Oil Price Volatility and the Department of Defense

Oil Price Volatility and the Department of Defense

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May 6, 2019
Oil Price Volatility and the Department of Defense
Oil Price Volatility
Note: According to DOE, graphic excludes nuclear energy. For
The price of crude oil historically rises or falls with the
more information, see DOD’s 2016 Operational Energy Strategy.
world economy. However, supply generally does not
smoothly follow demand and numerous factors can impact
DOD needs to match its appropriations with real-world
crude oil prices (e.g., supply, demand, available supply,
market oil prices. According to DOD’s FY2019 Budget
value of the dollar, geopolitical risks). Thus, oil prices can
Certification Report, 2008, 2009, and 2012 were the most
be volatile. Volatility in crude oil prices can disrupt or
challenging years for the department’s procurement of
enable oil industry investments and production—factors
petroleum products, as the projected prices did not
that can have a ripple effect on the global economy. The
accurately anticipate the volatile market conditions in those
market also responds to geopolitical events. For example,
years. Since FY2009, according to DOD, the standard price
sanctions on crude oil may constrain supply, which can
has been maintained throughout the year twice—FY2013
affect prices and access.
and FY2014.
In general, the price of crude oil affects the price of
In the fourth quarter of 2014, the price of crude oil
petroleum products (e.g., gasoline, jet fuel) for U.S.
decreased roughly 40% and has remained low compared to
consumers, including the Department of Defense (DOD).
the FY2013 and FY2014 prices. Subsequently, petroleum
This In Focus discusses the impacts the price of crude oil
product expenses declined for DOD in FY2015 and
has on fuel procurement for DOD. It also illustrates some
FY2016 resulting in a surplus in each of these fiscal years.
recent geopolitical events that may have an impact on price
DOD reprogrammed a portion of these funds, as authorized
and how DOD budgets to accommodate oil price volatility.
by 10 U.S.C. §2208, and Congress rescinded a portion. In
FY2016, DOD reprogrammed approximately $2 billion to
Oil Price Effects on Defense Spending
other accounts and Congress rescinded about $1 billion.
DOD uses more energy than any other federal agency. In
FY2017, DOD spent about $11.9 billion on energy, roughly
According to DOD’s FY2017 Operational Energy Annual
76% of the entire federal government’s energy
Report, from FY2013 to FY2017, total operational energy
expenditures. DOD depends heavily on petroleum products
demand remained relatively stable, around 87 million
(e.g., jet fuel, diesel, fuel oil) to perform mission operations
barrels per year, while the price of crude oil fluctuated. The
(see Figure 1). Historically, operational energy (energy
price of oil declined in 2014 resulting in fuel expenditures
required for training, moving, and sustaining military forces
dropping from $14.8 billion in FY2013 to $8.2 billion in
and weapons platforms for military operations and training)
FY2017, a decrease of around 45%.
constitutes roughly 70% of DOD energy use.
Recent Geopolitical Developments
Figure 1. DOD Energy Consumption by Fuel Type
Energy production decisions, political destabilization, and
Percent of Total, FY2017, Measured by British Thermal Units
war are some of the world events that can affect the price of
oil, and, as a result, the costs of operations for DOD. Some
analysts have expressed concerns that the oil market could
potentially enter a period of price volatility due to recent
geopolitical developments. Such developments include
sanctions on Iran and recent actions taken by the
Organization of the Petroleum Exporting Countries
(OPEC).
Iran
In mid-2012, the United States and the European Union
enforced sanctions on Iran. These sanctions resulted in Iran
cutting its crude production by around 1 million barrels per
day (Mb/d) through 2015, according to the U.S. Energy
Information Administration. In 2016, after sanctions were
lifted as part of the Joint Comprehensive Plan of Action
(JCPOA), Iran increased crude production to pre-sanctions

levels of nearly 4 Mb/d.
Source: U.S. Department of Energy, Office of Energy Efficiency and
Renewable Energy.
In May 2018, the Trump Administration announced its
intention to withdraw from the JCPOA. In August 2018, the
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Oil Price Volatility and the Department of Defense
Administration announced it would reimpose sanctions on
maintenance) for their customers. The price is based on the
Iran. In September 2018, Iran’s crude oil exports fell to
Administration’s projected price of refined petroleum
1.72 Mb/d, their lowest level in almost three years.
products and DLA’s projected operating costs. According
to a 2014 GAO report, the standard price is intended to
On November 5, 2018, eight countries received waivers to
remain unchanged throughout the year. Projecting accurate
the Iranian oil sanctions through May 2, 2019. On April 23,
prices for crude oil however can be challenging in extreme
2019, the Trump Administration announced it would no
market volatility.
longer issue or extend waivers beyond May 2. In April
2019, Iran’s exports further decreased to approximately 1
Working Capital Funds
Mb/d.
WCFs are revolving funds that do not expire and are used
throughout DOD in an effort to efficiently provide services
Organization of the Petroleum Exporting
or industrial capabilities. Defense WCFs are primarily
Countries
designed to help protect against price volatility. WCFs may
The 14 member countries of OPEC account for
realize gains or losses within each fiscal year. To correct for
approximately 40% of global crude oil production, which
these difference the DOD may adjust the standard price for
totals nearly 100 Mb/d. OPEC countries, particularly Saudi
the next year. Gains may be retained in WCFs and in effect
Arabia, often maintain varying levels of spare oil capacity.
returned to customers by offsetting a portion of costs in
The International Energy Agency estimated OPEC’s spare
future fiscal years, as well as used to offset losses in other
capacity at 3.3 Mb/d as of March 2019, most of which was
fiscal years.
located in Saudi Arabia. Those countries with the greatest
spare capacity are sometimes referred to as “swing
10 U.S.C. §2208 authorizes the Secretary of Defense to
producers.” This spare capacity may enable these countries
establish a variety of WCFs to support DOD operations.
to more easily influence the oil market.
DOD has established five WCF accounts. The Defense-
Wide WCF includes activities managed by DLA. The
Swing producers may use their spare capacity to bring
Defense-Wide WCF is used to stabilize the impact of
balance to an often unstable market. They may also have
market changes. If prices are higher than projected the
the ability to directly affect the price of oil by increasing
Defense-Wide WCF account may be able absorb the
supply immediately by exporting their spare capacity,
difference.
causing downward pressure on price. Due to the relatively
inflexible nature of crude oil demand, a small change in
However, if market prices exceed what is available in the
supply can result in a large change in price. With Iran’s oil
Defense-Wide WCF account, DOD has two options. First,
waivers ending, the White House has stated it was working
it can reprogram funds from other accounts, though this
with Saudi Arabia and the United Arab Emirates to
may have adverse effects on other DOD activities. Second,
guarantee an “adequately supplied” market.
DOD can change the set standard price during the current
year. According to a 2014 GAO report, DOD adjusted the
Congress in recent years has introduced several bills to
standard price 13 times between FY2009 and FY2013.
address OPEC price manipulation concerns. For example,
the No Oil Producing and Exporting Cartels (NOPEC) Act
Alternatively, if the market is well below the set price,
of 2019 (H.R. 948 and S. 370) would modify the Sherman
DOD can adjust the price downward. When excess cash
Antitrust Act (15 U.S.C. 1 et seq.), criminalizing actions by
accumulates in a WCF, DOD officials or some in Congress
cartels that affect markets and prices for certain
may see that money as a funding source for other
commodities, including crude oil. It would make production
requirements. Setting prices in advance and using WCFs is
and price manipulation illegal.
intended to help DOD maintain a stable price for customers,
despite volatile market conditions.
DOD Volatility Management
Managing an organization as large and complex as DOD
Considerations for Congress
presents certain challenges, especially when procuring
Although DOD uses WCFs to accommodate volatility,
petroleum products in an often difficult to predict global
when reprogramming is required it can have unintended
market. DOD manages procurement through the Defense
consequences. For instance, it can move funding from
Logistics Agency (DLA) and attempts to balance volatility
accounts that support current operations or other potentially
through the use of working capital funds (WCFs).
unrelated priorities. Congress may consider how certain
policy approaches may affect the price of oil.
Defense Logistics Agency
Fuel for DOD is procured exclusively through DLA. The
CRS Products
price of refined petroleum product constitutes nearly 80%
of what DLA charges to its DOD customers (the remaining
CRS Report R45493, The World Oil Market and U.S. Policy:
20% consists of transportation, maintenance, and other
Background and Select Issues for Congress, by Heather L.
costs). DLA purchases fuel for the DOD on the open
Greenley
market and is therefore subject to market price volatility.
CRS Report RS20871, Iran Sanctions, by Kenneth Katzman
CRS In Focus IF11186, No Oil Producing and Exporting Cartels
Around 18 months in advance, DOD sets a standard fuel
(NOPEC) Act of 2019, by Phillip Brown
price for a particular budget year, including the cost of the
product and related expenses (e.g., transportation,
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Oil Price Volatility and the Department of Defense

IF11202
Heather L. Greenley, Analyst in Energy Policy

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