Reconsidering the Strategic Petroleum Reserve

Reconsidering the Strategic Petroleum Reserve

April 5, 2018
Reconsidering the Strategic Petroleum Reserve
The Strategic Petroleum Reserve (SPR) was authorized by
import gap between domestic consumption and domestic
the Energy Policy and Conservation Act (EPCA) of 1975
production continued to widen, disruptions in oil supply
(P.L. 94-163). EPCA, passed in the wake of the oil embargo
from international markets would result in the closure of
of 1973-1974, set out U.S. energy policy in the areas of
part of the refining and/or pipeline networks.
production, consumption, and reserve stocks. In 2018, the
U.S. position in world markets is significantly different
Concern over consumer gasoline disruptions and refinery
from that of the 1970s and a reconsideration of the size
utilization are somewhat at odds. Minimizing consumer
and/or need for the SPR might be warranted.
disruption might indicate the need for a petroleum products
reserve, while insuring the continuous operation of the oil
What Is the SPR?
refining/transportation industries might suggest the need for
EPCA authorized the creation of an up to 1 billion barrel
a crude oil reserve. Language in EPCA allowed the new
petroleum reserve. While the primary component of the
reserve to include either crude oil or products, or both.
SPR is crude oil, currently about 660 million barrels, stored
in Texas and Louisiana, the reserve also includes the
Evolution of the SPR
Northeast Home Heating Oil Reserve (2 million barrels of
Since the 1970s the SPR’s role has evolved to include
ultralow sulfur heating oil) located in Massachusetts, New
natural disaster protection and economic stabilization.
Jersey, and Connecticut, as well as the Northeast Gasoline
Hurricanes Katrina, Sandy, and Harvey have resulted in
Reserve (1 million barrels of gasoline) located in the New
drawdowns from the SPR to supply refineries and aid
York harbor and Boston areas. The first of these product
consumers. However, some argue infrastructure damage, to
reserves recognized the importance of heating oil in the
include waterways and ports, roads, and refineries, might be
New England home heating fuel mix, while the second was
more of an impediment to an orderly market than actual
established in response to the gasoline market disruption in
fuel supply issues. The open bidding policies of SPR
the wake of Hurricane Sandy in 2012.
drawdowns, which allow foreign-based oil trading firms to
win the right to purchase SPR oil, may limit the
Initial Justifications for the SPR
effectiveness of SPR use in short-term natural emergencies.
In 1973, the Organization of the Arab Petroleum Exporting
It may be difficult to target SPR supplies to those domestic
Countries (OAPEC) initiated an oil supply embargo against
firms that need access to SPR oil under current bidding
the United States and the Netherlands in response to those
rules.
nations’ support of Israel in the October 1973 war. There
was concern that a new era had emerged in which oil
In addition, the Energy Policy and Conservation Act
supplies would be used as a political weapon. For the
Amendments of 1990 (P.L. 101-383) expanded EPCA
United States, domestic oil production had peaked in 1970
authorities to allow the President to authorize SPR
and was expected to decline in future years, consumption
drawdowns when market conditions exist such that there is,
growth seemed set to continue, and the only significant
or is likely to be, economic disruption in the form of higher
emergency stocks were commercial inventories held by oil
prices even if no formal emergency is declared. President
companies.
Obama used this authority to direct the drawdown and sale
of 30 million barrels of crude oil from the SPR in 2011 due
U.S. gasoline consumers’ first exposure to the perceived
to the likelihood of higher oil prices resulting from the
effects of the OAPEC embargo included gasoline supply
disruption of Libyan oil supplies. While it is not clear that
shortages, gasoline stations with restricted operating hours,
this type of market intervention is effective, the use of the
purchase limits, waiting lines, and higher gasoline prices.
SPR for price stabilization in place of market forces,
The institution of federal non-price gasoline rationing
although allowed by statute, is a change from the original
schemes, intended to alleviate problems related to the
application of the authority.
supply shortages, may have exacerbated the shortages. A
publicly held supply reserve of crude oil or petroleum
International Obligations
products was viewed as a viable way to shield the domestic
The United States is a member of the International Energy
markets from the disruptive effects of supply manipulation
Agency. The 1974 Agreement on an International Energy
by countries exporting oil to the United States.
Program (IEP) specifies member nation emergency
response mechanisms. The agreement requires member
The United States historically has possessed a petroleum
nations to hold no less than 90 days of the previous year’s
refining industry of sufficient domestic capacity to meet the
net imports as emergency stocks. The reserves may be held
needs of domestic demand for petroleum products. In
as crude oil, petroleum products, or as a mixture of the two.
addition, an oil transportation system is available to
The reserves may be owned by the public sector, the private
efficiently move oil and petroleum products around the
sector, or as a mixture of the two. Oil exporting (net)
country. Concern existed in the mid-1970s that if the net
member countries are exempt from the stock holding
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Reconsidering the Strategic Petroleum Reserve
requirements. The IEP also includes drawdown and oil
Private Inventories Replacing the SPR
sharing policies in an emergency.
At the end of 2017 the SPR held 662.8 million barrels of
crude oil. Privately held stocks of crude oil were 421.1
In recent years, as U.S. production of crude oil has
million barrels. In addition, the private sector held 1.282
increased and consumption growth has slowed, holdings in
billion barrels of petroleum products. In theory, private
the SPR have increased beyond the 90-day requirement.
stocks might be sufficient to provide for emergency supply.
The Energy Information Administration (EIA) reports that
However, the motivation for private holdings of stocks of
SPR monthly holding averaged 182 days of net imports in
oil is likely related to inventory concerns, market supply
2017, and if current net import trends continue, the SPR
management, and profitability, not emergency
excess balance beyond IEP requirements may grow.
preparedness. In addition, in recent short-term emergencies
like hurricanes, the main supply impediment was likely
Do We Still Need the SPR?
infrastructure damage rather than resource supply
An important consideration in assessing the continued need
shortages. For example, in Hurricane Sandy, the main
for, or the size of, an SPR is the nature of world oil markets
bottlenecks were likely electricity outages and blocked
and the position of the United States in those markets today.
roadways which made fuel delivery and distribution
difficult.
At the time of EPCA, the United States had passed its
believed peak oil production and it was expected that
Currently, the United States meets its IEP obligations with
declining production would occur. Consumption of
publicly held stocks alone. Most other nations count either
petroleum products was increasing. As a result of these
both public and private stocks, or private stocks alone in
conditions, net imports and dependence on world oil
meeting their IEP obligations. The United States could opt
markets was increasing. Today, in 2018, and looking into
to follow similar policies, eliminating the need for the SPR,
the near future, the situation is different. As a result of
or justifying a smaller publicly held reserve.
improved technology and the development of shale oil
deposits, U.S. oil production has roughly doubled since
While current holdings of oil in the SPR are 662.8 million
2008, and is projected to continue to increase. Some see the
barrels of crude oil, the actual holdings available for
United States in the near term as becoming the world’s
emergency drawdown are less. Legislation adopted since
largest oil producer, and having greater influence on world
2015 mandates drawdown and sale of SPR oil to fund a
oil prices. In addition, consumption growth has moderated.
variety of programs over the period FY2018 through
The United States has become a leading exporter of
FY2027.
petroleum products, and exports of crude oil are also
increasing, moderating U.S. dependence on world oil
As a result of this legislation, 266 million barrels of the
markets.
662.8 million barrels in the SPR are obligated, leaving a
balance of 396.8 million barrels available to meet SPR
In the 1970s, organized oil futures markets did not exist and
responsibilities. It is not possible to precisely estimate how
the spot market was largely limited to Rotterdam, the
many days of net import coverage this quantity of reserve
Netherlands. Today, a wide variety of standardized futures
oil will provide because for calculation purposes, the net
and options contracts are traded worldwide by parties
import value used is the previous year’s net imports, while
interested in both the physical and financial sides of the
mandated oil drawdowns extend over 10 years.
market. In addition, customized derivative contracts can be
traded on over-the-counter markets.
Conclusion
The SPR was authorized in the 1970s in a time that the
Derivative markets have the ability to smooth out expected
world oil market was changing in unexpected ways and the
oil shortages. For example, if geo-political conditions
U.S. position in that market was perceived as becoming
indicated that oil shortages might develop in the near-term,
weaker. The SPR was thought to be a tool to mitigate the
market participants would likely bid up the price of futures
effects of that weaker position.
contracts in an attempt to lock-in supplies. As the futures
price of oil rose above the spot price, at some point this
In 2018, the oil market and the U.S. role in the market are
would cause speculators to buy, or stockpile, oil with the
quite different than that of the 1970s. As a result of these
plan of selling the oil when prices rise in the future. These
changing conditions, debate on the role, size, and even
actions would tend to smooth out the effects of anticipated
existence of the SPR might be justified.
shortages.

Derivative contract adjustments might be less effective at
helping in very short term events like hurricanes. For the

derivative based adjustment process to be effective,
sufficient time must be available for the futures contract to

be bid up sufficiently relative to the spot price, as well for
oil to accumulate in storage. In addition, market participants

must be able to anticipate the potential for emergency
conditions in the market. These conditions may not be met
Robert Pirog, Specialist in Energy Economics
in the case of natural disasters like hurricanes.
IF10869
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Reconsidering the Strategic Petroleum Reserve

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