What is the Strategic Petroleum Reserve (SPR)?

What is the Strategic Petroleum Reserve (SPR)?

Yesterday Meet the Press host David Gregory asked White House Chief of Staff Bill Daley if the President was considering releasing oil from the Strategic Petroleum Reserve (SPR):

MR. GREGORY: But what about the shorter term? Does the president—there’s calls to tap the strategic petroleum reserve, which comes up during these spikes. Is the president considering doing something that can arrest that spike?

MR. DALEY: Well, we’re looking at the options. There’s—there—the spike—the, the issue of, of, of the reserves is one we’re considering. It is something that only is done—has been done in very rare occasions. There’s a bunch of factors that have to be looked at, and it is just not the price. Again, the uncertainty—I think there’s no one who doubts that the uncertainty in the Middle East right now has caused this tremendous increase in the last number of weeks.

MR. GREGORY: But it’s on the table, which I think is the significant development.

MR. DALEY: Well, I think all consider—all matters have to be on the table when you go through—when you see the difficulty coming out of this economic crisis we’re in and the fragility of it.

Let’s look at the Strategic Petroleum Reserve and the President’s option to release oil from it.

What is the Strategic Petroleum Reserve?

The SPR is a bunch of holes in the ground. The Strategic Petroleum Reserve is a collection of salt caverns at four locations in Louisiana and Texas along the Gulf Coast.  Those salt caverns hold 727 million barrels of oil, managed by the Department of Energy.

The SPR is a national insurance policy. Specifically, it insures the U.S. against a severe oil supply disruption. Without this insurance, our economy could be even more sensitive to a big oil supply shock than it already is.

Created in 1975 after the Arab oil embargo, the SPR is designed to be an emergency reserve.  If Venezuela’s Hugo Chavez suddenly were to decide he is no longer going to sell oil to the U.S., we would face a short-term supply disruption while we waited for supplies to arrive from other producer nations.  President Bush (41) released oil from the SPR when Operation Desert Storm began in January 1991, in anticipation of supply disruptions in the Middle East.  When Hurricane Katrina damaged much of the Gulf of Mexico oil infrastructure, we suddenly lost about 25% of domestic production and President Bush (43) released oil from the SPR.  If terrorists were to blow up major elements of the global or domestic oil supply chain, that could cause a severe supply disruption.  The SPR is not a backup supply to be used frequently when gasoline gets expensive, it’s an emergency strategic supply to be used only in a crisis.

Releasing oil from the SPR is a Presidential decision, based principally on the advice of the Secretary of Energy.  The President’s White House economic and national security advisors are usually involved in the decision as well.

The U.S. relies more heavily on government stocks than private reserves.  The same is true for the Japanese.  The Europeans rely more on privately held commercial stocks.  Since their governments don’t own that oil, the Europeans mandate that commercial storage facilities hold a certain amount of emergency reserves.  Also, you can’t drain your stocks down to zero; you have to leave some oil in the tanks and especially the pipes to make the hydraulics work.

The U.S., Japan, and Germany have the biggest reserves.  Then there are the Chinese, who so far have not been full participants in the international coordination system run by the International Energy Agency (IEA).  Reserve withdrawals are more effective when they are coordinated among the countries with the largest reserves.

The U.S. government fills the SPR in two ways.  They buy oil on the open market, and they receive oil as payments in kind for drilling leases granted by the government (called Royalty-in-Kind).

How big is the SPR?

The Strategic Petroleum Reserve can hold 727 million barrels of oil.  At the moment it’s full, at 726.6 million barrels.

Here are some figures for comparison:

  • The global oil market is about 86 million barrels per day (bpd).
  • The U.S. consumes about 19-20 million bpd of oil and petroleum products.  We import about half that.
  • The Desert Storm SPR release totaled 21 million barrels.
  • The Katrina SPR release coincidentally also totaled 21 million barrels.
  • There are 42 gallons of oil in a barrel.
  • A barrel of oil results in about 44 gallons of products, including about 19 gallons of gasoline, 10 gallons of diesel, 4 gallons of jet fuel, and 11ish gallons of other stuff.  This means you get a gallon of gasoline from about 2.1 gallons of oil.

As the economy grows, any fixed-size SPR gets effectively smaller. Insurance is measured in “days of import protection”: take the average number of barrels per day that we import, and divide it into the oil we have, and that’s how many days of import protection we have.

The U.S. imports (net) about 10-11 million barrels of oil each day.  At the moment the SPR is full:  there are 726.6 million barrels of oil stored in these salt caverns.  Divide 726.6 M by 10-11 M and you get 66-73 days.

Since you won’t replace lost imports barrel-for-barrel, the number is more of a relative than an absolute measure of how much your insurance is worth.  A significant SPR release might be 100,000 bpd.

We don’t worry about losing all of our imports simultaneously.  Almost one-quarter of our imports come from Canada.  Our next biggest suppliers are Venezuela (11%), Saudi Arabia (10%), Mexico (9%), and Nigeria (8%).  There are risks to each of these (much less so for Canada and Mexico).

A 2005 law requires the SPR to be increased to 1 billion barrels.  President Bush (43) proposed doubling the current SPR to 1.5 billion barrels and increasing the size of our insurance policy.  Congress has not provided significant funding for either expansion.

When should the President release oil from the SPR?

The Saudis are the first line of defense when there is a disruption in global supply.  If that worries you, then figure out ways to use less oil, because the Saudis will always have the largest and lowest cost marginal supply in the world.  The Saudis often/usually have spare production capacity that they hold in reserve.  They appear to have dialed up their production in recent weeks, offsetting most of the recently lost production in Libya.

The phrase severe supply disruption is the key to the President’s decision about an SPR release.  Oil is expensive right now for four reasons:

  1. Fundamentals — The global economy is recovering and demanding more oil.  Global supply and demand are tight.
  2. Some Libyan supply has recently gone offline – maybe 850K – 1M bpd.
  3. Oil market participants are worried that events in Tunisia, Egypt, Libya, and Bahrain could spread to other oil-producing nations in the Middle East and North Africa, further disrupting supply.
  4. Nobody is quite sure how much unused capacity the Saudis have available.

It’s hard to conclusively tease out the price effects of each factor, but policymakers need to try.  High gasoline prices alone are insufficient to justify an SPR release.  You have to look at why prices are increasing.  One expert recently surmised that about $100 of the current $115/barrel world price (Brent) results from tight fundamentals, and the other $15-ish is from actual and feared supply disruptions.

If global economic growth accelerates (oh please oh please), then global demand will increase and the price of oil will continue to climb.  That’s unfortunate and a medium-term economic problem.  It’s not a reason to tap the strategic reserve.

If supplies are further disrupted, for instance by geopolitical events, then that is a viable reason for an SPR release, if the President thinks it is severe enough to justify tapping our emergency reserve.

You also shouldn’t expect an SPR release to have a huge effect on the pump price of gasoline.    With oil around $100/barrel, if the President were to release 100,000 b/d from the SPR, that would probably lower the price of oil by about $2/barrel initially.  That’s about ten cents per gallon of gasoline, maybe a bit more if the release were coordinated with other nations and reduced the fear premium in global oil markets.  The effect would wear off over time as markets adjust to the increased supply.

Should President Obama release oil from the SPR now?

Mr. Gregory asked Chief of Staff Daley if the President is considering releasing the SPR because the price of gasoline has spiked.  He further asked if the President is “considering doing something to arrest that spike.”

The President should consider a release only if he determines there’s a severe supply disruption, not just because the price of gasoline has increased.  And if he does approve a release, it will not “arrest” the price increase at the pump.

The U.S. imports almost no oil directly from Libya – they supply about 0.6% of all our imports.  Most Libyan oil goes to Europe, and some to China.  Still, it’s best to think of oil as if it were a single big global pool.  If more Libyan production were to go offline, prices in Europe would jump.  Oil tankers in the Atlantic headed west for the U.S. might turn around and head east seeking out those higher prices, causing prices to rise in the U.S.  (The reverse happened after Hurricane Katrina – tankers headed for Europe turned around and headed for the Southeastern U.S. after prices jumped from lost Gulf of Mexico supply.)

So far it appears the Saudis are mitigating much of the lost Libyan production.  Based on public information, I think it’s hard to justify an SPR release now.  If a lot more supply goes offline (in Libya or elsewhere), and if the Saudis lack the spare capacity to offset that additional loss, then the President will have a tough call to make.

(photo credit: Department of Energy, Office of Fossil Energy)

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