current prices are
disruptions. Similarly, both public and private oil stocks
measured by the spot price, while future prices are
have some role in oil price determination and movements.
measured by the trading value of futures contracts.
As the world oil market and the U.S. market evolve, it is
reasonable to reassess the role of each of these components
The price of oil reached a recent peak in July 2014, at over
of the U.S. energy security equation.
$100 per barrel. Between that time and now, the price has
declined to below $40 per barrel, and currently has risen to
Robert Pirog, Specialist in Energy Economics
about $50 per barrel. The price of oil fell in 2014 largely as
a result of global production running ahead of demand. Oil
IF10630
prices falling and reaching low levels relative to the
previous peak are reflected in increasing private stocks.
Both reflect an over-production of oil relative to market
demand.
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Stocks of Oil: Security and Price Effects

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