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[Senate Hearing 111-67]
[From the U.S. Government Publishing Office]

                                                         S. Hrg. 111-67

                      STRATEGIC PETROLEUM RESERVE

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                      ENERGY AND NATURAL RESOURCES
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                                   TO

     RECEIVE TESTIMONY ON S. 967, THE STRATEGIC PETROLEUM RESERVE 
   MODERNIZATION ACT OF 2009, AND S. 283, A BILL TO AMEND THE ENERGY 
POLICY AND CONSERVATION ACT TO MODIFY THE CONDITIONS FOR THE RELEASE OF 
      PRODUCTS FROM THE NORTHEAST HOME HEATING OIL RESERVE ACCOUNT

                               __________

                              May 12, 2009

                       Printed for the use of the
               Committee on Energy and Natural Resources

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50-874 PDF                WASHINGTON : 2009
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20402-0001

               COMMITTEE ON ENERGY AND NATURAL RESOURCES

                  JEFF BINGAMAN, New Mexico, Chairman

BYRON L. DORGAN, North Dakota        LISA MURKOWSKI, Alaska
RON WYDEN, Oregon                    RICHARD BURR, North Carolina
TIM JOHNSON, South Dakota            JOHN BARRASSO, Wyoming
MARY L. LANDRIEU, Louisiana          SAM BROWNBACK, Kansas
MARIA CANTWELL, Washington           JAMES E. RISCH, Idaho
ROBERT MENENDEZ, New Jersey          JOHN McCAIN, Arizona
BLANCHE L. LINCOLN, Arkansas         ROBERT F. BENNETT, Utah
BERNARD SANDERS, Vermont             JIM BUNNING, Kentucky
EVAN BAYH, Indiana                   JEFF SESSIONS, Alabama
DEBBIE STABENOW, Michigan            BOB CORKER, Tennessee
MARK UDALL, Colorado
JEANNE SHAHEEN, New Hampshire

                    Robert M. Simon, Staff Director
                      Sam E. Fowler, Chief Counsel
               McKie Campbell, Republican Staff Director
               Karen K. Billups, Republican Chief Counsel

                            C O N T E N T S

                              ----------                              

                               STATEMENTS

                                                                   Page

Bingaman, Hon. Jeff, U.S. Senator From New Mexico................     1
Book, Kevin, Managing Director, Research, ClearView Energy 
  Partners, LLC..................................................    24
Houssin, Didier, Director, Director for Energy Markets and 
  Security, International Energy Agency, Paris, France...........    29
Johnson, David F., Deputy Assistant Secretary for Petroleum 
  Reserves, Department of Energy.................................     4
Murkowski, Hon. Lisa, U.S. Senator From Alaska...................     3
Rusco, Frank, Director, Natural Resources and Environment, 
  Government Accountability Office...............................     8
Shages, John D., Independent Consultant..........................    17

                                APPENDIX

Responses to additional questions................................    49

 
                      STRATEGIC PETROLEUM RESERVE

                              ----------                              

                         TUESDAY, MAY 12, 2009

                                       U.S. Senate,
                 Committee on Energy and Natural Resources,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 2:34 p.m. in room 
SD-366, Dirksen Senate Office Building, Hon. Jeff Bingaman, 
chairman, presiding.

OPENING STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR FROM NEW 
                             MEXICO

    The Chairman. Ok. Why don't we get started? Thank you all 
for being here. Today we want to have testimony on two bills 
that seek to improve our emergency petroleum reserve policy.
    In the last few years we've experienced several oil market 
disruptions that resulted from hurricanes taking operations in 
the Gulf of Mexico region offline. Most recently in September 
2008, Hurricanes Gustav and Ike caused a disruption that left 
many gas stations throughout the Southeast without sufficient 
gasoline and diesel for weeks following the storms. It strikes 
me that we can and should do better than that.
    We expect to be facing a world with more hurricanes and 
more extreme weather situations in the future. We need to 
decide either to learn to live with temporary regional gasoline 
and diesel outages or we need to be prepared to deal with the 
aftermath of these storms in a better way than we have in the 
past and prevent these kinds of shortages. I believe we should 
take this latter approach. Preventing these kinds of hurricane-
related shortages is an achievable goal.
    We've learned in this country that when oil supplies are 
disrupted, economic hardships follow. This is not simply about 
inconvenience to those regions whose transport might be 
temporarily constrained. It's also about making sure that there 
is sufficient fuel for emergency services and about minimizing 
longer lasting economic damage that results from price spikes 
and disrupted commerce.
    In the 1970s we created the Strategic Petroleum Reserve to 
prevent this kind of fallout from oil supply disruptions. At 
the time we were concerned about crude oil disruptions in 
exporting countries. We had a very robust domestic refining 
system. We were confident that our refining system could 
safeguard our markets from disruption as long as we could get 
enough crude to those refineries.
    Therefore we made the decision which made sense at the time 
to keep only crude oil in the Strategic Petroleum Reserve. 
However we are now increasingly reliant on imported gasoline 
and diesel as well as imported oil. We've also seen that our 
need for extra oil supplies from the Strategic Petroleum 
Reserve comes primarily from hurricanes and other weather-
related events, not from geopolitical disruptions in other 
countries.
    In the 34 years of history and its 34 years of history the 
Strategic Petroleum Reserve has been used as a result of only 
one geopolitical event, that is Desert Shield and Desert Storm 
in 1990 and 1991. The SPR has been used far more frequently to 
offset weather related glitches in the system. It makes sense 
that our reserve policy should evolve to meet this new need.
    I note that we're considering today a bill in addition to 
the one I've been describing. We're also considering a bill 
sponsored by Senators Snowe and Dodd and Kerry which seeks to 
alter the drawdown criteria for the Northeast Home Heating Oil 
Reserve. I understand my colleague's concern that the home 
heating oil reserve has never been tapped since its creation in 
2000. However it strikes me that experts often caution us again 
legislation that refers to specific price points.
    So I look forward to hearing from the witnesses on these 
important bills. I defer to Senator Murkowski for her comments.
    [The prepared statement of Senator Snowe follows:]
  Prepared Statement of Hon. Olympia J. Snowe, U.S. Senator From Maine
    Thank you, Chairman Bingaman and Ranking Member Murkowski for 
holding this hearing today on the structure of the Strategic Petroleum 
Reserve and the Northeast Home Heating Oil Reserve. While there is no 
question that we must develop policies that achieve energy independence 
for United States, we must ensure that our energy defenses today are 
structured to allow maximum flexibility if our country experiences 
another energy crisis.
    I strongly believe that last year's energy crisis demonstrated the 
need to improve the Northeast Home Heating Oil Reserve program and I 
developed legislation (S.283) with Senators Dodd and Kerry to address 
the problems. The essential issue is that the federal law governing the 
Northeast Home Heating Oil Reserve constrains the Administration within 
the confines of an arbitrary mathematical formula to trigger the 
release of the reserves. Compounding the problem is that the current 
formula for release fails to consider the ramifications of historically 
high heating oil prices on the health and safety of the people of the 
Northeast.
    The legislation that I have formulated with Senators Dodd and Kerry 
would address this issue and allow the Administration to release 
heating oil if there is a significant supply disruption, or if the 
health and safety of Northeast residents are threatened. In addition, 
the legislation would mandate that, at a price threshold of $4 per 
gallon for heating oil, the reserve would be sold in a systematic 
process. I believe that this legislation will provide flexibility as 
well as certainty that heating oil currently sitting in New England 
will be used when it is most essential to the region's population.
    Through Senator Dodd's leadership in 2000, Congress created the 
Northeast Home Heating Oil Reserve, which put in place a critical tool 
to reduce supply disruptions. At that point, heating oil prices were 
$1.49 per gallon, and while the situation has improved since the 
historic price spike last summer, it is clear that the Northeast 
remains dangerously reliant on a commodity that has shown extreme price 
volatility in recent years. The need for the Heating Oil Reserve was 
clearly illustrated this past summer when a catastrophe was emerging 
for our region with heating oil reaching the unprecedented level of $5 
per gallon. Thankfully, the Northeast Home Heating Oil Reserve provided 
a basic level of assurance that heating oil could be provided if 
supplies were dramatically interrupted.
    However, the trigger mechanism for the release of the funds is 
convoluted to the point that the program's functionality is in question 
and would not have allowed the reserve to be utilized if these prices 
had persisted. Indeed, under the law, the President does not have the 
ability to release heating oil from the reserve even if the health and 
safety of the population are at risk. Rather, the current threshold for 
release is when the differential between crude oil and heating oil is 
60 percent higher than the five-year average. As a result, neither the 
overall price of heating oil nor the plight of our constituents has any 
effect on the release of the reserve. The formula trigger in statute is 
flawed to the point that the actual trigger has come close to being met 
not when crude oil prices are rising, but plummeting. This is clearly 
not the intent of the reserve and, without legislation, a meaningful 
federal tool that could be used to respond to an energy emergency is 
severely weakened.
    I would like to thank the Chairman and Ranking Member again for 
holding this hearing and look forward to working with them to improve 
the legislation to address any concerns.

        STATEMENT OF HON. LISA MURKOWSKI, U.S. SENATOR 
                          FROM ALASKA

    Senator Murkowski. Thank you, Mr. Chairman. I want to join 
you in welcoming the panel to the committee this afternoon.
    I think we as a Nation have learned a number of hard 
lessons in the past few years with regard to energy supplies 
and price spikes. You mentioned the situation following 
Hurricanes Katrina and Rita and what happens when Gulf supplies 
get taken off line. We saw that again with Hurricane Gustav 
really reinforcing that.
    Then last summer we spent a great deal of time debating 
whether to drawdown on the Strategic Petroleum Reserve or halt 
its filling in order to combat the record oil and gas prices at 
the time. But this proposal, we have before us today, goes 
beyond anything we have tried as the Federal Government. I have 
a few concerns about the idea of storing refined fuel in a 
centralized location. It seems to me that whatever problems can 
prevent normal fuel supplies from getting to market in an 
emergency are also going to exist as problems for our 
government supply of fuel getting to market in an emergency.
    Strategic reserves of crude oil guard against supply 
disruptions from the foreign nations on which America chooses 
to rely upon for most of our oil. But refined reserves could be 
less about guarding against supply disruptions than perhaps 
guarding against outages of normal supply lines. Just as a 
general rule I have questions about how Congress can solve the 
issue better than the private sector.
    The private sector is pretty typically incentivized to get 
the supplies online and into the stream of commerce with that 
said I'm very interested today in hearing the testimony from an 
excellent panel of witnesses. I'm happy to get a better sense 
as to why this proposal may or may not make sense.
    I appreciate the opportunity to hear from the witnesses 
today and explore this a bit further. Thank you.
    The Chairman. Thank you very much. Let me just introduce 
our five witnesses. Then we'll hear from each of them.
    Mr. David Johnson is the Deputy Assistant Secretary for 
Petroleum Reserves in the Office of Fossil Energy in the 
Department of Energy. Thank you for being here.
    Dr. Frank Rusco is the Director of Natural Resources and 
Environment with the Government Accountability Office. Thank 
you for being here.
    Mr. John Shages is the former Deputy Assistant Secretary 
for Petroleum Reserves in the Office of Fossil Energy. Thank 
you for coming.
    Mr. Kevin Book is Managing Director of ClearView Energy 
Partners here in Washington, DC.
    Mr. Houssin is the Director of the Office of Oil Markets 
and Emergency Preparedness in the International Energy Agency 
in Paris. Thank you very much for coming.
    If each of you could take 5 or 6 minutes and just make the 
main points that you think we need to understand that relates 
to this issue we would be very much appreciative. Then we'll 
probably have questions at that time.
    Mr. Johnson.

 STATEMENT OF DAVID F. JOHNSON, DEPUTY ASSISTANT SECRETARY FOR 
            PETROLEUM RESERVES, DEPARTMENT OF ENERGY

    Mr. Johnson. Thank you. Mr. Chairman and members of the 
committee, I'm pleased to be here today to discuss the issue of 
developing a refined product storage in the Strategic Petroleum 
Reserve. As you know the Reserve was established by Congress 
through the passage of the Energy Policy and Conservation Act 
in 1975 in response to the Arab oil embargoes.
    The underpinning policy of the United States Petroleum 
Reserve has been to store crude oil. The Reserve has served to 
protect the Nation from crude oil disruptions over three 
decades. This decision was based primarily on the recognition 
that the United States has a robust, sophisticated and flexible 
refining industry.
    In 2000 President Clinton directed the Department of Energy 
to establish a home heating oil reserve. Congress passed 
legislation to authorize the creation of the Northeast Home 
Heating Oil Reserve to address the heating oil supply 
vulnerabilities of that region. These two recent stockpiles in 
our open, flexible, competitive market have adequately 
addressed our vulnerabilities.
    In the last 4-year period the United States Gulf Coast bore 
the impacts of two of the three most damaging hurricanes in 
American history. The SPR was utilized in response to these 
hurricanes both in 2005 and 2008. In both instances the Reserve 
provided loans of crude oil to the Gulf Coast refiners that 
were operating but unable to secure crude supplies.
    Additionally the Strategic Petroleum Reserve executed a 
Presidentially ordered draw down of crude oil in 2005 as part 
of the coordinated IEA response to the disaster. In 2005 our 
IEA partners released their stocks of refined products which 
made available for sale additional fuel supplies to meet United 
States demands until domestic refining and distribution 
infrastructure were brought back online. Despite the efforts of 
the United States Strategic Petroleum Reserve and the IEA 
member countries, there were still some markets that could not 
be immediately supplied with refined products.
    These markets were south of Virginia and north of Florida. 
They lacked the infrastructure to receive and distribute 
imports from the Atlantic coast to the inland population 
centers. As such this area is heavily dependent on gasoline 
supplies from the Gulf Coast refining centers through major 
product pipelines. This situation was realized again after 
Hurricanes Gustav and Ike damaged the Gulf Coast supply and the 
distribution infrastructure in 2008. This time, however, the 
United States did not deem it necessary to request that the IEA 
initiate a coordinated release of its stocks.
    The events of 2005 and 2008 have shown us that the 
Strategic Petroleum program may be limiting this ability to 
address some short term interruptions to our domestic refined 
product supply and distribution infrastructure. The question 
now to be answered is, do we have an increased probability of 
events such as hurricanes in the Gulf of Mexico that lead to 
short term disruptions of limited size that would warrant the 
additional costs of developing a refined product reserve. A 
major technical difference between storing refined products and 
storing crude oil is the relative stability of the commodity.
    If stored properly, as crude is in the Strategic Petroleum 
Reserve caverns, it can be stored almost indefinitely without 
impact on quality or stability of the crude. However, refined 
products have a very limited storage life. These products 
degrade over time. The stocks require regular rotation and 
refreshment. The need to periodically rotate stocks adds to the 
cost of potential refined product reserve.
    There are also many different regional and seasonal product 
specifications particularly for gasoline. Storing the right 
product and managing the rotation of stocks could be a 
challenge. However, many countries and private companies here 
and abroad have successfully built and maintained refined 
product storage. Therefore, there would be little to no 
technical uncertainty associated with the building of a refined 
product reserve.
    I would like to conclude by saying that the administration 
has not, at this time, formulated a position on this proposed 
legislation and has not made a decision on the need to alter 
our crude oil reserve. The Strategic Petroleum Reserve 
currently with 720 million barrels of crude oil stands ready to 
provide crude oil to protect the U.S. in the event of a supply 
disruption. Additionally we look forward to working with 
Congress to make sure that the SPR continues to meet the 
Nation's need for energy security in the future.
    This concludes my prepared testimony. I'll be happy to 
respond to questions that you have.
    [The prepared statement of Mr. Johnson follows:]
Prepared Statement of David F. Johnson, Deputy Assistant Secretary for 
                Petroleum Reserves, Department of Energy
    Mr. Chairman and members of the Committee, I am pleased to be here 
today to discuss the issue of developing refined products storage in 
the Strategic Petroleum Reserve. As you know, the SPR was established 
by Congress through passage of the Energy Policy and Conservation Act 
in 1975 in response to the Arab oil embargoes. The primary policy of 
the U.S. petroleum stockpiling program has been to store crude oil. The 
SPR has served to protect our Nation from crude oil supply 
interruptions for over three decades. This decision was based on the 
recognition that the United States has a robust, sophisticated and 
flexible refining industry. However, due to a temporary shipping 
disruption in Boston Harbor in 2000 prices for heating oil jumped 
dramatically for about a week in the midst of a very cold period. 
President Clinton directed the Department of Energy to establish a 
heating oil reserve and the Congress passed legislation authorizing the 
creation of the Northeast Home Heating Oil Reserve to address heating 
oil supply vulnerabilities in that region. These two stockpiles and our 
open, flexible, and competitive market have been adequate to 
effectively address our vulnerabilities.
           domestic refining and distribution infrastructure
    The SPR currently consists of four storage facilities, two each in 
Louisiana and Texas, with a combined capacity to store 727 million 
barrels of crude oil in underground salt caverns. The current inventory 
of the SPR is just over 720 million barrels. The Gulf Coast region is 
the point of entry for over half of U.S. crude oil imports. 
Additionally, of the 17.6 million barrels per day of operable refining 
capacity in the U.S., nearly half or 8.4 million barrels per day is 
located in the U.S. Gulf Coast region. Locating the SPR storage 
facilities along the Gulf Coast allows direct access to all major 
commercial supply and distribution infrastructure within the region in 
the event of a supply disruption and allows access to the region's vast 
salt domes, which provide the lowest cost storage option for crude oil.
    From the Gulf Coast, domestic crude oil production and foreign 
imports flow inland to refineries within the region and in the Midwest. 
Once refined, products such as gasoline, diesel, and jet fuel are 
shipped around the country by marine vessels and pipelines. A major 
disruption to the supply and distribution systems of the Gulf Coast 
region can potentially affect the entire country. However, the majority 
of the refined products produced in the Gulf Coast region are shipped 
to the East Coast, the Midwest, or consumed within the region.
    Refined products travel to the Midwest primarily via pipeline 
systems. Within the Midwest region, there is approximately 3.6 million 
barrels per day of refining capacity; however, the region also receives 
over 900,000 barrels per day of refined product from the Gulf Coast 
region. In the event of a Gulf Coast disruption, the SPR can supply 
Midwest refineries with crude oil to meet that region's refinery 
demand, but the Midwest must rely upon product stocks stored in the 
region or seek additional imports to offset losses in the refined 
products received from the Gulf Coast. The average storage for gasoline 
in the Midwest since 1990 has been about 50 million barrels, and the 
average storage of distillate (diesel and heating oil) was about 29 
million barrels. The SPR is currently unable to directly offset any 
additional loss in refined product supply to the region.
    There is currently only 1.6 million barrels per day of refining 
capacity on the U.S. East Coast, none of which is north of New York 
City. As a result, the large population centers along the Eastern 
Seaboard must receive substantial fuels supplies, either imported or 
domestic, from outside the region. According to the Energy Information 
Administration, the U.S. East Coast consumes 40 percent to 45 percent, 
or over 3 million barrels per day, of the refined products produced in 
the U.S. Gulf Coast region. Between 500,000 and 600,000 barrels per day 
of Gulf Coast products are shipped to the East Coast on barges or other 
small vessels. However, a significant quantity of fuels supplied to the 
East Coast from the Gulf Coast arrives via pipeline. The Colonial 
Pipeline and the Plantation Pipeline systems have the ability to 
transport up to 2.4 million barrels per day and 600,000 barrels per day 
of petroleum products, respectively, to markets in both the South-
Central and Eastern United States. These pipelines supply all or some 
of the refined products consumed in major population centers such as 
Nashville, TN; Atlanta, GA; Charlotte, NC; Washington, DC; 
Philadelphia, PA; and New York City. The East Coast receives an 
additional 1.5 million barrels per day of refined product imports. 
Aside from the relatively small quantity of heating oil stored in the 
Northeast Home Heating Oil Reserve, the region must rely upon product 
stocks stored in the region or seek additional imports to offset losses 
in refined products received from the Gulf Coast. The average storage 
for gasoline in the Northeast since November 1990 has been about 50 
million barrels, and the average storage of distillate (diesel and 
heating oil) was about 48 million barrels. The SPR is currently unable 
to directly offset any additional loss in refined product supply to the 
region.
    In the event of a major petroleum supply interruption, it has long 
been assumed that the SPR could supply crude oil to our domestic 
refiners which would produce the necessary refined products or that we 
will be able to increase imports of available alternative supplies or 
strategic refined products stocks that were released by our 
International Energy Agency (IEA) partners. While this is still true, 
our recent experiences with hurricanes hitting the Gulf Coast have 
demonstrated that there are some regions that may not have access to 
alternative fuel supplies, leading to localized disruptions. However, 
these disruptions were of short-term duration.
           hurricane vulnerabilities and distribution impacts
    In a four-year period, the United States Gulf Coast bore the impact 
of two of the three most damaging hurricanes in American history.
    Over the three-week period following Hurricane Katrina in 2005, the 
wholesale price of gasoline on the Gulf Coast increased by over 38 
percent, to $2.60 per gallon, before gradually retreating. The 
wholesale price of diesel fuel increased by 41 percent to $2.70 per 
gallon over the same period. Within a month of Hurricane Katrina, 
product imports increased nearly 25 percent above the pre-hurricane 
level offsetting much of the decline in domestic production. This 
situation was mirrored in September 2008 when Hurricanes Gustav and Ike 
hit the Gulf Coast in close succession. Wholesale gasoline prices on 
the Gulf Coast increased by 22 percent to $3.66 per gallon in the first 
half of September 2008 when Hurricanes Gustav and Ike both struck the 
U.S. Higher gasoline prices lasted through October 2008. However, 
wholesale prices of diesel fuel actually fell over this period of time 
due to the rapidly decreasing prices of crude oil. By the end of 
September 2008, product imports increased by more than 30 percent above 
the pre-Hurricane Gustav level in response to the increase in fuel 
prices and helped address lower domestic production.
    The SPR was utilized in response to the hurricanes of both 2005 and 
2008. In both instances the Reserve provided loans of crude oil to Gulf 
Coast refiners that were operating but unable to secure crude supplies. 
Additionally, the SPR executed a Presidentially-ordered sale of crude 
oil in 2005 as part of a coordinated IEA response to the disaster. In 
2005, our IEA partners released their stocks of refined products, which 
made available for sale additional fuel supplies to meet U.S. demand 
until domestic refining and distribution infrastructure was brought 
back online.
    Despite the efforts of the U.S. SPR and IEA member countries, there 
were some markets that could not be immediately supplied with refined 
products. These markets, south of Virginia and north of Florida, lack 
the infrastructure to receive and distribute imports from the Atlantic 
coast to inland population centers. As such, this area is heavily 
dependent on gasoline supplies from the Gulf Coast refinery centers 
through major product pipelines. Disruptions to pipeline service were 
linked in many cases to electricity outages, rather than to damage to 
the pipelines themselves. This situation was realized again after 
Hurricanes Gustav and Ike damaged the Gulf Coast supply and 
distribution infrastructure in 2008. This time, however, the United 
States did not deem it necessary to request that the IEA initiate a 
coordinated emergency release of its stocks from our IEA partners.
    It is also important to note that there are several areas in the 
United States that primarily receive their refined products through a 
single mode of transportation. For example, there are parts of the 
western United States that would be completely cut off from fuel 
supplies if an earthquake or other disaster affected refinery or 
pipeline operations.
       spr mission and capabilities of a regional product reserve
    The SPR was established in response to the Arab oil embargo of 1973 
to protect the United States from interruption to our foreign crude oil 
imports. The decision to store only crude oil in the Reserve was based 
largely on the notion that our domestic refining industry was secure 
and had the ability to refine and distribute SPR crude oil to meet 
consumers' needs during an extended supply disruption. The Department 
of Energy still considers that a large SPR focused on crude oil storage 
to be the best way to protect the Nation from the negative impacts of a 
short-term international interruption to our crude oil imports. 
However, the events of 2005 and 2008 have shown us that this system may 
be limited in its ability to address some short-term interruptions to 
our domestic refined products supply and distribution infrastructure. 
The question now to be answered is: do we have an increased probability 
of events such as hurricanes in the Gulf of Mexico that lead to short-
term disruptions of limited size that warrant the additional cost of 
developing a refined products reserve? The cost of storing refined 
products has also been a factor supporting the ``all crude oil'' SPR 
philosophy. The cost of storing refined products can be substantially 
higher than that of storing crude oil. As an example, it costs $4.80 
per barrel per year to store heating oil in the Northeast Home Heating 
Oil Reserve, whereas the cost to store crude oil in the SPR is $0.21 
per barrel per year. The costs incurred from a domestic product reserve 
must then be carefully weighed against the benefits of a new product 
reserve.
                            technical issues
    A major technical difference between storing refined products and 
storing crude oil is the relative stability of the commodity. When 
stored properly, as it is in SPR salt caverns, crude oil can be stored 
almost indefinitely without any impact on the quality or stability of 
the crude. However, refined products have a limited storage life. The 
products degrade over time and stocks require regular rotation and 
replenishment. The need to continuously rotate stocks adds logistical 
constraints and costs to any potential refined products reserve. There 
are also many different regional and seasonal product specifications, 
particularly for gasoline. Storing the right products and managing the 
rotation of these stocks could be a challenge. However, many countries 
and private companies, both here and abroad, have successfully built 
and maintained refined products storage. Therefore, there would be 
little or no technical uncertainty associated with building a refined 
products reserve.
                               conclusion
    I would like to conclude by saying that the Administration has not 
at this time formulated a position on this proposed legislation and has 
not made a decision on the need to alter our SPR Policy. The Strategic 
Petroleum Reserve currently with 720 million barrels of crude oil 
stands ready to provide crude oil to protect the U.S. in the event of a 
supply disruption. Additionally, we look forward to working with 
Congress to make sure that the SPR continues to meet the Nation's need 
for energy security into the future. This concludes my prepared 
testimony, and I will be happy to respond to any questions you may 
have.

    The Chairman. Thank you very much.
    Dr. Rusco.

   STATEMENT OF FRANK RUSCO, DIRECTOR, NATURAL RESOURCES AND 
         ENVIRONMENT, GOVERNMENT ACCOUNTABILITY OFFICE

    Mr. Rusco. Thank you. Mr. Chairman and members of the 
committee, thank you for the opportunity to participate in this 
hearing on the potential for a strategic petroleum product 
reserve and the management of the Northeast Home Heating Oil 
Reserve.
    In my summary statement I will discuss two primary factors 
that illustrate the potential value of a strategic petroleum 
product reserve. I will also discuss a key issue, specific to 
the United States, which if not addressed could complicate the 
holding of strategic petroleum product reserves. Last I will 
discuss one important lesson learned from evaluating the 
management of the current Strategic Petroleum Reserve that can 
be applied to reduce the costs of filling and maintaining a 
strategic product reserve or the Home Heating Oil Reserve 
should it be used or expanded going forward.
    Two primary factors illustrate the potential benefits of a 
strategic petroleum product reserve.
    First, as has long been the case with crude oil, gasoline 
and other petroleum products are increasingly globally traded 
commodities. The United States is now a large net importer of 
gasoline. While there are clear benefits associated with buying 
gasoline from Europe and other regions when prices make such 
purchases advantageous.
    There are also potential costs. Specifically the global 
nature of gasoline and other petroleum products means that 
events anywhere in the world that disrupt supplies of these 
products can reduce United States supplies and increase prices. 
It also means that the supply chain from refiner to final 
consumer for gasoline may be both longer and more complicated 
than it used to be which may increase the amount of time it 
takes to resupply in the event of a domestic refining or 
pipeline disruption.
    Another factor favoring a strategic product reserve is the 
nature of supply disruption such as Hurricanes Katrina and Rita 
which can be expected to result in losses of refining capacity 
or delivery infrastructure. In such cases a strategic crude oil 
reserve as we currently have is of far less help than it is in 
responding to a disruption that only affects crude oil supply. 
Having both crude oil and petroleum products would provide some 
diversification against the varied types of supply risk that 
the country faces and enable a response to more types of 
disruption than the current reserve allows.
    With regard to challenges associated with a strategic 
product reserve there are a number of issues such as the higher 
cost of storing petroleum products than for crude oil and the 
fact that crude oil can be stored almost indefinitely while 
gasoline will have to be turned over every 18 to 24 months to 
maintain its integrity as a motor fuel. However, a number of 
countries do hold petroleum product reserves. So we know it is 
technically feasible and that these countries have found it in 
their interest to do so.
    I want to focus therefore on one issue specific to the 
United States which if left unaddressed potentially complicates 
the holding of petroleum product reserves. This issue is a 
proliferation of fuel types in the United States that has 
resulted from Federal and State efforts to improve air quality. 
For example there are over a dozen special, cleaner burning 
blends of gasoline that are required to be used in specific 
regions or localities and which have contributed to improved 
air quality in these areas.
    To be maximally effective a petroleum product reserve might 
have to maintain stocks of all of these blends. Recently this 
proliferation of fuel types has continued as international, 
Federal, State and local initiatives to increase the use of 
biofuels appear to be headed toward a patchwork of different 
biofuel blends that vary by region or locality. This could 
further complicate the shipping and storage of appropriate 
blends of gasoline and biofuel blending agents for strategic 
purposes, especially as biofuel use is evolving and changing 
over time.
    Many of the complications associated with having different 
fuel types could be reduced if supply emergencies large enough 
to illicit the use of strategic reserves were accompanied by 
waivers of requirements to use special fuel blends. Thereby 
allowing the limited number of fuel blends to be used anywhere 
and reducing the number of blends that would be kept in the 
reserve. Currently EPA has the authority to waive the 
requirement to use special blends and has done so in the past, 
most notably in the aftermath of Hurricanes Katrina and Rita. 
However this authority is not linked explicitly to decisions on 
when to use strategic reserves.
    Last there is an opportunity to save a great deal of money 
when filling strategic reserves by paying attention to prices. 
Our past evaluations of the current Strategic Petroleum Reserve 
indicate that following the dollar cost averaging approach when 
filling can save money regardless of the level or trend of 
prices as long as there is price volatility. With a product 
reserve this too would apply. But there is also systematic, 
seasonal price variation that could further reduce the costs of 
filling the reserve initially or replenishing it when and if it 
is used. The same can be said for the Northeast Home Heating 
Oil Reserve in the event that it is put into use or expanded in 
the future.
    While we have not studied this in enough detail to estimate 
the range of potential savings for product reserves a 
combination of dollar cost averaging and buying more during 
traditionally lower priced periods. For example, winter months 
for gasoline would likely save millions of dollars compared to 
a strategy of simply buying products at a steady rate as has 
been done for much of the filling of the existing Strategic 
Petroleum Reserve.
    This concludes my oral statement. I would be happy to 
answer any questions. Thank you.
    [The prepared statement of Mr. Rusco follows:]
  Prepared Statement of Frank Rusco, Director, Natural Resources and 
             Environment, Government Accountability Office
                      Strategic Petroleum Reserve
issues regarding the inclusion of refined petroleum products as part of 
                    the strategic petroleum reserve
Why GAO Did This Study
    The possibility of storing refined petroleum products as part of 
the Strategic Petroleum Reserve (SPR) has been contemplated since the 
SPR was created in 1975. The SPR, which currently holds about 700 
million barrels of crude oil, was created to help insulate the U.S. 
economy from oil supply disruptions. However, the SPR does not contain 
refined products such as gasoline, diesel fuel, or jet fuel. The Energy 
Policy Act of 2005 directed the Department of Energy (DOE) to increase 
the SPR's capacity from 727 million barrels to 1 billion barrels, which 
it plans to do by 2018.
    With the possibility of including refined products as part of the 
expansion of the SPR, this testimony discusses (1) some of the 
arguments for and against including refined products in the SPR and (2) 
lessons learned from the management of the existing crude oil SPR that 
may be applicable to refined products.
    To address these issues, GAO relied on its 2006 report on the SPR 
(GAO-06-872), 2007 report on the globalization of petroleum products 
(GAO-08-14), and two 2008 testimonies on the costeffectiveness of 
filling the SPR (GAO-08-512T and GAO-08-726T). GAO also reviewed prior 
DOE and International Energy Agency studies on refined product 
reserves.
What GAO Found
    Since the SPR, the largest crude oil reserve in the world, was 
created in 1975 a number of arguments have been made for and against 
including refined petroleum products. Some of the arguments for 
including refined products in the SPR are: (1) the United States' 
increased reliance on imports and resulting exposure to supply 
disruptions or unexpected increases in demand elsewhere in the world, 
(2) possible reduced refinery capacity during weather related supply 
disruptions, (3) time needed for petroleum product imports to reach all 
regions of the United States in case of an emergency, and (4) port 
capacity bottlenecks in the United States, which limit the amount of 
petroleum products that can be imported quickly during emergencies. For 
example, the damage caused by Hurricane Katrina demonstrated that the 
concentration of refineries on the Gulf Coast and resulting damage to 
pipelines left the United States to rely on imports of refined product 
from Europe. Consequently, regions experienced a shortage of gasoline 
and prices rose. Conversely, some of the arguments against including 
refined products in the SPR are: (1) the surplus of refined products in 
Europe, (2) the high storage costs of refined products, (3) the use of 
a variety of different type of blends of refined products--``boutique'' 
fuels--in the United States, and (4) policy alternatives that may 
diminish reliance on oil. For example, Europe has a surplus of gasoline 
products because of a shift to diesel engines, which experts say will 
continue for the foreseeable future. Europe's surplus of gasoline is 
available to the United States in emergencies and provided deliveries 
following Hurricanes Katrina and Rita in 2005.
    The following three lessons learned from the management of the 
existing SPR may have some applicability in dealing with refined 
products.

   Select a cost-effective mix of products. In 2006, GAO 
        recommended that DOE include at least 10 percent heavy crude 
        oil in the SPR. If DOE bought 100 million barrels of heavy 
        crude oil during its expansion of the SPR it could save over $1 
        billion in nominal terms, assuming a price differential of $12 
        between the price of light and heavy crude, the average 
        differential from 2003 through 2007. Similarly, if directed to 
        include refined products as part of the SPR, DOE will need to 
        determine the most cost-effective mix of products.
   Consider using a dollar-cost-averaging acquisition approach. 
        Also in 2006, GAO recommended that DOE consider acquiring a 
        steady dollar value--rather than a steady volume--of oil over 
        time when filling the SPR. This would allow DOE to acquire more 
        oil when prices are low and less when prices are high. GAO 
        expects that a dollar-cost-averaging acquisition method would 
        also provide benefits when acquiring refined products.
   Maximize cost-effective storage options. According to DOE, 
        below ground salt formations offer the lowest cost approach for 
        storing crude oil for long periods of time--$3.50 per barrel in 
        capital cost versus $15 to $18 per barrel for above ground 
        storage tanks. Similarly, DOE will need to explore the most 
        cost-effective storage options for refined products.

    Mr. Chairman and Members of the Committee:
    We are pleased to be here today to participate in the Committee's 
hearing on the proposal to include refined petroleum products as part 
of the Strategic Petroleum Reserve (SPR). The Energy Policy and 
Conservation Act authorized the establishment of the SPR in 1975 to 
help protect the U.S. economy from damage caused by oil supply 
disruptions following the Arab oil embargo of 1973 to 1974.\1\ The SPR, 
which consists of over 700 million barrels of crude oil stored in salt 
caverns in Texas and Louisiana, is owned by the federal government and 
operated by the Department of Energy (DOE). When processed, crude oil 
is refined to produce petroleum products such as gasoline, diesel, and 
jet fuel. As originally enacted, the Energy Policy and Conservation Act 
envisioned the possibility that the SPR would include a variety of 
petroleum products stored at locations across the country. 
Specifically, section 154(d) of the 1975 act stated that:
---------------------------------------------------------------------------
    \1\ Pub. L. No. 94-163, Title I, Part B, 89 Stat. 881-90 (1975), 
codified as amended at 42 U.S.C. Sec. Sec.  6231-6247(b).

          The Strategic Petroleum Reserve Plan shall be designed to 
        assure, to the maximum extent practicable, that the Reserve 
        will minimize the impact of any interruption or reduction in 
        imports of refined petroleum products and residual fuel oil in 
        any region which the Administrator determines is, or is likely 
        to become, dependent upon such imports for a substantial 
        portion of the total energy requirements of such region. The 
        Strategic Petroleum Reserve Plan shall be designed to assure, 
        to the maximum extent practicable, that each noncontiguous area 
        of the United States which does not have overland access to 
        domestic crude oil production has its component of the 
        Strategic Petroleum Reserve within its respective territory.\2\
---------------------------------------------------------------------------
    \2\ Repealed by Pub. L. No. 106-469, Title I, Sec.  103(7)(C), 114 
Stat. 2030 (2000).

    However, a Federal Energy Administration (FEA) study in 1977\3\ 
found that, at that time, it was less costly to maintain a centralized 
crude oil reserve rather than dispersed storage with multiple product 
reserves. The possibility of including refined petroleum products at 
part of the SPR has been studied periodically by DOE since the mid-
1970s and each time the idea has been rejected.
---------------------------------------------------------------------------
    \3\ FEA, which was a predecessor agency to DOE, authored the 1977 
study. FEA's functions were transferred to DOE effective October 1, 
1977.
---------------------------------------------------------------------------
    Since 1974, the United States and 27 other nations have become 
members of the International Energy Agency (IEA) and have agreed to 
maintain reserves of oil or petroleum products equaling 90 days of net 
imports and to release these reserves and reduce demand during oil 
supply disruptions.\4\ IEA member nations fulfill this obligation in 
various ways; some countries require that industry hold reserves, 
others have created government reserves, and some countries hold a 
combination of the two. Additionally, some IEA countries hold refined 
products in addition to crude oil reserves while the U.S. holds only 
crude oil. In May 2009, the SPR contained about 719 million barrels, 
equal to about 65 days of 2008 U.S. average net monthly oil imports. In 
addition to government reserves, private industry inventory of crude 
oil and petroleum products varies over time, but DOE estimates that 
private inventory contains an amount equivalent to an additional 59 
days of U.S. oil imports. Thus, at the current level of oil demand, the 
SPR combined with private industry holdings contains enough oil and 
petroleum products to exceed the United States' 90-day reserve 
requirement.
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    \4\ The 28 member countries of the International Energy Agency are 
Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, 
France, Germany, Greece, Hungary, Ireland, Italy, Japan, Republic of 
Korea, Luxembourg, The Netherlands, New Zealand, Norway, Poland, 
Portugal, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United 
Kingdom, and United States.
---------------------------------------------------------------------------
    The Energy Policy Act of 2005 directed DOE to increase the SPR 
inventory to 1 billion barrels.\5\ DOE plans to accomplish this 
increase by 2018 and has chosen to increase the size of two current SPR 
sites and create one new site to accommodate the expansion in 
inventory. In August 2006 we made a number of recommendations to the 
Secretary of Energy to improve the operation of the SPR and to improve 
decisions surrounding the SPR's use and expansion.\6\ Specifically, we 
recommended, among other things, that the Secretary should study how to 
best implement experts' suggestions to fill the SPR more cost-
effectively and to conduct a new review about the optimal oil mix in 
the SPR. Largely based on our August 2006 report, we testified twice in 
2008 on options for DOE to improve the cost-effectiveness of filling 
the SPR to 1 billion barrels.\7\
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    \5\ Pub. L. No. 109-58, Title III, Sec.  301(e)(1), 119 Stat. 684 
(2005).
    \6\ GAO, Strategic Petroleum Reserve: Available Oil Can Provide 
Significant Benefits, but Many Factors Should Influence Future 
Decisions about Fill, Use, and Expansion, GAO-06-872 (Washington, D.C.: 
Aug. 24, 2006).
    \7\ GAO, Strategic Petroleum Reserve: Options to Improve the Cost-
Effectiveness of Filling the Reserve, GAO-08-521T, (Washington, D.C.: 
Feb. 26, 2008); and GAO, Strategic Petroleum Reserve: Improving the 
Cost-Effectiveness of Filling the Reserve, GAO-08-726T (Washington, 
D.C.: Apr. 24, 2008).
---------------------------------------------------------------------------
    With the expansion of the SPR, the issue of including refined 
petroleum products has resurfaced. As Congress debates whether to 
require DOE to include refined petroleum products, our testimony today 
will (1) summarize some of the arguments for and against including 
refined petroleum products and (2) highlight some of the lesson learned 
from the management of the existing SPR that may be applicable to 
refined petroleum products.
    To address these issues, we reviewed our August 2006 report on the 
SPR, our December 2007 report on the globalization of petroleum 
products,\8\ and our two 2008 testimonies on the cost-effectiveness of 
filling the SPR. We also reviewed the Energy Policy and Conservation 
Act, as amended; the regulations on the acquisition of petroleum for 
the SPR;\9\ and prior DOE studies on the feasibility of including 
refined petroleum products as part of the SPR. In addition, we spoke 
with an IEA official and we reviewed IEA documents dealing with the 
issue of refined petroleum product reserves in the United States and 
other IEA member countries overseas. We conducted our work from April 
2009 to May 2009 in accordance with all sections of GAO's Quality 
Assurance Framework that are relevant to our objectives. The framework 
requires that we plan and perform the engagement to obtain sufficient 
and appropriate evidence to meet our stated objectives and to discuss 
any limitations in our work. We believe that the information and data 
obtained, and the analysis conducted, provide a reasonable basis for 
any findings and conclusions.
---------------------------------------------------------------------------
    \8\ GAO, Energy Markets: Increasing Globalization of Petroleum 
Products Markets, Tightening Refining Demand and Supply Balance, and 
Other Trends Have Implications for U.S. Energy Supply, Prices, and 
Price Volatility, GAO-08-14 (Washington, D.C.: Dec. 20, 2007).
    \9\ 10 C.F.R. Part 626.
---------------------------------------------------------------------------
                               background
    The United States is the largest consumer of crude oil and 
petroleum products. In 2007, the U.S. share of world oil consumption 
was approximately 24 percent. While DOE projects that U.S. demand for 
oil will continue to grow, domestic production has generally been in 
decline for decades, leading to greater reliance on imported oil. U.S. 
imports of oil have increased from 32 percent of domestic demand in 
1985 to 58 percent in 2007.
    In managing the SPR, the Secretary of Energy is authorized by the 
Energy Policy and Conservation Act, as amended, to place in storage, 
transport, or exchange, (1) crude oil produced from federal lands; (2) 
crude oil which the United States is entitled to receive in kind as 
royalties from production on federal lands; and (3) petroleum products 
acquired by purchase, exchange, or otherwise.\10\ The act also states 
that the Secretary shall, to the greatest extent practicable, acquire 
petroleum products for the SPR in a manner that minimizes the cost of 
the SPR and the nation's vulnerability to a severe energy supply 
interruption, among other things.\11\ In addition, until being repealed 
in 2000, the act provided the Secretary discretionary authority to 
require importers and refiners of petroleum products to store and 
maintain readily available inventories, and it directed the Secretary 
to establish and maintain regional petroleum reserves under certain 
circumstances.\12\
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    \10\ 42 U.S.C. Sec.  6240(a).
    \11\ 42 U.S.C. Sec.  6240(b).
    \12\ Pub. L. No. 94-163, Title 1, Part B, Sec. Sec.  156, 157, 89 
Stat. 885-86 (1975), previously codified as amended at 42 U.S.C. Sec.  
6236 (Industrial Petroleum Reserve) and Sec.  6237 (Regional Petroleum 
Reserve), respectively. Repealed by Pub. L. No. 106-469, Title I, 
Sec. Sec.  103(9),(10), 114 Stat. 2030 (2000).
---------------------------------------------------------------------------
    Under conditions prescribed by Energy Policy and Conservation Act, 
as amended, the President has the discretion to authorize the Secretary 
of Energy to release the oil in the SPR to minimize significant supply 
disruptions.\13\ In the event of an oil supply disruption, the SPR can 
provide supply to the market--by selling stored crude oil or trading 
this oil in exchange for a larger amount of oil to be returned later. 
Presidents have twice ordered that oil be sold from the SPR in response 
to oil supply disruptions: that is, in response to the 1990-1991 
Persian Gulf War and Hurricane Katrina in 2005. When oil is released 
from the SPR, it flows through commercial pipelines or on waterborne 
vessels to refineries, where it is converted into gasoline and other 
petroleum products, then transported to distribution centers for sale 
to the public. Additionally, the SPR has sold or exchanged oil on 
several other occasions, including providing small quantities of oil to 
refiners to help them through short-term localized oil shortages.
---------------------------------------------------------------------------
    \13\ Pub. L. No. 94-163, Sec.  161, 89 Stat. 888-89 (1975), 
codified as amended at 42 U.S.C. Sec.  6241.
---------------------------------------------------------------------------
    Oil markets have changed substantially in the 34 years since the 
establishment of the SPR. At the time of the Arab oil embargo, price 
controls in the United States prevented the prices of oil and petroleum 
products from increasing as much as they otherwise might have, 
contributing to a physical oil shortage that caused long lines at 
gasoline stations throughout the United States. Now that the oil market 
is global, the price of oil is determined in the world market primarily 
on the basis of supply and demand. In the absence of price controls, 
scarcity is generally expressed in the form of higher prices, as 
purchasers are free to bid as high as they want to secure oil supply. 
In a global market, an oil supply disruption anywhere in the world 
raises prices everywhere. Releasing oil reserves during a disruption 
provides a global benefit by reducing oil prices in the world market.
    In response to various congressional directives, DOE has studied 
the issue of including refined petroleum products at various times 
since 1975. After the initial SPR plan was developed, the issue was 
reviewed again in whole, or in part, in 1977, 1982, 1989, and 1998.\14\ 
Except for the 1998 report, DOE concluded that including refined 
petroleum products as part of the SPR was unnecessary and too 
expensive. The 1998 study dealt with establishing a home heating oil 
reserve and while it did not conclude that a reserve should or should 
not be established, it did find the construction of such a reserve 
would have net negative benefits. The 2000 amendments to the Energy 
Policy and Conservation Act authorized the Secretary to establish a 
Northeast Home Heating Oil Reserve, which was created and filled that 
same year. Although this reserve is considered separate from the SPR, 
it is authorized to contain 2 million barrels of heating oil and 
currently holds nearly that amount.\15\ The Reserve is an emergency 
source of heating oil to address a severe energy supply interruption in 
the Northeast.\16\ According to DOE, the intent was to create a reserve 
large enough to allow commercial companies to compensate for 
interruptions in supply of heating oil during severe winter weather, 
but not so large as to dissuade suppliers from responding to increasing 
prices as a sign that more supply is needed. To date, the Northeast 
Home Heating Oil Reserve has not been used to address an emergency 
winter shortage situation.
---------------------------------------------------------------------------
    \14\ Federal Energy Administration, Strategic Petroleum Reserve 
Office, Strategic Petroleum Reserve Plan, Energy Publication No. 95-2 
(Washington, D.C.: January 1977); DOE, Office of the Secretary, A 
Report to the Congress: Regional Petroleum Reserves, DOE/EP-0080 
(Washington, D.C.: Dec. 31, 1982); DOE, Office of the Assistant 
Secretary for Fossil Energy, Report to the Congress on Expansion of the 
Strategic Petroleum Reserve to One Billion Barrels, DOE/FE-0126 
(Washington, D.C.: Apr. 1989); DOE, Office of the Assistant Secretary 
for Fossil Energy, Report to Congress on the Feasibility of 
Establishing a Heating Oil Component of the Strategic Petroleum 
Reserve, DOE/FE-0376 (Washington, D.C.: June 1998).
    \15\ During June 2007, DOE sold 35,000 of its two million barrel 
reserve in order to cover the higher costs of new storage contracts. In 
August 2008, DOE repurchased 19,253 barrels of heating oil using $3 
million of appropriated funds, taking the inventory to 1,984,253 
barrels.
    \16\ Pub. L. No. 106-469, Title II, 114 Stat. 2034-37 (2000), 
codified as amended at 42 U.S.C. Sec. Sec.  6250-6250e.
---------------------------------------------------------------------------
   some of the arguments for and against including refined petroleum 
                          products in the spr
    Some of the arguments for including refined petroleum products in 
the SPR are: (1) the United States' increased reliance on foreign 
imports and resulting exposure to supply disruptions or unexpected 
increases in demand elsewhere in the world, (2) possible reduced 
refinery capacity during weather related supply disruptions, (3) time 
needed for petroleum product imports to reach all regions of the United 
States in case of an emergency, and (4) port capacity bottlenecks in 
the United States which limit the amount of petroleum products that can 
be imported quickly during emergencies. Some of the arguments against 
including refined petroleum products in the SPR are: (1) the surplus of 
gasoline in Europe, (2) the high storage costs of refined products, (3) 
the use of `boutique' fuels in the United States, and (4) policy 
alternatives may diminish U.S. reliance on oil.
Some of the Arguments for Including Refined Petroleum Products in the 
        SPR
    First, in our December 2007 report,\17\ we found that while the 
United States was largely self-sufficient in gasoline in 1970, in 
fiscal year 2007, we imported over 10 percent of our annual consumption 
of gasoline and smaller percentages of jet fuel and some other 
products.\18\ We also found that along with an increased reliance on 
imports the United States is exposed to supply disruptions or 
unexpected increases in demand anywhere else in the world. Because the 
SPR contains only crude oil, if an unexpected supply disruption occurs 
in a supply center for the United States, the government's emergency 
strategy would rely on sufficient volumes of the SPR and a refinery 
sector able to turn out products at a pace necessary to meet consumer 
demands in a crisis. Any growth in demand in the United States would 
put increasing pressure on this policy, and for much of the past 25 
years, demand for refined petroleum products in the United States and 
internationally has outpaced growth in refining capacity.
---------------------------------------------------------------------------
    \17\ GAO-08-14.
    \18\ Total gasoline includes both finished motor gasoline and motor 
gasoline blending components.
---------------------------------------------------------------------------
    Second, in our August 2006 report,\19\ we found that the ability of 
the SPR to reduce economic damage may be impaired if refineries are not 
able to operate at capacity or transport of oil to refineries is 
delayed. For example, petroleum product prices still increased 
dramatically following Hurricanes Katrina and Rita, in part because 
many refineries are located in the Gulf Coast region and power outages 
shut down pipelines that refineries depend upon to supply their crude 
oil and to transport their refined petroleum products to consumers. DOE 
reported that 21 refineries in affected states were either shut down or 
operating at reduced capacity in the aftermath of the hurricane. In 
total, nearly 30 percent of the refining capacity in the United States 
was shut down, disrupting supplies of gasoline and other products. Two 
pipelines that send petroleum products from the Gulf coast to the East 
Coast and the Midwest were also shut down as a result of Hurricane 
Katrina. For example, Colonial Pipeline, which transports petroleum 
products to the Southeast and much of the East Coast, was not fully 
operational for a week after Hurricane Katrina. Consequently, average 
retail gasoline prices increased 45 cents per gallon between August 29 
and September 5, short-term gasoline shortages occurred in some places, 
and the media reported gasoline prices greater than $5 per gallon in 
Georgia. The hurricane came on the heels of a period of high crude oil 
prices and a tight balance worldwide between petroleum demand and 
supply, and illustrated the volatility of gasoline prices given the 
vulnerability of the gasoline infrastructure to natural or other 
disruptions.
---------------------------------------------------------------------------
    \19\ GAO-06-872.
---------------------------------------------------------------------------
    Third, because some foreign suppliers are farther from the U.S. 
demand centers they serve than the relevant domestic supply center, the 
time it takes to get additional product to a demand center experiencing 
a supply shortfall may be longer than it would be if the United States 
had its own product reserves. For example, imports of gasoline to the 
West Coast may come from as far away as Asia or the Middle East, and 
the transport time and therefore cost is greater. To the extent that 
imported gasoline or other petroleum products come from far away, the 
lengthening of the supply chain has implications for the ability to 
respond rapidly to domestic supply shortfalls. Specifically, if 
supplies to relieve a domestic regional supply shortfall must come from 
farther away, the price increases associated with such shortfalls may 
be greater and/or last longer. In this sense, the West Coast and the 
middle of the country are more vulnerable to price increases or 
volatility than is the Northeast, which can receive shipments of 
gasoline from Europe, often on voyages of less than a week.
    Fourth, the receipt of petroleum products may be delayed because 
port facilities are operating at or near capacity. For example, one-
fourth of the ports in a U.S. Maritime Administration (MARAD) survey 
described their infrastructure impediments as ``severe.'' Officials 
from the interagency U. S. Committee on the Maritime Transportation 
System, which includes MARAD, the National Oceanic and Atmospheric 
Administration, and the U.S. Army Corps of Engineers, told us that U.S. 
ports and waterways are constrained in capacity and utilization, and 
anticipate marine supply infrastructure will become more constrained in 
the future. Officials at the Ports of Los Angeles, Long Beach, Oakland, 
Houston, Savannah, and Charleston reported congestion and emphasized in 
a 2005 report that they are experiencing higher than projected growth 
levels. In fact, one European product transporter we spoke with said 
that the European response to Hurricanes Rita and Katrina were hindered 
because East Coast ports in the United States could not handle the 
number of oil tankers carrying petroleum products from Europe, with 
some tankers waiting for as long as 2 weeks at port.
Some of the Arguments Against Including Refined Petroleum Products in 
        the SPR
    First, a key impetus for global trade in petroleum products has 
been a structural surplus in production of gasoline and a deficit in 
production of diesel in Europe. This surplus of gasoline is largely the 
result of a systematic switch in European countries toward automobiles 
with diesel-powered engines, which are more fuel efficient than 
gasolinepowered engines. European regulators promoted diesel fuel use 
in Europe by taxing diesel at a lower rate, and European demand for 
diesel vehicles rose. The European refining and marketing sector 
responded to this change in demand by importing increasing amounts of 
diesel, and exporting a growing surplus of gasoline to the United 
States and elsewhere. The United States has purchased increasing 
amounts of gasoline, including gasoline blendstocks, from Europe in 
recent years. These imports have generally had a strong seasonal 
component, with higher levels of imports during the peak summer driving 
months and lower imports during the fall and winter. The major 
exception to this seasonality came in the months of October 2005 
through January 2006, when imports surged in response to U.S. 
shortfalls resulting from Hurricanes Katrina and Rita in August and 
September 2005, respectively. Experts and company representatives told 
us they believe this structural imbalance within the European Union 
will continue for the foreseeable future, and perhaps widen, resulting 
in more exports of European gasoline and blending components to the 
United States.
    Second, in its prior reports on the subject, DOE found that refined 
petroleum product reserves are more costly than crude oil to store and 
must be periodically used and replaced to avoid deterioration of the 
products. Although DOE officials said some refined products can be 
stored in salt caverns just as the SPR crude oil is currently stored, 
these caverns are predominantly found on the Gulf Coast. In order to 
store refined product in other parts of the United States, storage 
tanks may need to be built, which is costlier than centralized salt 
cavern storage. According to DOE, stockpiling oil in salt caverns costs 
about $3.50 per barrel in capital costs. Storing oil in aboveground 
tanks, by comparison, can cost $15 to $18 per barrel. One of the 
maintenance costs of refined petroleum products that is not associated 
with crude oil storage is turnover, or replacement costs, because 
refined products deteriorate more quickly. Turnover of the product is 
required to ensure quality. For example, DOE found that when gasoline 
is stored in above-ground tanks, the turnover time is 18 to 24 months. 
Conversely, DOE found that crude oil could be stored for prolonged 
periods without losing quality. The more frequent the turnover, the 
higher the throughput and administrative costs.
    Third, while the language in the Energy Policy and Conservation Act 
addresses refined petroleum products as well as crude oil, DOE 
conducted a study in 1977 that found geographically dispersed, small 
reserves of a variety of petroleum products would be more costly than a 
centralized crude oil reserve. For example, many states have adopted 
the use of special gasoline blends--or `boutique' fuels, which could 
pose a challenge in incorporating refined products in the SPR. Unless 
requirements to use these fuels were waived during emergencies, as they 
were in the aftermath of Hurricanes Katrina and Rita, boutique fuels 
could need to be strategically stored at multiple regional, state, or 
local locations due to reduced product fungibility. Conversely, crude 
oil provides flexibility in responding to fluctuations in refined 
product market needs as regional fuel specifications and environmental 
requirements change over time. Furthermore, the switching of seasonal 
blends to meet environmental requirements and product degradation would 
require inventory turnover as compared to crude oil storage, which does 
not require the same level of turnover.
    Fourth, there are several policy choices that might diminish the 
growth in U.S. demand for oil. First, research and investment in 
alternative fuels might reduce the growth of U.S. oil demand. Vehicles 
that use alternative fuels, including ethanol, biodiesel, liquefied 
coal, and fuels made from natural gas, are now generally more expensive 
or less convenient to own than conventional vehicles, because of higher 
vehicle and fuel costs and a lack of refueling infrastructure. 
Alternative-fuel vehicles could become more viable in the marketplace 
if their costs and fuel delivery infrastructure become more comparable 
to vehicles fueled by petroleum products. Second, greater use of 
advanced fuel-efficient vehicles, such as hybrid electric and advanced 
diesel cars and trucks, could reduce U.S. oil demand. The Energy Policy 
Act of 2005, as amended, directs the Secretary of Energy to establish a 
program that includes grants to automobile manufacturers to encourage 
domestic production of these vehicles.\20\ Third, improving the 
Corporate Average Fuel Economy (CAFE) standards could curb demand for 
petroleum fuels. After these standards were established in 1975, the 
average fuel economy of new light-duty vehicles improved from 13.1 
miles per gallon in 1975 to a peak of 22.1 miles per gallon in 
1987.\21\ More recently, the fuel economy of new vehicles in the United 
States has stagnated at approximately 21 miles per gallon. However, 
CAFE standards have recently been raised to require auto manufacturers 
to achieve a combined fuel economy average of 35 miles per gallon for 
both passenger and nonpassenger vehicles beginning in model year 
2020.\22\ Any future increases could further decrease the U.S. oil 
demand.
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    \20\ Pub. L. No. 109-58, Title VII, Sec.  712, 119 Stat. 818 
(2005), codified as amended at 42 U.S.C. 16062.
    \21\ According to the Environmental Protection Agency, these fuel 
economy numbers are based on ``real world'' estimates that the federal 
government provides to consumers and are about 15 percent lower than 
the values used for compliance with the CAFE program.
    \22\ Pub. L. No. 110-140, Sec. 102, 121 Stat. 1498 (2007).
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  lessons learned from the management of the existing spr that may be 
                 relevant to refined petroleum products
    The following three lessons learned from the management of the 
existing crude oil SPR highlight some of the issues that may need to be 
considered in acquiring refined petroleum products.

   Select a cost-effective mix of products. To fill the SPR in 
        a more cost-effective manner, we recommended in August 2006 
        that DOE include in the SPR at least 10 percent heavy crude 
        oils,\23\ which are generally cheaper to acquire than the 
        lighter oils that comprise the SPR's volume.\24\ Including 
        heavier oil in the SPR could significantly reduce fill costs 
        because heavier oil is generally less expensive than lighter 
        grades. For example, if DOE included 10 percent heavy oil in 
        the SPR as it expands to 1 billion barrels that would require 
        DOE to add 100 million barrels of heavy oil, or about one-third 
        of the total new fill. From 2003 through 2007, Maya--a common 
        heavy crude oil--has traded for about $12 less per barrel on 
        average than West Texas Intermediate--a common light crude oil. 
        If this price difference were to persist over the duration of 
        the new fill period, DOE would save about $1.2 billion in 
        nominal terms by filling the SPR with 100 million barrels of 
        heavy oil.\25\ Similarly, refined petroleum products included 
        as part of the SPR may comprise a number of different types of 
        products (e.g., gasoline, diesel, and jet fuel) and possibly 
        different blends of products (e.g., different grades and 
        mixtures of gasoline); DOE will need to determine the most 
        cost-effective mix of products in light of existing legal and 
        regulatory requirements to use specific blends of fuels.
---------------------------------------------------------------------------
    \23\ GAO-06-872.
    \24\ The weight of oil is measured by its gravity index. According 
to DOE's Energy Information Administration, light oil is greater than 
38 degrees gravity; intermediate oils, such as those in the SPR, are 22 
to 38 degrees gravity; and heavy oil is 22 degrees gravity or below. 
See DOE, Office of the Assistant Secretary for Fossil Energy, Strategic 
Petroleum Reserve: Annual Report for Calendar Year 2007 (DOE/FE-0525), 
for information on the composition of the SPR.
    \25\ This calculation is intended to illustrate the magnitude of 
potential savings, and is not meant to be a projection of actual 
savings. The actual price difference between light and heavy oil over 
the course of the new fill could be smaller or larger than over the 
past 5 years, which would either reduce or increase the savings.
---------------------------------------------------------------------------
   Consider using a dollar-cost-averaging acquisition approach. 
        Also in our August 2006 report, we recommended that DOE 
        consider filling the SPR by acquiring a steady dollar value of 
        oil over time, rather than a steady volume as has occurred in 
        recent years. This ``dollar-cost-averaging'' approach would 
        allow DOE to take advantage of fluctuations in oil prices and 
        ensure that more oil would be acquired when prices are low and 
        less when prices are high. In August 2006, we reported that if 
        DOE had used this approach from October 2001 through August 
        2005, it could have saved approximately $590 million in fill 
        costs. We also ran simulations to estimate potential future 
        cost savings from using a dollar-cost-averaging approach over 5 
        years and found that DOE could save money regardless of the 
        price of oil as long as there is price volatility, and that the 
        savings would be generally greater if oil prices were more 
        volatile. We would expect a dollar-cost-averaging acquisition 
        method to also provide positive benefits when acquiring refined 
        petroleum products.
   Maximize cost-effective storage options. According to DOE, 
        salt formations offer the lowest cost, most environmentally 
        secure way to store crude oil for long periods of time. 
        Stockpiling oil in artificially created caverns, deep within 
        rock-hard salt, has historically cost about $3.50 per barrel in 
        capital costs. In comparison, storing oil in above-ground tanks 
        can cost $15 to $18 per barrel. Similarly, for those refined 
        petroleum products that can be stored below ground, salt 
        formations may offer a cost-effective storage option. However, 
        possible storage options would need to be evaluated hand-in-
        hand with the need to (1) turn over the refined stocks 
        periodically because their stability deteriorates over time, 
        and (2) transport the refined petroleum products quickly to 
        major population centers where the products will be used.

    The Chairman. Thank you very much.
    Mr. Shages, thank you for being here.

        STATEMENT OF JOHN SHAGES, INDEPENDENT CONSULTANT

    Mr. Shages. Thank you very much, Mr. Chairman, Senator 
Murkowski.
    During my 22-year association with the Strategic Petroleum 
Reserve there were occasions when the government either would 
have or should have acted to prevent oil markets from becoming 
seriously imbalanced, but did not. Either because the response 
was outside of the physical capabilities of the reserve or the 
government paralyzed itself debating the complexities of a 
Presidential emergency finding. As some changes to the 
authorizing legislation in the reserves characteristics, we 
will certainly miss future opportunities.
    I believe there are major issues that should be addressed 
by the Congress and the administration to modernize the 
reserve. S. 967 effectively addresses two of these issues.
    First, the SPR inventory is all crude oil. In 1976 a case 
was made for refineries and the Nation's systems of pipelines 
were so robust the reserve could be all crude oil. The storage 
sites could be located on the Gulf of Mexico which would reduce 
both capital and operating costs.
    While that reasoning was sound for many years, twice in the 
last 5 years we saw hurricanes shut down the whole petroleum 
industry for sustained periods. It is a mistake to assert the 
crude oil supply is our only vulnerability when a large segment 
of the Southeast United States can be cutoff from fuel.
    There is no legitimate reason not to modernize the reserve 
by the inclusion of refined products other than cost avoidance. 
That issue can be addressed by proper management of the 
reserve. S. 967 addresses this issue by mandating refined 
products as part of the reserve. I endorse that mandate.
    Second, the United States has literally wrapped itself in 
legislative red tape by requiring a finding of an emergency by 
the President to sell oil. It is no small matter to declare a 
national emergency. Appropriately the White House must be 
cautious about taking such a step for fear that the finding 
itself may make the situation worse.
    Consequently over 33 years we've had only two such 
findings. One associated with the outbreak of war in 1991 and 
one due to Hurricane Katrina. Everyone realizes that this 
hurdle is problematic.
    Both the Clinton and Bush administrations turned to oil 
loans to augment the drawdown authorities. While making loans 
is an appropriate way to respond to some supply disruptions the 
legal authority is frankly a loop hole. In addition loans are 
most appropriately used in situations involving a few 
refineries and when current prices are higher than future 
prices. But not all emergencies coincide with those 
circumstances.
    S. 967 solves this problem by authorizing the Secretary of 
Energy rather than the President to determine that a drawdown 
in sale from the reserve is needed. This is appropriate. The 
Secretary is supported by the best expertise available on 
timely usage of the reserve. The decisionmaking process will 
not be cluttered with all the departments of the executive 
branch. I highly endorse the change in drawdown authority that 
will be made by S. 967.
    Third, S. 283 makes major changes to the authorization for 
using the Northeast Home Heating Oil Reserve. Unfortunately 
those changes would make the drawdown authority highly 
subjective. It also includes an absolute trigger price of $4 
per gallon adjusted for inflation.
    In the event the price stays above $4, liquidates the 
heating oil inventory without provision for replacement. A far 
preferable approach would be to change the drawdown 
authorization to mirror the change made by S. 967 for the 
Strategic Petroleum Reserve. If the Secretary rather than the 
President were allowed to determine the appropriate 
circumstances for a drawdown the reserves management could be 
more nimble and flexible.
    Fourth, we will reach a critical milestone this year when 
the SPR reaches an inventory equal to its rated capacity. At 
that time the Secretary of Energy effectively loses two weapons 
in his policy arsenal.
    First, because the authority to make loans from the Reserve 
is dependent upon acquiring oil the Secretary will be 
constrained by the lack of capacity to store newly acquired 
oil.
    Second, the energy policy of the United States can 
effectively be undermined by OPEC and price volatility.
    While we tend to think of oil price spikes as being 
devastating to our economy, price collapses wreak havoc on 
domestic suppliers, increase our imports and set the Nation up 
for the next price spike. There is no question that the 
collapse of oil prices at the end of 2008 is responsible for a 
50-percent drop in domestic drilling activity and bankruptcy 
among ethanol producers.
    The most effective way that the governments have for 
dealing with collapsing oil prices is to buy and store surplus 
oil. The Strategic Petroleum Reserve Office is capable of 
conducting a counter cyclical buying policy, the Reserve must 
be expanded to have that option. There is only one reason for 
not expanding the Reserve and that is the associated cost which 
leads me to my last recommendation to the committee.
    The Strategic Petroleum Reserve Office has shown that it 
can make loans of oil from the Reserve and in consideration 
receive in kind premiums. The value of those premiums to date 
is hundreds of millions of dollars. There is potential for more 
except that there will be no in kind premiums if there is no 
place to store the oil.
    A number of road blocks to expansion and making loans would 
be cleared away if, as part of the modernization, Congress 
authorized the SPR Office to take loan premiums in cash, put 
that money into the SPR petroleum account, and fund future 
expansion costs from the petroleum account.
    Mr. Chairman, this concludes my prepared statement.
    [The prepared statement of Mr. Shages follows:]
      Prepared Statement of John D. Shages, Independent Consultant
    I am pleased to be here today to discuss S. 967 the Strategic 
Petroleum Reserve Modernization Act of 2009, S. 283 Release of Products 
From Northeast Home Heating Oil Reserve, as well as other potential 
improvements in the Strategic Petroleum Reserve (Reserve) and petroleum 
stockpiling generally. By way of background I spent over thirty years 
in the Department of Energy and its predecessor organizations. I joined 
the Strategic Petroleum Reserve Office in 1985 and retired in 2007 as 
the Deputy Assistant Secretary for Petroleum Reserves. Since that time 
I have engaged in private consulting on strategic petroleum 
stockpiling. I am proud to have been associated with the Department and 
the Petroleum Reserves Office, and I believe that it is one program 
that has given a tremendous return to the American taxpayer in 
repayment for its support.
    The Reserve is the Nation's first and only immediately deployable 
defense against a major oil supply interruption. Since its initial 
authorization in 1975 the Reserve has evolved both physically and 
managerially to be flexible and available for a wide array of problems. 
Nevertheless, there are five major improvements that can be made in the 
Reserve system as it now exists, three relate to physical properties, 
one to sales and loan authorities, and one to financing. S. 967 
addresses two of these issues. In the interest of being concise I will 
dispense with general background and will only address these 
opportunities.
    The Reserve today contains no refined products, has a capacity to 
hold oil which has not improved in almost twenty years, and consists of 
only two high quality streams of oil. All three of these 
characteristics require attention.
    Include Refined Products in the Reserve: In the initial legislative 
authorization of the Reserve the Energy Policy and Conservation Act 
(Act)anticipated the Reserve would provide a defense against 
disruptions of oil imports, which was a direct response to the Arab 
OPEC oil embargo of 1973-74. The perception of vulnerability to 
international disruptions was fortified by the Iranian revolution of 
1980-81, which caused fuel shortages, a devastating price spike, and 
sent the country into a major recession. The Act directly addressed the 
issue of supply assurance by requiring that the Reserve contain both 
regional and refined components. However, the Act allowed for the 
substitution of crude oil in centralized facilities if the Department 
of Energy found centralized facilities and crude oil could reasonably 
protect all regions of the country and reduce the Reserve's cost 
significantly. In fact, the initial Strategic Petroleum Reserve Plan 
sent to Congress in 1977 persuasively made the case that American 
refineries and a robust logistics system would amply protect the 
country as long as the refineries had sufficient access to crude oil. 
The Plan also emphasized that centralized storage would substantially 
reduce the cost of storage. Consequently, the Reserve inventory is now 
located at four sites along the Texas and Louisiana Gulf Coast and is 
composed of crude oil. This configuration of the Reserve was not 
seriously questioned until 2000. That year, the eastern half of the 
country suffered a late season freeze that disrupted heating oil and 
natural gas supplies. In the Northeast there was a danger of literally 
running out of heating oil.
    In response to that near physical shortage of heating fuels, the 
Clinton administration determined to modify the Strategic Petroleum 
Reserve Plan to include a heating oil component in the Northeast. That 
change to the plan was made and the Strategic Petroleum Reserve Office 
exchanged enough crude oil to acquire two million barrels of heating 
oil and storage services. Later in 2000, Congress directly ratified 
this change by amending the Act to directly authorize the Northeast 
Home Heating Oil Reserve (Heating Oil Reserve) as a separate entity 
from the Strategic Petroleum Reserve.
    Despite the addition of the Heating Oil Reserve, the Nations' 
stockpile of oil is still overwhelmingly oriented to protection against 
crude oil disruptions based upon the assumption of a robust refining 
industry and an extensive system of pipelines. The weather events of 
2005 and 2008 seriously challenge the validity of this assumption. We 
have discovered that massive hurricanes can cause regional shortages by 
disrupting crude oil production in the Gulf of Mexico, refineries along 
the Gulf Coast, the pipelines that carry crude oil and refined 
products, and the power lines that are essential for both the 
refineries and pipelines to operate. In both 2005 and 2008 the inland 
parts of the Southeast--especially the city of Atlanta--suffered 
shortages of fuel because of absolute dependence on the Colonial and 
Plantation Pipelines. Even though those pipelines were operable soon 
after the storms, there were limited products for the pipelines to move 
because refineries remained closed due either to direct damage or 
because power could not be restored quickly to the refineries.
    Today there is a widely held belief that the Gulf Coast will be 
visited by more devastating storms in the future. In addition the 
Southwest is also highly dependent upon a single pipeline system 
originating in Los Angeles. In the event of a major earthquake in the 
Los Angeles area, it is easy to construct a scenario in which supplies 
of oil products are disrupted into southern Nevada, Utah, New Mexico 
and Arizona.
    Over the last 30 years debates about the value of the Strategic 
Petroleum to the United States have focused primarily on its ability to 
prevent the price of oil from spiking during a disruption and the 
associated economic havoc that frequently follows such spikes. Now we 
are faced with two recent examples of an entire region that could not 
be adequately supplied regardless of price. While the rest of the 
Nation was being relieved of very high fuel prices by September 2008, 
the interior Southeast was suffering disruptive fuel shortages that 
kept prices at devastatingly high levels for business and individual 
consumers.
    In consideration of these developments, amending the composition of 
the Strategic Petroleum Reserve to contain a substantial refined 
product component would be prudent. Given that the anticipated 
disruptions will be discrete events and the effects limited in 
duration, the refined product component could be relatively small--in 
the range of 30 million barrels--and could consist of just gasoline and 
diesel fuel. The exact design and location of the facilities should be 
left to the Department of Energy with due consideration to minimizing 
the cost of new facilities and operations. One attractive option is to 
include caverns for refined products in the new Reserve site being 
planned in Mississippi. S. 967 provides positive, unambiguous direction 
to the Department of Energy to create a refined product component 
within the Strategic Petroleum Reserve. It also allows the Department 
flexibility to accomplish the mission in the lowest cost way without 
undue impacts on markets and allows for acquisitions during off peak 
periods. I fully endorse the spirit and language of S. 967 for this 
purpose.
    Expand the Reserve: The Reserve is a very powerful tool for 
American economic and foreign policy. While most analysts appreciate 
the potential of the Reserve to moderate the effects of oil shortages 
and control surging oil prices, there has been very little attention 
focused on the value of having empty storage capacity simply because we 
have always had more storage capacity than inventory. That situation 
will change in the fourth quarter of this year when the inventory 
reaches the rated 727 million barrel capacity of the Reserve. There are 
a number of reasons that justify adding to the capacity of the Reserve 
and I will address four of the most important.
    First, the goal of having more oil inventory is justified by the 
threat posed to our economy by disruptions and price spikes. The 
economic rationale for the Reserve has evolved and been refined over 
the past thirty years. At the heart of the argument is the observation 
that oil price spikes have preceded 10 of the 11 recessions which have 
occurred since the Second World War. Regardless of whether price spikes 
have been the sole causes of recessions or contributory, it would be 
implausible to argue that the gigantic price increase that occurred 
during 2007-2008 had nothing to do with the current state of our 
economy or that its role was inconsequential. A recent paper by 
Professor James Hamilton, the person credited with being the first to 
publish his observations on the frequency of recessions after oil 
shocks, eloquently defends the pertinence of this hypothesis relating 
the current severe recession to the oil shock. By his calculations 
absent the price shock during the year starting October 2007 the GDP of 
the United States would have grown 3.5 percent more than it actually 
did, equal to about $500 billion. Having a Reserve large enough that 
the President would feel comfortable using it to suppress a $100 per 
barrel price spike rather than allowing it to drive the economy into 
recession would easily be worth the cost of that expansion.
    In 2006, the Administration conducted a study of the appropriate 
size of the Reserve, including all of the interested government 
agencies and outside expert consultants. Based on the probabilities of 
future disruptions, resulting price increases and the impacts of those 
price increases, the study found that an increase to one billion 
barrels was justified. The study also found that there were 
unquantifiable benefits of a larger Reserve such as its deterrent value 
and the freedom given to administrations to conduct foreign policy in a 
hostile world.
    Second, the empty space available in the Reserve gives the 
government the ability to determine our own domestic energy policy 
without being undermined by the OPEC. After the major disruptions of 
1973-74 and 1980-81, the United States embarked upon a major effort to 
control its own energy future, by producing more energy and being more 
efficient in its use. As a result oil demand dropped and imports were 
dramatically reduced, until 1986 when oil prices collapsed. At that 
point our domestic oil industry was devastated, virtually all 
alternative energy initiatives were abandoned, consumption rose and 
imports filled the ever increasing gap between production and demand. 
In 1997-98 that scenario repeated itself setting us up for the 
situation that we faced in 2007-08, and which was only resolved by 
putting the United States and then the whole world into a recession. 
One certain way to assure an oil price spike is to allow oil prices to 
collapse first, and the oil market and OPEC left to their own devices 
may not keep that from happening again. The much preferable alternative 
is to have a substantial Strategic Petroleum Reserve capacity which 
would allow the Government to step into the market and acquire enough 
oil to support prices while supply and demand return to a long term 
balance. In addition to being good overall energy policy this strategy 
has the advantage of allowing the government to buy lots of oil at low 
prices, thereby reducing the cost of the Reserve and applying common 
sense business principles. The history of the Reserve is sadly replete 
with times of sitting on our hands out of complacency when prices are 
low and then trying to make up for lost time when the opportunity for a 
bargain is long past. With today's emphasis on creating work for 
engineers and contractors who are unemployed, now is an obviously good 
time to be building the storage facilities for a larger reserve.
    Third, while the overview of the Strategic Petroleum Reserve makes 
it appear very robust, the system is skewed to the western Gulf of 
Mexico and does not adequately support Mississippi River refiners and 
the Capline distribution system which services that area. In the 
original plans for the Reserve, there were two sites supporting the 
refineries along the Mississippi River: Bayou Choctaw and Weeks Island. 
However, due to leakage Weeks Island was decommissioned a decade ago 
and the entire Mississippi River region is supported by only the Bayou 
Choctaw site. While Bayou Choctaw is very strategically placed, it is 
the smallest storage site of the four, with a capacity of only 73 
million barrels. Furthermore, with only six oil caverns the maximum 
drawdown capability of the site is only 515,000 barrels per day, and 
can reach that rate only using sour oil. The maximum rate for sweet oil 
is only 300,000 barrels per day because with only two caverns of sweet, 
the inventory is depleted very quickly. Furthermore, one of the sweet 
caverns at Bayou Choctaw has a salt wall so close to the edge of the 
salt dome that it cannot be refilled after the oil is drawn down. 
Simply maintaining the current inadequate capacity of the site will 
require the eventual addition of a new cavern. The Capline system has 
been used time and again to respond to emergencies and requires an 
upgrade.
    The ultimate resolution of this issue for the Capline complex is 
development of the new Strategic Petroleum Reserve site proposed for 
Richton, Mississippi. That new site will add capacity and drawdown 
capability to the Capline complex, and it will be far enough inland to 
have reduced hurricane vulnerability. It will also create an option for 
siting a refined product reserve component of the Reserve. However, at 
this time there is no budget available or requested for going beyond 
land acquisition.
    Fourth, in the absence of an amendment to EPCA to expand the 
drawdown and sales authorities of the Secretary, the ability of the 
Secretary to make oil loans will be effectively curtailed or 
constrained once the inventory reaches the Reserves capacity of 727 
million barrels later this year. This very helpful tool has been used 
many times, and the amount of oil delivered from the Reserve to 
stressed markets overshadows the total from the two emergency sales. In 
order to preserve the effectiveness of this authority, which is 
dependent upon acquiring oil, the Reserve would need to be expanded to 
accommodate the premiums that are received in consideration of the 
loans.
    The Strategic Petroleum Reserve is fully authorized to one billion 
barrels by the Energy Policy and Conservation Act and no further 
legislation is required for these necessary improvements. However, as 
always, the Reserve will be in competition for resources to create the 
necessary facilities. As we have seen in the past, such competition can 
cause the Reserve to be static for many years between bursts of 
activity. For this reason, I recommend that authorization be given to 
the Reserve for self funding expansion, and I will address this 
proposal later in my testimony.
    Add a Heavy Oil Component: All Strategic Petroleum Reserve 
inventory is classified as either sweet or sour oil. However, the 
reality is that even the sour oil is very high quality with an API 
gravity higher than 30 degrees and a sulfur content of about one 
percent. This formulation was ideal 30 years ago, but over time it is 
less reflective of the oils that U.S. refineries are using. Because the 
oils used as feedstock today have been continuously getting heavier 
with higher sulfur content, refiners have been improving the 
sophistication of their facilities to make the best use of the lower 
grade feedstock. As a result, some refineries today can produce more 
high value finished products in a day from lower grade oil than they 
could from the high quality oil in the Reserve. In recognition of this 
fact the General Accountability Office recommended the Department of 
Energy add a third crude stream of heavy oil. The Department agreed 
with that recommendation and said that the issue would be addressed as 
part of the expansion to one billion barrels. That last decision would 
eliminate the cost and operational issues that would be generated if 
one site were converted to handle a third oil stream.
    As with expansion, this initiative does not require any new 
legislative authorization, but it also will require capital 
expenditures, which will be difficult to fund by conventional 
appropriations. The Department has said that this issue could be 
addressed efficiently during expansion to one billion barrels. 
Resolution of this issue can, therefore, be accomplished by allowing 
self funding of expansion as will be discussed below.
    Modernize Authorities to Sell and Exchange Oil From the Reserve: In 
addition to its focus on foreign oil disruptions, the Energy Policy and 
Conservation Act enacted in 1975 carefully constrained use of the 
Reserve to emergency circumstances, by requiring a presidential finding 
of a ``severe energy supply interruption'' of significant scope and 
duration and accompanying severe price increase, as a precondition for 
withdrawals and sales from the Reserve. This very tall hurdle assures 
that the Reserve will be used infrequently and that there will be 
debate within any administration about whether or not to make such a 
finding. One reason for this is no administration will be eager to 
lightly and frequently have the President sign a document declaring an 
emergency condition. Doing so can by itself can unnecessarily unnerve 
the public, effect international relations, and have unpredictable 
effects on financial markets.
    Congress realized the highly restrictive nature of this language in 
the wake of the 1989 Exxon Valdez oil spill, when oil loadings in 
Alaska were halted. Oil prices on the West Coast immediately rose and 
there were calls for releasing oil from the Reserve, but the 
Administration argued that it did not have authority to release oil for 
a disruption that was clearly of a limited scope and duration. Congress 
subsequently amended the drawdown and sale section of the Act to 
clarify the authority of the President to act in a lesser domestic 
emergency, but, while the result was to expand the authority of the 
President, it is generally acknowledged that it is no easier to get a 
presidential finding than it was before the amendments. Today, after 34 
years, there have been only two Presidential findings requiring a 
drawdown and sale from the Reserve.
    This generally very restrictive policy constrained both the Clinton 
and Bush administrations from using the Reserve to address serious but 
relatively lesser disruptions. Consequently, beginning in 1996, in 
response to a pipeline malfunction in Texas, the Department began 
lending oil to companies in exchange for a promise to repay the oil 
plus a premium. While the practical benefits of this policy have been 
substantial and undeniable the legal foundation is convoluted. The 
authorization for these loans--technically referred to as 
``exchanges''--is the acquisition authorities contained in the Energy 
Policy and Conservation Act, which provide that the Secretary may 
``acquire oil by purchase, exchange or otherwise''. Therefore, the 
legal rationale for all of the many loans that have been made in the 
last 13 years is not to avoid a shortage or price spike but to acquire 
the oil premiums that the Government receives in consideration of the 
loan. This situation is confusing at best, but may also unnecessarily 
constrain the government from acting in the Nation's best interest. For 
example, in the Spring of 2008 in reaction to very high oil prices, 
Congress passed legislation prohibiting oil acquisition for the 
Strategic Petroleum Reserve through the end of the calendar year. That 
seemingly straightforward act effectively eliminated the authority of 
the Secretary of Energy to conduct loans because the loan authority 
depends upon the authority to acquire oil. Later in 2008 when 
hurricanes disrupted the oil industry on the Gulf Coast, the Department 
was forced to go through legal gymnastics to justify two back-to-back 
``test oil exchanges'' under the secretary's very limited authority to 
conduct test sales. A similar problem may occur as the capacity to add 
oil to the Reserve diminishes due to the fill program and natural 
cavern shrinkage.
    One way to rationalize the legal authorities for loans and also 
remove the hobbling effect of the requirement for a presidential 
finding would be to expand the authorities of the Secretary to sell oil 
from the Reserve and to initiate loans. S. 967 addresses the sales 
authority issue by amending section 161 of EPCA to transfer 
responsibility for determining a drawdown is necessary from the 
President to the Secretary of Energy. It further modifies the language 
to give more weight to markets and deemphasize the necessity for 
physical disruptions when considering whether or not it is appropriate 
to sell oil from the Reserve. For the reasons stated above it is my 
opinion that this amendment is a major improvement to the current 
situation, and will allow the Reserve to be used whenever it is 
justifiable, without creating the tension associated with a 
Presidential finding of an emergency.
    While S. 967 addresses the sale issues, it is silent regarding the 
authority of the Secretary to engage in exchanges/loans of oil. I 
believe that it would improve the flexibility of the Secretary to 
address minor emergencies if he were authorized to conduct exchanges/
loans under the drawdown authorities of the Act rather than the 
acquisition authorities, without raising any issues comparable to those 
that are created by the proposal to transfer sales authority to the 
Secretary.
    Allow Self-Funding Improvements to the Strategic Petroleum Reserve: 
Regardless of the degree to which congress desires to improve the 
Strategic Petroleum Reserve, whether increasing its size, adding 
capacity at Bayou Choctaw, adding refined products, or adding a third 
crude type, there will be capital costs and the probability of 
increased operational costs. At this time there are no funds in either 
the fiscal year 2009 SPR appropriation or the proposed 2010 budget for 
any of these initiatives, and it is improbable that money will be added 
by congress due to the size of the national budget deficit. The 
implication is that Strategic Petroleum Reserve policy may be driven 
not by good public policy but by budget constraints, and the Reserve 
may stay static at 727 million barrels, without any refined products, 
and only two crude streams indefinitely.
    This constraint can be relieved and simultaneous solve a problem 
discussed above--the legal requirement to acquire oil in order to 
exchange (loan) oil. The proposal to resolve these problems is to allow 
the Strategic Petroleum Reserve to self fund expansions with the 
proceeds of occasional sales and exchanges.
    The current inventory of the SPR is very robust and when even a 
small oil volume is sold it generates substantial revenues. For 
example, the Secretary of Energy has authority to conduct test sales of 
up to 5 million barrels. At current prices a test sale would produce 
more than $250 million in revenue. Revenues from all oil sales are 
treated in the same way; the revenues are deposited in the SPR 
Petroleum Account and require no further appropriation or budgeting to 
be used by the Department. However, at this time these funds may only 
be used for the acquisition, transportation, injection of petroleum 
into the Reserve, and the cost of sales. The funds in the SPR Petroleum 
Account may not be used for expansion or capital improvements.
    Amending EPCA to allow expansion of the Reserve beyond its current 
capacity to be paid for from the SPR Petroleum Account would eliminate 
the budget bottleneck now facing the Congress and the Reserve. Of 
course funds would be needed in the SPR Petroleum Account to make the 
proposed amendment effective. That could be solved by a second simple 
amendment which would allow the Secretary to make exchanges of oil 
(loans) and take the premiums in cash, rather than in oil as is now 
required. The authority might also give him the authority to sell small 
amount of oil for operational or financial reasons---say 5 million 
barrels in any fiscal year. This second amendment would have the 
desirable effect of funding expansion without requiring new 
appropriations as part of the budget and would also eliminate the 
problem discussed earlier regarding the ability of the Secretary to 
make loans once the Reserve reaches it rated capacity of 727 million 
barrels. From a management perspective it will also create an incentive 
for the SPR Office to work diligently during its negotiations for oil 
loans, thereby bringing business style discipline to the Government.
    An objection might be raised that using oil funds for expansion 
would deplete the oil inventory, however, we would expect the SPR 
Office to periodically conduct exchanges and take premiums in kind to 
keep the inventory of the Reserve near the 727 million barrel capacity.
    Northeast Home Heating Oil Reserve: The Heating Oil Reserve is very 
much different in size and purpose from the Strategic Petroleum 
Reserve. However, like the Reserve, the authorization for its use as 
defined in the Act militates against its use. S. 283 seeks to address 
this issue, but is flawed in numerous ways. Primarily S. 283 leaves the 
authority to determining that a drawdown is necessary with the 
President. We have discussed the difficulties this creates for the much 
bigger oil Reserve, and are near to insurmountable for a regional 
reserve with only two million barrels of oil. The changes in language 
offered in S. 283 would not have the desired effect.
    S. 283 also directs mandatory releases linked to an inflation 
adjusted $4.00 per gallon price for heating oil. The receipts from 
these sales would be given to the Weatherization program. This is bad 
public policy because specific price thresholds written into 
legislation have a way of enduring past their relevant period. 
Furthermore, the price of heating oil probably will be driven by crude 
oil prices more than any other factor, and crude prices are notoriously 
fickle. If this legislation had been in effect for the last two years, 
all of the heating oil would be sold and the money transferred away, 
with the effect being that today there would be no heating oil in the 
Heating Oil Reserve. As written, S. 283 would be a notice that the 
Northeast Home Heating Oil Reserve is to be abolished at an arbitrary 
and unknown time. As written I recommend that S. 283 not be adopted. 
However, in the spirit of S. 967, I would endorse applying the same 
amendments written for the Strategic Petroleum Reserve release 
authorities to the release authorities for the Northeast Home Heating 
Oil Reserve. All the reasons that make transferring the release 
authority from the President to the Secretary a good idea for crude oil 
also apply to heating oil in the Heating Oil Reserve.
    In summary, the SPR is a well defined government program that has 
been well managed and today provides an unparalleled level of 
protection to the United States and our allies. Nevertheless, there are 
substantial opportunities to make the program stronger and more 
effective, some of which will require legislation. I endorse S. 967 and 
encourage the Committee to look favorably upon making other changes 
that will help to keep the Strategic Petroleum program dynamic and 
strong.
    Mr. Chairman and members of the Committee, this completes my 
opening statement and I would be happy to answer any questions you may 
have.

    The Chairman. Thank you very much.
    Mr. Book.

STATEMENT OF KEVIN BOOK, MANAGING DIRECTOR, RESEARCH, CLEARVIEW 
                      ENERGY PARTNERS, LLC

    Mr. Book. Thank you, Chairman Bingaman, Ranking Member 
Murkowski for the privilege of contributing to your discussion 
this afternoon. I want to applaud this committee's foresight in 
considering future energy challenges even as economic crisis 
temporarily obscures many of the troubling indicia of scarcity 
that so recently captured public attention. Business cycles 
after all tend to recover from one step back with two steps 
forward.
    The Nation's Strategic Petroleum Reserve for oil is a 
valuable insurance policy. More than 700 million barrels can 
reach refineries within days of any disruption. In light of 
recent hurricanes it seems prudent to ask if a similar strategy 
exists for refined products.
    Last week Energy Secretary Stephen Chu hinted that a 
products reserve might be no simple task. Indeed improving the 
status quo will require overcoming chemical, practical, 
logistical and economic challenges.
    Chemistry first and it's been alluded to several times, 
crude oil is quite stable, but finished gasoline can go stale 
in a period of as little as 60 to 90 days as a result of 
evaporation, oxidation, separation of fuel alcohols and 
condensation of water vapors. Preservatives can extend its 
shelf life at added cost, but the continuous churning in 
inventory may be the cheapest way to keep gasoline fresh.
    Next, practical questions. Consumers usually see through 
gasoline grades at the pump. But refiners and blenders 
transport and sell dozens of individual blends during the 
course of a year. Storing all these blends, as has been 
mentioned, would require active management of significant 
inventories. A single emergency speck of gasoline could solve 
the boutique fuels problem. But where would the refining 
capacity to stock the strategic reserve come from?
    Refiner's spare capacity is mostly a consequence of 
hopefully fleeting economic weakness. If refiners run harder 
where will the products other than gasoline go? About three 
quarters of U.S. refiner's runs are light products. But 
gasoline comprises only about 55 to 60 percent of total 
volumes.
    Should the Reserve contain other products and if so, in 
what proportion?
    The alternatives might be subsidies for refiners that 
reconfigure for lighter runs or Federal purchases of refined 
products imports. But that said. More than 90 percent of 
refined products consumed in the U.S. today are produced here.
    Third, logistics. Siting the product reserve away from the 
Gulf Coast might come at the impractically high price of new 
supporting infrastructure. Coastal refiners face hurricane 
disruptions. Refineries are on the coast because that's where 
the ships come in. The pipelines that carry products to their 
markets are on the coast because that's where the refineries 
are.
    Unfortunately pipeline pumping equipment shares a common 
vulnerability with refineries themselves. Both types of 
infrastructure need electricity. Even if strategic reserves 
were available in the immediate aftermath of a serious 
disruption, pipelines might prove inoperable as with Hurricanes 
Katrina, Rita, Gustav and Ike.
    Last, economics. Unlike other top oil producing nations, we 
have no national oil company. Approximately 169,000 gas 
stations operate profitably as a result of competition among a 
large number of individually invested, private owners. By 
buying an expensive commodity to sell a cheap one, without 
control over either price isn't an easy business.
    Normalized profits are in the mid to high single digit 
percentages. Retailers and refiners earn their money at the 
margins, a fraction of a cent at a time. Upgrades and capacity 
increases carry billion dollar price tags. But government 
policies can change quickly. As recent experience reveals 
demand patterns can shift virtually overnight.
    To balance the risk of negative refining margins. Refiners 
and retailers have relatively inelastic long term demand 
trends. As difficult and expensive as it may be to operate an 
existing refinery, it is still more difficult and expensive to 
build and operate a new one.
    In this context unanticipated introduction of new supply 
into a tight market could undermine industry profitability and 
potentially drive smaller players out of business. In addition 
a Federal product safety net might lead cash strapped industry 
players to reduce working inventories below typical levels to 
free up capital negating the benefit of the reserve. There are 
other opportunities however.
    At a vastly oversimplified level, refined products value 
chains break into four links: extraction, refining, 
transportation and storage and fourth, consumption. Each link 
is a policy opportunity for supply security. Increased domestic 
crude oil production is the most direct route to supply 
security. But other policy options includes biofuels, souring 
up refineries to use Canadian oils, environmentally responsible 
Fischer-Tropsch conversion of biomass and coal, electric 
vehicles and natural gas as a fuel for fleet vehicles.
    Economically viable refinery expansions could provide a 
working reserve instead of a fuel storage facility sited in one 
or several physical locations. This does, however, involve 
considering existing deterrents to new capacity including 
permitting delays, air quality restrictions, environmental 
surcharges. Especially those that could be imposed for 
greenhouse gas emissions.
    Blenders and refiners operate at economically efficient 
inventory levels and building parallel transportation and 
storage infrastructure makes little more sense than building a 
parallel refining industry for the same reason, prohibitive 
cost. But tax policies could encourage larger working 
inventories of finished products within existing transportation 
and storage infrastructure putting products at intermediate 
locations closer to end users.
    Last, and perhaps most importantly, policies that 
discourage excessive demand encourage the production and the 
diffusion of energy efficiency technologies and transform 
energy use patterns by enabling better short, medium, and long 
term planning can buffer the impact of supply disruptions by 
reducing the economic reach of any shortfall.
    Mr. Chairman, this concludes my prepared remarks. I will 
look forward to any questions at the appropriate time.
    [The prepared statement of Mr. Book follows:]
    Prepared Statement of Kevin Book, Managing Director, Research, 
                     ClearView Energy Partners, LLC
    Thank you, Chairman Bingaman, Ranking Member Murkowski, and 
distinguished members of this Committee for the privilege of 
contributing to your discussion this afternoon. My name is Kevin Book 
and I am a managing director and energy analyst at ClearView Energy 
Partners, LLC, a research and consulting firm headquartered here in 
Washington, D.C. that serves institutional investors and energy sector 
clients.
                       a strategy for the future
    The nation's Strategic Petroleum Reserve for oil (SPR) is one of 
the most valuable insurance policies an industrialized nation can have. 
More than 700 million barrels of oil contained within the SPR have the 
potential to reach many of the nation's refineries within days of any 
disruption of our highly import-dependent oil supply. In light of 
recent hurricane-related disruptions to the operation of these 
refineries, it seems prudent to ask whether there might be a mitigation 
strategy that could ensure similar continuity in refined products 
supply. Last week, Energy Secretary Steven Chu addressed this very 
matter. In public comments the Secretary offered at a press conference, 
he hinted that a products reserve might be no simple task, observing 
that

          For example, if a severe hurricane takes out a lot of the oil 
        refining capacity in the United States, there might be a 
        shortage, and I think that's the justification for [a products 
        reserve]. The countervailing argument for that is that it's 
        harder to store [refined products] underground.

    I would like to examine several of the challenges to which Energy 
Secretary Chu alluded and highlight several other potential policy 
mechanisms that might increase transportation fuels supply security by 
impacting other links of the refined products value chain.
                               challenges
    Let me begin by applauding this Committee's foresight in 
considering the energy challenges our nation may face in the future, 
even as economic crisis temporarily obscures many of the troubling 
indicia of scarcity that so recently captured public attention. Many 
financial investors generate value for their clients in a similar 
fashion by having the courage to buy when everyone else is selling, 
secure in the knowledge that business cycles tend to recover from one 
step back with two steps forward. Figure 1* presents a recent history 
of US annual demand for motor gasoline and projects two scenarios for 
the years ahead.
---------------------------------------------------------------------------
    * Figures 1-3 have been retained in committee files.
---------------------------------------------------------------------------
    The blue diamonds in Figure 1 reveal last year's dramatic decline 
in gasoline demand. According to EIA data, sales fell from 137.46 
billion gallons in 2007 to 132.22 billion gallons in 2008, probably 
more a result of consumers' adaptive responses to high prices than any 
structural change that might have occurred had drivers traded out of 
low-efficiency cars in favor of higher-fuel-economy vehicles. The red 
squares chart one possible course of gasoline demand in the unlikely 
event that a brisk recovery returns American drivers to their old ways. 
The green triangles present an alternative view of the future, informed 
by the history of the early 1980s, in which recovery might release 
pent-up new car demand and consumers' memories of recent price peaks 
might coincide with the arrival of a higher-efficiency vehicle fleet to 
dramatically destroy gasoline demand prior to its eventual recovery.
    Whether the slope of future demand is shallow or steep, and 
irrespective of whether pent-up automobile purchases bring a ``kink'' 
in the demand curve, it seems a safe bet that broader economic recovery 
will depend on an uninterrupted supply of affordable transportation 
fuels. Even so, any policy improving the status quo will need to 
address chemical, practical, logistical and economic challenges.
    Chemical challenges. Energy technologies may sometimes be best 
explained through familiar analogies, so let me offer an oversimplified 
comparison between crude oil and cereal grains. Most cereal grains, 
once dried and properly stored, are quite durable. The same is true of 
crude oil, whether it is stored in an underground salt cavern, in the 
hull of a tanker or in a commercial storage tank. When the miller 
grinds grain into flour, he removes many of its natural protective 
elements and transforms it into an intermediate good that is both more 
perishable and more useful than its granular precursor. The same is 
true, though it is a multi-stage process, when refiners manufacture 
specific fuels out of crude oil and ship them via pipeline, barge and 
truck to blending terminals. The most perishable link in the grain 
value chain is the bread the baker bakes, which tends to go stale 
fairly quickly once exposed to air and water. This, too, is true of 
finished gasoline, which can go stale over a period of as little as 60-
90 days. Evaporation can strip gasoline of its octane-enhancing lighter 
``ends'', oxidative degradation of refined petroleum can create 
gelatinous clumps that can gum up fuel lines and fuel alcohols can 
separate from fuel blends or attract water vapor from humid air. As a 
result, the procurement and storage processes associated with the 
current SPR may be unsuitable for a strategic refined products reserve. 
As with baked goods, preservatives added to gasoline could extend its 
``shelf life'' at added cost but, for a variety of practical reasons, 
the continuous churning of inventory under existing distribution 
practices may be the cheapest way to keep gasoline fresh.
    Practical challenges. The map in Figure 2, available on 
ExxonMobil's website, offers a perspective on the diversity of gasoline 
blends required around the nation during the course of a typical year. 
Even though a consumer buying gasoline at a service station might 
encounter only three grades of gasoline at the dispenser, many refiners 
and blenders transport and sell dozens of individual blends in order to 
conform to environmental regulations stipulating different 
specifications during winter and summer. Storing all of these blends 
would require active management of significant inventories, and no 
single blend might be available in sufficient quantities to 
meaningfully offset a supply disruption.
    This ``boutique fuels'' problem could be surmounted by establishing 
a single, ``emergency spec'' of gasoline, probably at the lowest common 
environmental denominator to yield the benefits of scale, and on the 
expectation that an emergency drawdown of strategic reserves would 
provide sufficient grounds for local or national air quality waivers. 
Even then, only a continued economic slowdown would be likely to leave 
refiners with adequate spare capacity to stock this strategic reserve, 
and increased refining runs in the absence of increasing demand would 
raise a larger practical consideration: about three-quarters of U.S. 
refiners' runs are ``light'' products, but gasoline comprises only 
about 55-60% of total volumes. In turn, this raises the question of 
whether the reserve should contain products other than gasoline and, if 
so, in what proportion? Alternatives to a multi-product reserve might 
include federal financial incentives to encourage willing refiners to 
undertake costly reconfigurations that increase gasoline fractions, or 
the use of federal funds to import refined products from overseas, even 
though more than 90% of refined products consumed in the U.S. are 
produced here today.
    Logistical challenges. Geographic diversification of a refined 
products reserve away from the Gulf Coast, although a sensible long-
term idea, might come at an impractically high price: the cost of new 
related and supporting infrastructure. The concentration of refineries 
on the nation's coasts that exposes our refining infrastructure to 
hurricane-related disruptions reflects the ship-borne conveyance of 
crude oil from foreign ports. Likewise, the pipeline infrastructure 
that transports gasoline and distillate fuels from refineries to 
intermediate destinations follows a similar geography. The Colonial, 
Centennial, Explorer and Plantation refined products pipelines, among 
others, are likely to be the primary transport routes for refined 
products drawn from a strategic reserve sited in the Gulf Coast, as 
well. Unfortunately, this does not circumvent a common vulnerability 
that pipeline pumping equipment shares with refineries themselves: both 
types of infrastructure require electricity to operate, so pipelines 
might prove inoperable in the event of a serious disruption, as in the 
immediate aftermath of hurricanes Katrina and Rita in 2005 and 
hurricanes Gustav and Ike in 2008, even if strategic reserves were 
available.
    Economic challenges. In many ways, the U.S. refining sector is one 
of the purest forms of public-private partnership. Unlike the other two 
of the world's top three oil-producing nations, the U.S. has no 
national upstream oil company and no national downstream refining and 
marketing entity. Across the nation, approximately 169,000 gasoline 
stations and fueling depots operate profitably, locally and virtually 
continuously to support our way of life and our economy. This would be 
very difficult to replicate on a national, top-down basis, especially 
if one hoped to achieve the economical service delivery that results 
from tremendous competition among a large number individually-vested, 
private owners.
    At the same time, buying an expensive commodity to sell a cheap one 
without any control over either price is not an easy business. As a 
legacy of decades of closely-regulated divestitures, retailers have 
little market power. The refiners who supply them must adhere to the 
above-mentioned framework of environmental standards. Retailers and 
refiners typically eke out normalized profits in the middle-to-high 
single-digit percentages and earn their money at the margins, a 
fraction of a cent at a time. Last but not least, refinery maintenance 
and expansion are time-consuming and expensive--complexity upgrades and 
capacity increases typically carry billion-dollar price tags and can 
require months to years of partial or total downtime--but government 
policies can change relatively quickly and, as recent experience 
reveals, demand patterns can shift virtually overnight. These factors 
add up to the ever-present risk of earning negative refining margins 
(refined products selling for lower per-barrel prices than the raw 
materials from which they are made).
    Refiners' and retailers' primary consolations are: (a) relatively-
inelastic, long-term refined products demand trends; and (b) the fact 
that, as difficult and expensive as it may be to operate an existing 
refinery, it is still more difficult and expensive to build and operate 
a new one. In this context, an autonomous supply of refined products 
could bring two unintended consequences. First, the unanticipated 
introduction of new supply into a tight market could undermine industry 
profitability and, potentially, drive smaller players out of business. 
Second, the assurance of a federal refined products safety net might 
lead cash-strapped industry players to consider reducing their working 
inventories below typical levels to free up capital, potentially 
negating the benefit of the reserve.
                             opportunities
    Figure 3, below, offers an oversimplified model of the refined 
products sector as a value chain that has four links: (1) raw material 
extraction or acquisition; (2) energy conversion (refining); (3) 
transportation and storage; and (4) end-user consumption.
    The downside of oversimplifying, of course, is that each of these 
little boxes represents far more than meets the eye. Crude oil 
extraction or acquisition is a topic as vast as the global economy. 
Energy conversion encapsulates 150 years of technologies for 
transforming crude oils into useful products. Transportation and 
storage refers to thousands of miles of pipeline and hundreds of 
thousands of dispensers, storage tanks and blending terminals of 
different sizes and descriptions. And the consumption ``fleet'' 
includes 240 million light-duty vehicles and 110 million households 
that can be influenced by policy actions and financial incentives.
    The scale of the real world behind our four-stage model has an 
upside: each link of the value chain offers significant policy 
opportunities towards greater refined products supply security.
    Raw material extraction/acquisition. Increased domestic crude oil 
production offers the most direct route to supply security 
(particularly as demand contraction may swiftly reverse when the global 
economy recovers), but other policy options include:

   Biofuels. The creation of the renewable fuels standard (RFS) 
        by the Energy Policy Act of 2005 may well have prevented a 
        catastrophic light products shortage when global crude oil 
        demand peaked during the second quarter of last year.
   ``Souring up''. Another factor preventing a gasoline shock 
        last summer may have been the ongoing modification of 
        refineries to make use of heavy, sour, unconventional oils like 
        those produced from oil sands in Alberta and Saskatchewan, a 
        lower-cost source of expanded capacity.
   Further feedstock diversification efforts could include 
        environmentally-responsible biomass and coal conversion into 
        distillate fuels and gasoline through the Fischer-Tropsch 
        process; electrification of passenger vehicles within urban 
        areas for short distance travel and encouraging natural gas as 
        a fuel for fleet vehicles.

    Energy conversion (refining). Policies that stimulate the economic 
expansion of existing refinery capacity and increase (or maintain) the 
operating margins of existing facilities may offer a way to promote a 
``working reserve'' instead of a fuel storage facility sited in one or 
several physical locations. Deterrents to new capacity include:

   Administrative and construction-related delays, which can 
        rapidly erode project profitability for most types of energy 
        infrastructure, and discourage projects on new sites;
   Air quality restrictions that limit the ability of existing 
        refiners to profitably expand or upgrade their facilities; and
   New surcharges for carbon dioxide and other greenhouse gas 
        emissions, which may further diminish economic incentives for 
        expansion and new facility construction unless refiners receive 
        emissions allowances in proportion to expected future costs.

    Transportation and storage. The nation's blenders and refiners seek 
to operate at economically efficient inventory levels. On the other 
hand, building parallel transportation and storage infrastructure makes 
little more sense than building a parallel refining industry does, and 
for the same reason: its prohibitive cost. Tax policies may offer the 
potential to augment the productive capacity of existing infrastructure 
by encouraging larger working inventories of finished products at 
intermediate locations closer to end-users.
    End-user consumption policies that discourage excessive demand, 
encourage the production and diffusion of greater energy efficiency 
technologies and transform energy use patterns by enabling better 
short-, medium-and long-term planning can also serve to buffer the 
impact of supply disruptions by reducing the economic reach of any 
shortfall. Inasmuch as this topic encompasses everything from public 
awareness strategies to industrial policy to urban planning, I will not 
attempt to treat it here, except to suggest that it might provide 
richer and more self-reinforcing mechanisms for improving supply 
security than a physical refined products reserve.
    Mr. Chairman, this concludes my prepared testimony. I will look 
forward to any questions at the appropriate time.

    The Chairman. Thank you very much.
    Mr. Houssin, thank you for being here. Thank you for coming 
to testify.

 STATEMENT OF DIDIER HOUSSIN, DIRECTOR FOR ENERGY MARKETS AND 
      SECURITY, INTERNATIONAL ENERGY AGENCY, PARIS, FRANCE

    Mr. Houssin. Thank you, Mr. Chairman for inviting me to 
share with this committee the views of the International Energy 
Agency on emergency policy and strategic reserves.
    As you know the IEA was created in 1974, 35 years ago, on 
the initiative of Secretary of State Henry Kissinger. The 
founding treaty obliged all member countries to create 
emergency petroleum reserve of 90 day based on the previous 
year net imports. To have demand restraint measures at hand. 
The treaty also created a solidarity mechanism which means that 
if one or several member countries are confronted with a sudden 
supply disruption, all member countries would take collective 
action by making oil available from their reserves and reducing 
the demand if the situation warranted it.
    When Hurricanes Katrina and Rita devastated production 
facilities in the Gulf of Mexico as well as refineries onshore 
and the power sector all IEA countries acted in solidarity 
drawing on their strategic reserves and providing the U.S. with 
products that were in extremely short supply. There are 
different ways for IEA countries to fulfill this requirement to 
maintain reserves of at least 90 days of their net imports. 
Some countries oblige industry to hold reserves. Others have 
created government owned reserves and some have a mix of a 
combination of both.
    Over time we've seen a positive trend with countries 
holding segregated public reserves. In 1984, 10 countries out 
of 21 members at that time had public reserves. Now we have 20 
out of 28 members that have public reserves. The amount of 
public reserve in the total of IEA countries has moved from 23 
percent to 37 percent.
    We are often asked why if emergency reserve can also be 
used for domestic supply disruption. Why not use stocks to 
bring down price when they spike? We think that to use the 
reserve for price management is dangerous territory and would 
fail.
    The market is currently aware that emergency stocks can and 
will be used during any severe supply disruption. This in 
itself helps to limit the price exuberance that can result in 
large spikes when there are physical disruptions. But a policy 
of releasing oils to counteract high prices would mainly add an 
additional source of speculation and wouldn't be efficient.
    Let's focus now on the evolution of the United States SPR. 
The level now represents 61 days of net imports whereby it was 
116 days in 1985. So even if the amount is increased in terms 
of net import it does considerably decreased.
    Currently the SPR hold mainly crude oil. The damage of 
Hurricanes Katrina and Rita exposed some of the vulnerabilities 
of the SPR that were explained before. For this reason in its 
review of the United States Emergency Preparedness in 2007 the 
IEA advised the United States Government to consider holding 
product stocks as part of any expansion of the Strategic 
Reserve and to consider a wider distribution of the reserve 
throughout the country.
    So why the IEA welcomes the expansion of the SPR we believe 
that the additional SPR borrows in the form of finished 
products and have in strategic locations to be defined by the 
DOE would bring great additional security for each dollar spent 
then purchases of additional crude oil. As an example for 30 
million barrels of product stocks this would represent in the 
form of gasoline, this would equate around to a little over 3 
days of consumption. Holding strategic reserves in terms of 
products is quite common in other IEA countries. For instance 
in Europe 55 percent of all public stocks are held in form of 
products.
    Just in Germany half of the stockholding agency reserves 
are held in products. Korea as well has 15 percent of its 
reserves in the form of products. Of course all security has a 
price. Strategic product stocks are more costly.
    For example, the yearly running costs for European 
countries start at about $3.00 per barrel stored looking at 
when we are looking at products. In most European countries the 
financing is done by special levy on the sale of petrol of less 
than one United States cent per liter. In the United States the 
running cost of the SPR are very low, about 20 United States 
cents per barrel stored which leaves some scope for the United 
States to expand the SPR with product stocks and still 
maintaining running costs well below that of other member 
countries.
    So in conclusion we think that the idea of having some 
increase of the SPR stocks in the form of products would be 
along the line of the IEA recommendation considering--
concerning the United States emergency policy. Thank you.
    [The prepared statement of Mr. Houssin follows:]
 Prepared Statement of Didier Houssin, Director for Energy Markets and 
          Security, International Energy Agency, Paris, France
    Mr Chairman, Ladies and Gentlemen
    Thank you for inviting me to give you the views of the 
International Energy Agency on emergency policy and strategic reserves.
    IEA policy for Energy Security considers both short and long term 
supply security. For the long term we focus on diversification of 
sources, adequacy of investment and energy savings. But even if we do 
all that for long term energy security, we can still be confronted with 
the potential for a sudden interruption in oil supplies. Geopolitical 
conflict, internal conflict in a producing country, hurricanes, 
earthquakes, strikes and myriad other incidents can all affect oil 
flows.
    One of those incidents in the past, the Arab oil embargo against 
certain OECD countries in 1973, demonstrated OECD countries' 
vulnerability. This event triggered a long lasting recession. In 
response, the US Secretary of State, Henry Kissinger at the time, took 
the initiative to create a defence mechanism, and the International 
Energy Agency was established.
    The founding treaty obliged all member countries to create 
emergency petroleum reserves of 90 days based on their previous year 
net imports and to have demand restraint measures at hand. The treaty 
also created a solidarity mechanism: if one, some or all of the member 
countries are confronted with a sudden supply disruption, all member 
countries would take collective action by making oil available from 
their reserves and reducing their demand if the situation warranted it.
    This mechanism proved to be useful. Knowing that OECD countries 
were less vulnerable as a result, producing countries came to 
understand that threats to disrupt supplies, or even actual supply 
disruptions, became less effective. Relations between producing 
countries and consuming countries improved, resulting in a continuous 
dialogue on oil security issues. Geopolitical tensions are still there, 
but on the whole relations are more productive. When a supply 
disruption occurs, it is now standard practice that we immediately 
contact the OPEC Secretariat and key producing countries to assess the 
situation together and to determine whether they are willing and able 
to bring additional production on line.
    That's not to say that the defence mechanism of the IEA is no 
longer needed. There are still substantive risks of supply disruptions 
and OPEC countries are not always in a position to provide additional 
relief. Indeed, the last time the strategic reserves were used was 
unrelated to geopolitics. When Hurricanes Katrina and Rita devastated 
production facilities in the Gulf of Mexico, refineries on shore and 
the power sector, all IEA countries acted in solidarity, drawing on 
their strategic reserves and providing the US with products that were 
in extremely short supply. The response was quick and effective, 
demonstrating the worth of IEA emergency preparedness and the quality 
of its Members' commitment to collective solidarity.
    As I previously noted, the IEA treaty obliges all members to 
maintain reserves of at least 90 days of their net imports. There are 
different ways in which countries can fulfil this requirement. Some 
countries oblige industry to hold reserves; others have created 
government-owned reserves. And some countries have a combination of 
both. Over time, we see a positive trend towards countries holding 
segregated public reserves. In 1984, 10 countries out of the 21 members 
at that time had public reserves. This year, we expect that 20 out of 
28 members will have public reserves. Another figure: at the start of 
1985, 23% of total reserves were owned by public bodies. We are now 
close to 37%. This increase is strengthening our ability to react 
promptly and concretely.
    Emergency stocks are still very relevant. I made reference to the 
last time the IEA called for a collective action--in the aftermath of 
the Hurricanes Katrina and Rita. While the last time the IEA released 
emergency stocks was in 2005, since then the IEA has been on alert 
several times, not only in the 2008 Hurricane season when Gustav and 
Ike hit the Gulf coast in rapid succession, but also because of 
incidents that have taken place in Iran, Iraq, Nigeria, in Russian 
pipelines to Europe and as a result of industrial actions.
    These alerts have been in addition to regular crisis simulation 
exercises. The capabilities of IEA countries to react quickly to global 
supply disruptions are tested on a regular basis. The last exercise was 
held in June of last year, with the participation of all 28 IEA Member-
countries and 14 non-member countries.
    Notwithstanding the above discussion, emergency reserves are not 
only created to react to international supply disruptions. They have 
proven to be an effective response to domestic disruptions as well. 
Industrial actions in parts of Europe have led to strategic releases. 
And the US has made recourse to its reserves to offset logistical 
problems. In this decade alone, the US used the SPR on 10 separate 
occasions to give relief to refineries when their supplies were 
disrupted. In such cases the oil is loaned from the SPR, not sold. When 
the disruption is over, oil companies that received oil return the oil 
with some additional quantity as a kind of interest payment.
    We are often asked: if emergency stocks can be used for domestic 
supply disruptions, why not use stocks to bring prices down when they 
spike? We think that to use the reserves for price management is 
dangerous territory and would fail. The market is currently aware that 
emergency stocks can and will be used during any severe supply 
disruption. This in itself helps to limit the price exuberance that can 
result in large spikes when there are physical disruptions. But, a 
policy of releasing oil to counteract high prices would add an 
additional source for speculation. Had we released stocks during the 
2004 price shock, there probably would have been a very short term 
dampening effect on prices, but the reverse could also have happened, 
for example, had the market worried that stock draw was reducing our 
strategic reserves and providing a negative incentive to invest in new 
supplies or improve efficiency, making the fundamental supply/demand 
situation even worse. As it turned out, we would also have been less 
prepared for the real supply disruption that occurred in 2005 and 
refilling of SPR's would have been at record prices.
    Let's focus now on the US SPR from the IEA's point of view. Today 
it is rapidly approaching its current capacity of 727 million barrels, 
covering 61 days of net imports. In 1985, just before domestic 
production in the US began to steadily decline--the SPR represented 116 
days. Even though the volume of SPR oil today is well above the amount 
back then, the number of days of net-imports it represents has declined 
considerably.
    Although the US has no obligation on industry to hold stocks, there 
are of course commercial reserves in the US, which currently stand at 
about 75 days, so in total the US is more than compliant with IEA 
rules. But compliance results to some extent from voluntary commercial 
stock holding by industry, and most of those stocks are needed for day-
to-day use. They are an important part of maintaining the supply and 
demand balance, their amounts are subject to fluctuations in market 
conditions, and are not volumes of additional oil that can be readily 
brought to market through emergency measures when markets are 
disrupted.
    The issue this Committee is discussing today is the composition of 
the SPR. Currently the SPR holds mainly crude oil. It is all located 
near the Gulf Coast, the most hurricane-prone, vulnerable region of the 
United States. There is also a small heating oil reserve of 2 million 
barrel in the North East, for extremely cold winters. The damage of 
Hurricanes Katrina and Rita in 2005 exposed some vulnerabilities of the 
SPR. For one, if all oil is stored in the same region, this oil cannot 
be moved if the region is cut off. And secondly, having crude oil will 
provide security only if there is enough refining capacity to process 
the crude oil. In the aftermath of Hurricanes Katrina and Rita, product 
supply became critical because refining capacity and the power sector 
were severely damaged. One million incremental barrels per day of 
products had to be shipped from Europe and Asia to give appropriate 
relief to the US market. Therefore, in its review of US emergency 
preparedness in 2007, the IEA advised the US to consider holding 
product stocks as part of any expansion of the strategic reserves and 
to place a significant share of crude and product reserves away from 
the Gulf of Mexico to reduce their vulnerability to extreme weather 
events. Hurricanes Gustav and Ike this past summer reminded us of the 
relevance of this recommendation.
    So while the IEA welcomes the expansions of the SPR, we believe 
that doing so by only adding more crude volumes to the SPR storage in 
the Gulf of Mexico would not effectively address the specific 
vulnerabilities underlined by recent hurricane seasons. Instead, we 
believe that additional SPR barrels in the form of finished product and 
held in strategic locations throughout the country, ready to be 
utilized when refineries or distribution networks are disrupted, would 
bring greater additional security for each dollar spent than purchases 
of additional crude oil.
    The proposal currently under consideration is to hold 30 million 
barrels of product stocks. If held in the form of finished motor 
gasoline, the single largest product consumed in the US, this would 
equate to a little over 3 days of consumption. Holding strategic 
reserves of product stocks is not uncommon; many IEA Member countries 
hold them, and just recently we have seen media reports about China's 
intention to hold some 70 million barrels of product stocks, or about 9 
days of consumption, by 2011.
    European IEA member countries which are also members of the 
European Union have a requirement to hold a large portion of their 
stocks in products, based on EU regulations. These require all EU 
members to maintain, through a combination of public stocks or 
requirements on industry, 90 days of consumption of gasoline, middle 
distillates and fuel oil. While a portion of this requirement can be 
met with the holding of crude stocks, the result is a significant 
portion of emergency stocks are held as refined products. Currently, 
some 55% of all public stocks held in Europe are in the form of 
product. For example, Germany's stockholding agency, EBV, holds over 
180 million barrels of strategic reserves, nearly half of which is made 
up of diesel and gasoline, and spread out over the country's different 
regions. In France, the stockholding agency SAGESS holds over 103 
million barrels of strategic reserves. Two thirds of this stock is 
diesel held in storage facilities throughout the country. SAGESS also 
holds 12% of its stock in the form of gasoline, with a good share of 
this being held in salt domes in the south of France.
    Outside of Europe, Japan and Korea are the other IEA member 
countries which hold strategic reserves of product stocks. In addition 
to holding public stocks of some 320 million barrels of crude oil, 
Japan holds a little over 7 million barrels of public LPG stocks. This 
is on top of its obligation on industry to hold at least 70 days of oil 
stocks in proportion to their imports. Furthermore, following the 
lessons learned from the IEA's 2005 collective action and as part of 
Japan's new national energy strategy, the Japanese government has been 
preparing the introduction of a new system for holding public product 
stocks. Korea also holds a portion of its public stocks in refined 
products and requires its industry to hold minimum levels of product 
stocks. Of its some 81 million barrels of public stocks, nearly 12 
million barrels are in the form of products, mostly middle distillates. 
These are held at storage sites located throughout the country.
    How public product stocks are held varies across the different 
member countries. As said, France holds stocks of gasoline in 
underground salt domes, but for the most part product stocks are held 
in above ground tanks which are either owned by the public stockholding 
agency or rented from industry. Public product stocks are sometimes 
held in commercial tank farms, either in separate tanks, as is the case 
in Germany, or commingled to some extent with the oil of industry, as 
for example in the Czech Republic. New storage can be developed when 
existing capacity is insufficient; in Spain the agency CORES recently 
commissioned the building of storage capacity to increase its public 
stockholding cover, including middle distillates, from 30 to 40 days.
    Of course, oil supply security has a price and strategic product 
stocks more so. For a typical European country with virtually no 
domestic production, the yearly running costs (without capital costs 
related to the buying of the oil itself) stand at about $ 3 per barrel 
stored. In most European countries the financing is done by a special 
levy on the sale of petrol of less than 1 US cent per litre. In other 
European countries, costs are paid by the government budget, equating 
to about $ 5 per inhabitant. In Japan, where space for storage is 
limited and thus expensive, strategic stockholding of crude oil is 
estimated to cost just over $ 2.5 per barrel.
    In the US, the running costs for the SPR are about 20 US cents per 
barrel stored--considerably lower than in Europe or Asia. This can be 
explained primarily by the favourable underground storage 
possibilities, whereas elsewhere above ground tanks are dominant or 
even floating storage, such as in Japan, is necessary. The fact that 
the US SPR is almost entirely crude oil is another reason for the lower 
cost per barrel, as refined products are more costly to store. As the 
financing of the US SPR is through the government budget; there is no 
levy at the pump for this. The running costs are therefore some 50 US 
cents per inhabitant, about 10% of the running costs elsewhere.
    The US system is thus very efficient, and the US taxpayer has 
received a great deal of security for the money spent on it. Such a 
savings, in comparison to other IEA member countries, leaves scope for 
the US to expand the SPR with product stocks, and still maintain 
running costs well below that of other member countries. For example, 
if the US were to hold 30 million barrels of product, and assuming the 
operational costs would be around the same as in Europe at $3 per 
barrel, the total cost of running the SPR (crude and product) would 
rise from 20 to 30 US cents per barrel, or about 75 cents per 
inhabitant.
    I have also been asked to comment about how the decision is taken 
in various member countries concerning when to use strategic stocks. I 
know that for the US, this is taken at the highest level possible, that 
of the President. For the most part, in other IEA member countries, 
such a decision is taken at the level of the minster responsible for 
energy matters. In some cases, consultation with a council of ministers 
is required before a final decision is made.
    In conclusion I would like to say that although the SPR system in 
the OECD countries dates back 35 years, it has evolved along with 
market realities and is even more effective today. The knowledge that 
we can supplement supply quickly when faced with a sudden supply 
disruption has a calming effect on oil markets.
    Looking at the SPR of the US: the current level is an enormous 
volume. But we have to realize that the US alone consumes about 25% of 
all oil produced globally. In terms of days of net imports, the SPR 
alone is well below the 90 day minimum that IEA member countries are 
committed to hold. Therefore, we wholeheartedly support the expanding 
of the volume of oil held in the SPR. However, the current SPR stocks 
are concentrated in the Gulf of Mexico and almost entirely in the form 
of crude oil, so the use of the SPR is vulnerable to events, such as 
hurricanes, which can take away the ability to refine the oil into a 
product useful for consumers. Therefore, we encourage the US to procure 
additional SPR barrels in the form of product stocks, held in storage 
more geographically spread across the country.
    US taxpayers have benefited from the SPR; not only during the two 
collective actions of the IEA, but also on numerous occasions when the 
market confronted domestic disruptions. The US SPR ranks amongst the 
most efficient reserve agencies globally, providing a high degree of 
oil security to the US for only 50 cents a year per citizen. The SPR, 
by expanding from its current level through the addition of refined 
products, could significantly enhance security of supply and still 
maintain costs per barrel of public stocks at levels well below those 
of other member countries.
    The SPR of the US has served as a model for many other countries 
within the IEA and beyond, notably in Asian countries like China, India 
and ASEAN states, which are currently developing or considering similar 
emergency reserves. In a time of heightened volatility in energy 
markets, the SPR should continue to uphold the same mission and 
ambitions as when it was first founded some 35 years ago.
    Thank you for your attention.

    The Chairman. Thank you. Thank all of you for your 
excellent testimony. Let me ask a couple of questions first 
here.
    Let me just zero in on this issue that I believe Dr. Rusco, 
you talked about and others did too about this proliferation of 
fuel types that we have and the particular problems that 
creates for us. I guess that I'm not real clear as to what you 
think the solution to that is in this context. I mean obviously 
if we could lessen the number of fuel types that would be a 
solution.
    But for purposes of making a product reserve work is there 
a simpler solution? Something that is more targeted to just 
fixing that problem?
    Mr. Rusco. I think that there are a number of possible 
solutions. The one that has been used during emergencies before 
is to provide a waiver. The Environmental Protection Agency can 
provide a waiver that allows areas that are required to use 
special blends to use any available fuel that's, you know, 
suitable. Obviously it has to be appropriate.
    If those, such a waiver were possible during the release of 
Strategic Reserves than the Strategic Reserve could keep a less 
than full fuel slate. If, for example, there were supplies kept 
in the West Coast and maybe it makes sense there to have 
California, you know, car gas. But if you're in the Midwest and 
there are a bunch of different types of special blends of fuel 
there, if during an emergency you could have a waiver of the 
requirement to use those special blends then you could keep in 
the Midwest special--or just one particular blend that would be 
useful in any of those areas.
    The Chairman. Ok. Let me ask about this suggestion that Mr. 
Shages has there about allowing the proceeds from SPR sales to 
be used to fund expansion or improvement of the reserve. That's 
what I understood you to be recommending.
    Mr. Shages. Actually I was talking about the proceeds that 
came from exchanges or loans as opposed to sales.
    The Chairman. Oh, ok. Let me ask Dr. Rusco. Have you looked 
at that proposal? Do you have a view on that or any of the rest 
of you have a view on that?
    Mr. Rusco. We have advocated in previous reports that DOE 
take a more active role in making such exchanges so that they 
can defer delivery of oil during times when prices are high in 
exchange for additional barrels in the future, that to be 
negotiated by DOE and the companies that are delivering oil. We 
think that that is--can be a source of additional savings.
    The Chairman. But on the issue of whether or not those 
savings should be put to use to expand and maintain the reserve 
itself rather than going back into something else. You don't 
have a view on that?
    Mr. Rusco. We have also advocated that using money rather 
than royalty in kind oil to fill the reserve would lead to 
greater efficiencies. To the extent that there were money put 
aside either through the sale of royalty in kind oil or 
authorized in some other way for the expansion of the reserve. 
Then the process that Mr. Shages talked about could be used and 
could save a great deal of money in filling it.
    The Chairman. Ok. Mr. Houssin, let me ask you how frequent 
is, in Europe, in other industrial countries that do have 
product reserves, how frequently are they actually used? I mean 
is this something that they have reserves everybody feels good 
and then that's the end of it, sort of like our Northeast Home 
Heating Reserve or is there an actual need for these on a 
periodic basis?
    Mr. Houssin. Yes. Actually the reserves have been used as 
in the U.S. The extra has been used through swaps to meet some 
logistical problems that some refiners in some regions can 
have, very specific local issues. We saw several times in 
Europe that the product stocks have been used.
    For instance when there were industrial actions in certain 
areas to meet with logistical problems. It can be done on a 
national basis only if the country complies with a 90 day 
obligation. So they don't need in that case. If this is above 
the 90 day obligation they don't need an IEA approval.
    The other case of course is a collective action as was done 
in 2005 where every IEA member participated through the 
collective action and as well as in 1990.
    The Chairman. Ok. Good.
    Senator Murkowski.
    Senator Murkowski. Thank you, Mr. Chairman. Mr. Johnson, 
this first question is directed to you. This morning the RAND 
Corporation released a report stating that the absence of a 
publicly stated policy on when the SPR will be used has a 
potential to trigger panic hoarding if market participants fear 
a major supply disruption and thus bringing on the very 
conditions that the SPR is supposed to ameliorate when we set 
it up.
    So I would ask you whether or not DOE will commit to 
providing certainty in the marketplace by developing a publicly 
stated policy as to when the SPR should be drawn down. I 
realize it is separate from what we're talking about here with 
a product reserve. But I figured the timeliness of this was 
worth the question.
    Mr. Johnson. I'm here to testify on the technical aspects 
of the reserve. The administration really hasn't set a policy 
on this. So therefore I can't really answer that.
    Senator Murkowski [presiding]. That is my question to you. 
We don't have a policy, a stated policy, as to when the SPR, 
when there should be a drawdown. As I say, according to this 
report it creates that same level of uncertainty that we're 
looking to ameliorate.
    So if in fact you don't feel that you can answer that 
question today, I can appreciate where you're coming from. But 
I do think it is something that the administration does need to 
look at as we are reviewing this situation with our Strategic 
Petroleum Reserve.
    Mr. Johnson. Ok.
    Senator Murkowski. I would like to ask and I'm not quite 
sure who will field this question. But as I understand as we've 
been talking about where a product reserve could be located. 
There's been some discussion about Mississippi because it ties 
in with existing access to resources within that region.
    There has been conversation that by siting it in the 
Southeast you are not allowing the other parts of the country 
to have access to such a product reserve. So given the makeup 
of the existing pipeline distribution system and the fact that 
California and the West Coast and the Southwest are thousands 
of miles away, earthquakes could clearly disrupt aspects of our 
supply distribution system.
    Would it be the intent to have multiple product reserves 
set up? Is that what we're contemplating here? We haven't 
really talked much about the cost.
    Mr. Houssin, you mentioned the cost that you've experienced 
in Europe. But I'd like to get a better handle as to what we're 
actually talking about in terms of the cost to establish and 
maintain and operate a product reserve.
    Mr. Shages, we have had little conversation on this. Mr. 
Book, I'd be curious to hear your thoughts as well.
    Mr. Shages. Yes. I always think that you can't look at 
these things as absolutes. You always have to compare costs 
with value. All the things that you point out we were 
absolutely correct.
    It's one reason why we've been focusing so much on the 
Richton dome site in Mississippi because it offers all of the 
advantages of salt on storage. It's also a plant site for 
expansion of the reserve overall. So the refined product 
portion of it could be an adjunct to the crude oil portion in 
which case a lot of the facilities in the management would be 
in common. So the marginal cost of adding refined products 
would be minimal.
    If you start putting in free standing sites that are not 
associated with salt in which case there almost certainly going 
to be steel tanks, then it's going to become much more 
expensive. But again it will be relative because one of the 
large costs is the land in the area that you're going to and 
environmental considerations in that specific area. So again, I 
tend to focus on the Mississippi site to service the Southeast.
    I am concerned also about the Southwest. Before I left the 
department we did some studies looking for sites for 
underground storage in the West. We didn't find any through the 
extent to which we did studies.
    None the less land is inexpensive in the West. I think it 
would be worthwhile doing the engineering cost estimates to see 
how much it would cost to build steel tank storage in some sort 
of central point which was outside of the earthquake damage 
that could occur in the Los Angeles area which could knock out 
the refineries and the pipelines, some place like Las Vegas and 
big demand center, but also sitting on the pipelines to 
distribute to Utah and New Mexico and various other places.
    But what I believe the beauty of the legislation is drafted 
is it gives DOE time to look at these things to do a tradeoff 
between the costs as they define them and the potential 
benefits. So whether it's really worth it to go to other parts 
of the country, upper Midwest or wherever it happens to be. I 
think the details will give you the answer to whether it's 
worth it or not.
    Senator Murkowski. Mr. Book, any comment on cost?
    Mr. Book. Yes. Thank you, Senator Murkowski. I think with 
the sort of the advance caveat that I'm using Monsieur 
Houssin's number in real time and back of the envelope right 
now.
    There's two things to think about from the cost 
perspective.
    The first is that the more decentralized your siting is, 
particularly if you have multiple products in storage, the more 
expensive it's going to be, obviously.
    The second thing is that you have to think in terms of sort 
of, total acquisition costs. I'm just going to use rough 
proxies here. Last night's gallon average was $2.25, so 30 
million barrels is 1.26 billion gallons or $2.83 billion to 
stock it.
    Three dollars per barrel at 30 million barrels is $90 
million a year. Your operating costs are comparable to 
essentially a refinery, a new refinery, your capital plus 
operating costs of the same size. In other words if you took 
the same requirement, you divide the 30 million by 365. You get 
82,000 barrels per day.
    Sort of think about the refinery producing more than just 
gasoline and transportation fuels. It expends up to about 
105,000 barrel per day refinery. At prevailing cost of building 
a new one, it's about $2.9 billion, slightly more than buying 
the fuel.
    So I think when you, as Mr. Shages talks about sort of the 
relative costs and benefits. This becomes sort of a fishing rod 
verses fish kind of question as well. Do you want to buy a lot 
of stuff or do you want to create the capacity to make the 
stuff?
    Senator Murkowski. I appreciate the responses. Mr. 
Chairman, I have other questions but I've got another committee 
that I need to attend. So I will submit them in writing.
    The Chairman [presiding]. Senator Corker.
    Senator Corker. Thank you, Mr. Chairman and thanks for 
having the hearing. Thank all of you for your testimony. This 
may have been slightly addressed earlier, but I don't think it 
was fully.
    You know we have this debate and we end up sort of using 
the petroleum reserve that we have right now almost in a 
populous way. You know, if prices get high then, you know, we 
put pressure on the President or we want to pass legislation 
here to send out all throughout the country to lower prices. 
Understand the way this, which it is not what its purpose is if 
my understanding is to keep us from being in a severe crisis in 
this country due to other kinds of disruption.
    This language I guess is modified and actually moves it to 
the Department of Energy, off the President's desk which I 
guess politically makes it easier for somebody to release it. I 
don't know what the purpose of that is exactly.
    But when we add, we're using the word, market to energy 
supply disruption, I'm just wondering if there's any fear on 
y'alls part that we're going to start releasing refined product 
when prices get high all of sudden and that's a reason for us, 
if you will, to be releasing product out on the marketplace 
based on the way this is now drafted.
    You're shaking your head, Mr. Book, up and down. So I'm 
going to let--you may have just been trying to be nice.
    Mr. Book. No, Senator Corker, I think actually there is 
risk to using the reserve frequently because it is an insurance 
policy. The more you do it in response to price, if you start 
that the market will look through it very quickly. I have 
clients that multi strategy hedge funds who trade crude oil. 
They're very sophisticated.
    They're likely to move faster in the way they trade oil 
than the United States Federal Government is. Simply put you 
turn the United States Strategic Petroleum Reserve from the 
best energy policy ever into a fairly feeble upstream oil 
company competing with the most sophisticated nations on earth.
    Senator Corker. So is it my understanding that you would 
think taking the word market out of this would be an 
interesting thing to do?
    Mr. Book. It's challenging to make the catalyst anything 
other than an emergency supply disruption, in my view, sir.
    Senator Corker. Ok. So it looks like maybe there may be 
some input from over here on that afterwards. So, you know, I 
guess I read something in one of the newspapers about this 
being a gift to southern Senators which I appreciate if that's 
the case. Typically I like to come to hearings and see what the 
bill is about before we jump on these things.
    But when we had a disruption in the south this last time it 
was really more about electricity and just having the ability 
to get power to the pumping facilities that were actually 
sending the product into Tennessee and other places. At least 
that was my understanding as to a part of the problem. I've got 
another part of it that I'll address in a minute.
    But is not the interruption of electricity supply one of 
the big issues as it relates to getting refined product to 
folks in various parts of the country after something like a 
hurricane?
    Hello? Mr. Shages? You guys in the industry answer. I 
understand the oil industry didn't want to be here. So they 
sent you all instead.
    [Laughter.]
    Senator Corker. Ok.
    Mr. Shages. No, that is absolutely correct. One of the 
reasons we're focusing on the Mississippi site is because it 
has a few strategic advantages. It's already miles inland from 
the coast which removes it somewhat from the hurricane area. It 
also moves it further up along the colonial and plantation 
pipelines which are the pipelines that are serving the 
Southeast.
    If there had been such a site in 2005 and 2008, that site 
would have been able to put the product into those pipelines 
and move it to the final consumers. So even though it's close 
to where the hurricanes did all the damage, it would provide 
the protection that we're talking about in the event of this 
typical type of large hurricane.
    Senator Corker. Ok. One of the things that I think occurred 
also was there was this issue of panic buying that took place. 
In other words all the news outlets were advertising that there 
wasn't going to be any gasoline or diesel and so people went 
out and bought huge amounts of gasoline and diesel which added 
to the problem.
    Then on top of that many of the retailers didn't want to 
buy at the high prices it was being sold to them at wholesale 
because they were afraid if they bought at that price and then 
tried to recoup what they paid for that the attorneys general 
would be after them from the standpoint of price gouging. Is 
that also an issue that comes into play?
    Mr. Shages. Frankly it's so far down the level of what the 
Federal Government could possibly try to control that I don't 
think so.
    Senator Corker. Now I'm not talking about things that--
actually I'm actually talking about those things that are sort 
of out of our control. I'm not saying that we should get 
involved in controlling that. But did that contribute to the 
shortages that took place during this last hurricane season?
    Mr. Shages. It sounds plausible to me, but I don't have any 
actual information.
    Senator Corker. Mr. Book.
    Mr. Book. My view is that the first factory you described, 
Senator is one of the biggest issues of all. It's like the hot 
summer day no one expects where everyone turns on the AC and 
the grid shutters and nearly goes down. Our system runs very 
lean and efficiently. It's the way we have such cheap motor 
fuels in this country.
    When people panic and buy that has an effect of depleting 
supply faster than retailers expected. If they think that they 
can't recoup their replacement cost we're not talking--only 10 
percent of the downstream is now owned by the integrated. It's 
a relatively small business, mom and pop kind of operation. 
They don't want to put themselves in a lot of capital risk.
    Senator Corker. So, so, then the big part of this issue is 
panic buying. Then a big part of the issue--part of the issue 
could be and I think this is true. In fact I know it's true in 
certain cases. The retailers don't want to pay at these pumped 
up prices that occur after this panic buying takes place 
because they don't want--they're afraid if they try to recoup 
what they paid for that the attorney generals will be on them 
for price gouging.
    So let me go back to the genesis and that is this whole 
issue of storing refined product. What does that do to help 
solve those particular issues we just brought up?
    Mr. Book. It's not necessarily a solution to panic buying 
because you could run through a lot of the supply available to 
you in a region before it could be replenished from a reserve. 
The flow down the colonial plantation pipelines is 2 weeks from 
the Gulf Coast all the way up to the Northeast. So even if you 
got a jump getting things into Tennessee as you would have 
wanted to have done. Panic buying could still have depleted 
your available reserves.
    Senator Corker. So, let me just one of my last questions. 
It's my understanding that before I got here it was discussed a 
little bit about the fact that we have sort of boutique types 
of laws in various States as to the type of fuel mixes that 
people can sell in respective States. If we have a place where 
we store refined product if we actually use it then we're going 
to need some State waivers to actually be able to pump this 
refined product around in various places.
    Would another solution that might also be highly beneficial 
be that during this period of time we have an automatic waiver 
process that kicks in so that when there is in fact refined 
product in other States that can be sold. I mean if this is a 
solution to the storage product would it not also be a solution 
to refined product existing in other places that could actually 
be used here. But yet for State laws that actually control 
these little boutique mixes.
    Would that be something that would also be helpful during 
these fraught times when there's not enough supply?
    Mr. Shages. If I may. I think there is a good analogy for 
the Strategic Petroleum Reserve if you were to have to drawdown 
the reserve at its maximum capacity the amount of pollutants 
going into the air would be tremendous. In the area that would 
happen is the Gulf Coast of Texas and Louisiana which are 
already non attainment areas as far as air quality.
    Those two States know about this. So agreements were put in 
place in advance that upon a declaration of an emergency on a 
full scale drawdown on the reserve if the States of Texas and 
Louisiana would waiver those things to allow the drawdown to 
take place despite all the pollution that would occur which is 
appropriate. I think the same sorts of things which I believe 
is what you're suggesting, could be put in place in advance for 
all the States that might be affected.
    Senator Corker. When on a relative basis how would that 
help in solving the problem as compared to having a strategic 
reserve, if you will, of refined product on a relative basis?
    Mr. Shages. I wasn't suggesting that that would be a 
substitute. I was suggesting that if you had refined product 
reserves in storage and they didn't meet the specification for 
the State at the time they might be drawn down that it would 
automatically be waived. So that whatever was in storage in the 
refined product reserve could be delivered to that State.
    I wasn't suggesting that one was a substitute for the 
other.
    Senator Corker. Mr. Chairman, I thank you. It's my sense 
then that you generally support this type of legislation. Is 
that true or false?
    Mr. Shages. I do support it. Yes, sir.
    Senator Corker. The concern then would be to do it in such 
a way that we don't use it as a mechanism to actually try to 
affect market prices.
    Mr. Shages. I----
    Senator Corker. Only do so when there's actually a crisis 
that exists that's keeping product from being there. Is that?
    Mr. Shages. For refined products I think that's absolutely 
true. I've testified that with regard to crude oil that when 
prices go extremely high, as they did last year, that that 
itself is devastating to our economy. It should be considered 
to use the Strategic Petroleum Reserve just for prices in that 
case.
    The Chairman. Senator Shaheen.
    Senator Shaheen. Yes. Thank you, Mr. Chairman. Thank you 
all for being here. I'm sorry that I have missed your comments. 
But as someone who has been Governor of New Hampshire at a time 
of supply disruption I can speak very personally to the 
importance of the Northeast Home Heating Oil Reserve and its 
potential to address concerns in New England.
    In New Hampshire we are probably one of the most heavily 
dependent States on oil because over 60 percent of people use 
it to heat their homes. Then of course when you add in the 
transportation sector it has a huge impact on the State. So let 
me apologize for having missed some of the questioning because 
you may have already addressed this issue.
    I think Senator Corker, you were talking about this in what 
little I heard from your remarks. But one of the concerns that 
we've heard from some of the business entities in New Hampshire 
is about the potential to drawdown from the reserve based on a 
political decision when prices spike as opposed to when there 
really seems to be need because of disruption in the oil 
supply. So can you speak to how you can determine the 
difference between the two and so that you can both reassure 
business that there's going to be real disruption but you can 
also reassure me as somebody who is trying to talk to consumers 
in New Hampshire who is concerned that when prices spike that 
it does create an emergency situation for many people in the 
State.
    Are the two desires contradictory or can you find some 
balance between those two and reassure both entities? I don't 
know who would like to address that.
    [Laughter.]
    Mr. Shages. Would you like me?
    Senator Shaheen. Yes, go ahead.
    Mr. Shages. Alright. I tend to think that you can make that 
distinction. But it's sort of the fine points that people in 
the industry.
    If you go back to the situation that created the Northeast 
Home Heating Oil Reserve in 2000, it was quite clear that 
because of the freeze up of all of the harbors and----
    Senator Shaheen. Yes, I remember that very clearly.
    Mr. Shages. We all remember that very well. When you have a 
situation like that it's quite clear that you have a supply 
shortage where even if there is heating oil it can't get to 
where it's supposed to be. It's late in the season so the 
inventories are already down.
    You can rack up all these things and say, it is a supply 
shortage. On the other side of it you can take situation like 
we've had the last 2 years where the price of crude oil was 
going through the roof. Naturally the price of heating oil has 
to follow since it's the predominant thing.
    So the typical consumer is not a specialist and doesn't 
know. They only know if the price is going to $4. So I think 
you do have to trust.
    I believe in this case it's Mr. Johnson and the other 
people in the Department of Energy that you--and wherever the 
authority is to drawdown that you want brought down just for 
price purposes, that you'll only drawdown in the event that 
there's a shortage that is going to cause a price increase. I 
think you have to trust their expertise on that.
    Senator Shaheen. Conversely are there benefits from tying 
the drawdown to a mandatory price spike?
    Mr. Shages. No.
    Senator Shaheen. So everybody would agree with that that 
there's no--that it wouldn't help to alleviate the price spike. 
For example this last year when we saw prices go above $4 a 
gallon there was agreement between Congress and the Bush 
administration that actually we should drawdown the petroleum 
reserves to try and alleviate the price impacts. Would you all 
disagree with that logic?
    Mr. Book. Senator, if I could.
    Senator Shaheen. Sure.
    Mr. Book. Any price becomes arbitrary over time. The 
lessons of the 1980s and the credits that were based on a 29 
barrel price were hard lessons for this government losing money 
over the next 3 decades. Four dollars won't seem like $4 in 10 
years. So that's the first problem.
    The second one really has more to do with the idea that if 
there's a clear understanding that something gets used at a 
certain time. It has no surprise value to the market. The 
market sees that, knows that that is the move.
    It's programmatic. Then any price manipulation power the 
government, good price manipulation power, the government might 
want to use, goes away because it's already priced into 
everyone's expectations looking ahead.
    Senator Shaheen. Thank you. Yes.
    Mr. Houssin. If I might just and one word from an IEA point 
of view clearly our position is trying. I think it's a position 
of all IEA government that the strategic reserves whether they 
are crude or product doesn't matter but the strategic reserves 
shouldn't be used for market manipulation. But just if there's 
a disruption or if we're very close or if we have a severe 
threat of a disruption, so a physical event that would justify 
a drawdown, a collective drawdown, possibly at IEA level.
    Then the question of having a strategic reserve in the form 
of crude product is up to each member country of the IEA to 
decide. So the U.S. mainly in crude oil and for instance in 
Europe, European countries have mainly products in their 
reserve. But it doesn't mean that the discussion about should 
we use strategic stocks to alleviate price spikes like last 
year.
    The fact these products are crude doesn't interfere in the 
discussions. This is not a discussion I would go along with 
previous speakers who have said that it should be done. 
Basically we had that same kind of discussion in Europe.
    Although the majority of reserve is made out of production, 
the decision was made not to drawdown stocks also in Europe.
    Senator Shaheen. Thank you. Yes.
    Mr. Shages. If I may just to clarify and draw a 
distinction. On the Strategic Petroleum Reserve side, I think 
there is a place for using the Strategic Petroleum Reserve to 
respond just to price increases and not necessarily to a 
disruption. I think it was a travesty last year when the price 
of oil went to $147 and OPEC countries when American officials 
went to them, hat in hand, and said the market is well 
supplied.
    There's no question in my mind if they had any pumping 
capacity they should have brought it online. But they didn't. I 
think it would be naive to think that the recession that we're 
in now is just caused by the housing problem or the mortgage 
problem.
    The fact that oil went to $147.00 played a huge role in 
that. Just to put it in a little perspective, a price increase 
from $47 to $147 given the level of imports we have means $1.2 
billion a day goes out of the United States to some foreign 
location. That money could be used to pay mortgages.
    So it had a huge impact. The fact that we, for whatever 
reason, felt constraint to sit on our hands is, you know, is 
unfortunate.
    Senator Shaheen. So you disagree with Mr. Book.
    Mr. Shages. There's a distinction between the product 
reserve and----
    Senator Shaheen. Right, right.
    Mr. Shages [continuing]. The Strategic Petroleum Reserve 
which is crude oil.
    Senator Shaheen. Right, I get it.
    Mr. Shages. I mean in size they are not going to be 
comparable no matter how big you make the refined product 
reserve. I think you should minimize the number of times that 
you go into the market because you don't--we're primarily going 
to be based on a free market system and there are millions of 
players in that. You don't want to interfere if you don't have 
to.
    But again I would figure it would be naive to say that the 
world crude oil market is a free market given OPEC and given 
countries like Russia that have huge reserves and are clearly 
controlling the price and then other players. The Chinese are 
not exporters they are importers, but they are clearly using 
sophisticated technique for building their Strategic Petroleum 
Reserves in doing what Mr. Rusco has been calling for. Sitting 
on their hands when prices are high and then going into the 
markets very heavily when prices are low.
    So you have these very big, non-commercial players moving 
prices around like crazy. For us to say we'll only intervene in 
the markets when there's a disruption. I think disruptions can 
happen at any time without anybody announcing them.
    Senator Shaheen. Thank you.
    The Chairman. Let me just clarify. As I understand as a 
follow on to your statement there, Mr. Shages. It's your view 
that limiting the any drawdown or sale of petroleum products to 
interruptions in supply is appropriate.
    Mr. Shages. I think that is appropriate.
    The Chairman. That's what we're trying to do here in this 
language. I think Senator Corker pointed out some ambiguity 
there which we need to correct perhaps. But I think our 
thought, at least my thought on this is that if we make 
provision for a product reserve it would, we would specify that 
the drawdown of this product reserve by the Secretary would be 
limited to circumstances where there is a supply disruption 
which may also result in a price change. But there would have 
to be a supply disruption that accompanied that.
    On the other issue that we've talked about a lot is this 
boutique fuel thing. Let me just clarify for Senator Corker and 
Senator Shaheen that part of our thinking in not specifying 
that in this legislation is that our committee doesn't have 
jurisdiction over that. I think that's clearly the Environment 
Committee. Therefore we did not include provision in here that 
specified exactly how EPA would handle that circumstance.
    But Mr. Shages, you pointed out that under current law the 
waivers that EPA grants relative to the Strategic Petroleum 
Reserve are a result of agreements entered into between the 
States.
    Mr. Shages. These are actually agreements between the 
Department of Energy and States of Texas and Louisiana, not the 
Environmental Protection Agency.
    The Chairman. Oh, I see. Ok. So you think similar 
agreements would be appropriate here?
    Mr. Shages. I do. I'm not familiar with the particular 
requirements of the States of North and South Carolina and 
Georgia.
    The Chairman. But are there any statutory authorization for 
those agreements or the Department of Energy takes it so that 
they have that authority for these agreements with the States?
    Mr. Johnson. The EPA delegates this down to the States. 
Because we will be loading ships at the terminals, there's 
always vapor that comes off and it goes over the allowed 
limits.
    So the States give us a waiver in an emergency so that we 
can load ships to reach the parts of the country that need to 
be helped. So we have agreements between us and the State 
energy offer.
    The Chairman. Us, being the Department of Energy?
    Mr. Johnson. Yes, correct.
    The Chairman. You think you could have similar agreements 
between the Department of Energy and the States----
    Mr. Johnson. No.
    The Chairman [continuing]. Involved with product reserve or 
no?
    Mr. Johnson. No, not DOE. In 2005 the EPA took the lead on 
that. The Department of Energy actually did due diligence with 
them to make sure there was need in the States.
    But they did blanket waivers. They granted waivers to 30 
States for Katrina and Rita for gasoline and diesel and other 
fuels to increase the imports to those areas.
    Then in 2008 the EPA didn't give a blanket waiver, but they 
gave a waiver to all the Gulf Coast States as well as, I think, 
Virginia and Florida. But they got waivers by asking for them 
and essentially they needed to bring in fuel that didn't meet 
their specs. So EPA----
    The Chairman. So I guess what I'm trying to determine is, 
do you feel comfortable with the way the law now allows this to 
happen or provides for this contingency or do you think we need 
to be specifying in law somewhere that someone has additional 
authority beyond what they have under current law?
    Mr. Johnson. I think at the national level the EPA waiver 
is a proper way to go, to look at the whole situation and grant 
waivers to the States that need it. If we get a product reserve 
would there be an advantage to setting up some national waiver 
like the Jones Act waiver for ships. I think that would be 
applicable. Yes.
    The Chairman. Ok. Alright. Senator Corker.
    Senator Corker. The very nature of a refined product as I 
understand it, the life cycle is far different than it is for 
just crude, unrefined product. How often is it for this product 
to remain useful that it would have to be actually back out of 
the reserve and into the marketplace for us to know that what 
was there was actually useful?
    Mr. Book.
    Mr. Book. Reasonable estimates would be somewhere between 
12 and 18 months. You'd have to circulate to be sure. That the 
differences by product type and the composition of the product.
    The way it works elsewhere where they do have product 
reserves is typically they rotate through a reservoir so that 
volumes pass through the storage tank on their way through to 
somewhere else. That limits by necessity, the size of the 
reservoir. The easiest way to do that is for companies to hold 
larger working inventories.
    The reason why we don't necessarily want to mandate that is 
that is literally taking money out of their pockets unless you 
find a way to make them whole. I suspect there's probably a 
nausea response to giving money to oil companies to hold bigger 
inventories.
    [Laughter.]
    Senator Corker. That is what happens in Europe, is that not 
correct? Many of the companies there, themselves, are required. 
I'm not advocating that, are required to hold certain amounts 
of reserves there for this very issue. Is that correct?
    Mr. Houssin. If I may. Part of the obligation is on the 
industry. But part is also on the public agencies that are--
it's similar as the SPR but the difference is that these 
agencies in Europe have their own stocks just for strategic 
reasons.
    But they behave very close to the markets because on so far 
that specific reason that the products have to turn over 
frequently. So they sell and buy. But their objective is to 
maintain the level of strategic reserves which is mandated by 
law.
    Senator Corker. By the----
    Mr. Houssin. In the way they act they are probably closer 
to the markets, even if the products are just maintained for 
strategic reasons when they are maintained by the public 
agencies.
    Senator Corker. Mr. Chairman, I, first of all, I very much 
appreciate the thoroughness with which you're going through 
this energy bill. I very much appreciate the fact that you're 
focusing on something that is more regional in nature recently 
and trying to find a solution for that. I would say that it 
seems to me one of the biggest issues since it doesn't sound 
like the currency, we can solve the currency of the product by 
letting it flow through the reserve.
    Are you saying we can or we can't?
    Mr. Book. Not cheaply. I mean we'd either have to have a 
lot of reserves that cost a lot of money in a lot of places or 
else not have very big ones.
    Senator Corker. Or release it into the market every 12 to 
18 months. In an essence be fiddling with the very issue you 
were talking about earlier. Is that correct?
    Mr. Book. Yes. I defer to how you would do that to the 
folks who've run the SPR and run it now. But the mechanics of 
doing it would not be easy to get the kind of volumes you're 
talking about here.
    Mr. Johnson. I mean, the Northeast Home Heating Oil Reserve 
that we have today, the two million barrels, is in commercial 
storage terminals. Is being turned over continuously, with the 
inventories that are there.
    So we have no refreshment requirements. It's automatically 
taken care of. Yes, on a small scale that's true.
    I do want to add that, you know, Germany and France also 
store products in salt caverns underground. In talking with 
them they look to rotate about every 2 years.
    The Danish also have some underground storage. They claim 
they can even go longer. I think there needs to be some study 
on the life of a product stored underground.
    Essentially it is longer than in storage tanks. So we think 
a product reserve could be actually kept longer than 12 to 18 
months.
    Mr. Book. Their products are mostly distillate fuels though 
and not refined.
    Mr. Johnson. It's both.
    Mr. Book. Not reformulated gasolines though.
    Mr. Johnson. It's gasoline and distillate.
    Senator Corker. Mr. Chairman, a number of interesting 
issues. Thank you. I think that, you know, the philosophical 
issue, it sounds like at least for those that are present today 
that the issue of insuring that this is not something that's 
used in the event of a price disruption, but only a supply 
disruption.
    I think we've seen for instance, just to use a most recent 
example of tarp. Once it can be used, it can be used for lots 
of things. Alot of people think that's good. A lot of people 
didn't intend for it to be that way.
    But it seems to me that that's the kind of thing we might 
want to think about. Again, I thank you very much for trying to 
address this issue.
    The Chairman. Alright. Thank you very much. Senator 
Shaheen.
    Senator Shaheen. I don't really have any more questions 
except to pick up on what you just said, Senator Corker. 
Because as I heard what folks said and as I look at the 
language in the bill, it does allow for using the reserve for 
price disruptions when those are deemed to be an emergency.
    Did I misunderstand? I thought there was some disagreement 
on the panel about whether that was an appropriate use of the 
reserve or not.
    Mr. Book. Senator, I think, if I may, properly. Mr. Shages 
is suggesting that it's appropriate to do it with crude oil, 
but not with refined products. I'm suggesting that it's not 
appropriate to do it on the basis of price with either crude or 
refined products.
    The Chairman. Just to clarify.
    Senator Shaheen. There is some disagreement among you all.
    The Chairman. I think just to clarify. We, to the extent 
that we wind up legislating the establishment of a product 
reserve we would try to clarify that it was intended that it 
only be drawn down where there is a severe energy market supply 
disruption, not a change in price. That's consistent with both 
Mr. Shages and Mr. Book's position with regard to product 
supplies as I'm understanding it.
    Senator Shaheen. But that doesn't resolve the difference in 
what they're saying, does it?
    The Chairman. No. They still have a difference of opinion 
that with regard to whether or not the crude oil could be used.
    Senator Shaheen. Right.
    The Chairman. Crude oil and the Strategic Petroleum Reserve 
today could be used for to deal with price spikes. I believe 
they have a difference of opinion on that. That's dealt with in 
current law to the extent it is.
    I don't think we're ready to change in that.
    Senator Shaheen. Ok. Thank you.
    The Chairman. Any other questions? If not, thank you all. I 
think it's been a useful hearing. We appreciate very much the 
testimony.
    That will conclude our hearing.
    [Whereupon, at 3:57 p.m. the hearing was adjourned.]
                                APPENDIX

                   Responses to Additional Questions

                              ----------                              

      Responses of Kevin Book to Questions From Senator Murkowski
    Question 1. This morning, the RAND Corporation released a report 
stating that the absence of a publicly-stated policy on when the 
Strategic Petroleum Reserve will be used has the potential to trigger 
panic hoarding if market participants fear a major supply disruption, 
bringing on the very conditions that the Strategic Petroleum Reserve 
was supposed to ameliorate.
    Should DOE commit to providing certainty in the marketplace by 
writing and holding a publicly stated policy on when the Strategic 
Reserve will be drawn down?
    Answer. Senator Murkowski, one of the greatest advantages of the 
current configuration of the Strategic Petroleum Reserve (SPR) may be, 
ironically enough, the tremendous range of tactical opportunities it 
offers in the event of a supply disruption. The current SPR sends very 
few market signals of any kind other than the affirming presence of a 
potent insurance policy.
    Programming draw-downs at defined prices or calendar intervals, or 
in conjunction with a publicly-announced set of protocols may have the 
untoward effect of riling energy end-users, but it is much more likely, 
in my view, to have the untoward effect of riling the intermediate 
commercial users (and traders) of crude oil and refined products.
    Why is this bad? Because introducing SPR oil to a marketplace that 
anticipates the trade not only undermines the value of the price 
pressure that introducing supply might exert, but it also leaves the 
U.S. Department of Energy vulnerable to traders who may be well-
positioned to structure transactions that exploit the limited scale and 
latency associated with flowing volumes from an intermittent source. 
The only certainty likely to obtain from planned draws may be a high 
degree of certainty that the U.S. government will lose money in the 
process.
    Question 2. During a supply disruption, the presence of a products 
reserve could create uncertainty about whether, when, and how much 
would be drawn down. High gasoline prices send a signal to the market 
participants and encourage product imports. Could the uncertainties 
surrounding a product reserve actually result in greater market 
volatility and discourage necessary imports of petroleum products? How 
do we need to address these unintended market consequences if we 
proceed forward with a regional product reserve?
    Answer. The presence of a fully-stocked products reserve might well 
discourage imports of refined products well before any supply 
disruption.
    In fact, the presence of a fully-stocked products reserve might 
well discourage production and storage of refined products within 
commercial inventories here at home.
    Today, although a majority of global crude deliveries are 
contracted in advance, tremendous volumes of oil and refined products 
freely traverse the open seas in search of the highest bidder.
    Scarcity premiums are a beacon for imports and for domestic 
production alike; the looming prospect of a government sale that 
undermines products margins could easily divert speculative cargoes to 
other ports of call where scarcity premiums are more certain.
    Likewise, commercial players in the U.S. have every incentive to 
minimize working capital to maintain their highest possible operating 
margins. Few refiners, blenders or retailers will want to tie up cash 
in gasoline inventories above and beyond reasonable operating minimums 
if there's no upside, because there will always be a reasonable risk of 
a government sale.
    The result could be greater volatility and lower commercial 
inventories in the event that U.S. and international commercial 
players, in an effort to maximize their own profits, might be ``free 
riding'' on government inventories.
    The nation's SPR in its current form does not undermine refiners' 
incentives to produce or invest precisely because it does not compete 
with the refining sector. On the contrary, the crude-only SPR supports 
domestic refiners by providing a critical input for production in the 
event that outside events disrupt ordinary supply chains.
    Question 3. Can you provide an estimated range of cost for the 
establishment and continued operation of a 30 million barrel refined 
product reserve as proposed?
    Answer. These are just ballpark estimates, but, taking the 
assumption of a near-term oil price of $65/bbl, Figure 1, below, 
presents a theoretical cost of filling the reserve of approximately 
$2.7B. The discounted costs of maintaining it for 30 years, using a 
slight reduction to the projections offered during testimony by the IEA 
($2.50/bbl instead of $3.00/bbl) to accommodate tax structures and 
overhead, would discount back to a present value of about $1.7 billion 
(Figure 2).
    Construction costs would vary depending on the architecture of the 
reserve and could range anywhere from $50 million to $500 million for a 
distributed reserve.
    Since it's impossible to make a good estimate of construction cost 
without a sense of the reserve's architecture, a back-of-the-envelope 
estimate would be about $4.4 billion, excluding construction.

                          Figure 1--Fuel Costs
------------------------------------------------------------------------------------------------------------------------------------------------
reserve size                                  30 million barrels
                                              1.26 billion gallons
------------------------------------------------------------------------
expected crude price                          $65.00 per barrel
------------------------------------------------------------------------
normalized refining margin                    $0.05 per barrel
------------------------------------------------------------------------
transportation costs                          $4.00 per barrel
------------------------------------------------------------------------
implied gasoline price                        $1.72 per gallon, net of
                                               taxes
------------------------------------------------------------------------
federal gasoline tax                          $0.184 per gallon
------------------------------------------------------------------------
average state gasoline tax                     $0.25 per gallon
------------------------------------------------------------------------
all-in implied cost                           $2.15 per gallon
------------------------------------------------------------------------
initial fueling cost                          $2.71 billion
------------------------------------------------------------------------

                      Figure 2--Ongoing Maintenance
------------------------------------------------------------------------------------------------------------------------------------------------
SPRO                                          700 million barrels
------------------------------------------------------------------------
annual operating costs                        $130.00 million per year
------------------------------------------------------------------------
variable cost, net of fuel                    $0.19 per annual barrel
------------------------------------------------------------------------
IEA product reserve cost                      $2.50 per annual barrel
------------------------------------------------------------------------
products:crude multiplier                     13.5
------------------------------------------------------------------------
proposed refined products reserve size        30.0 million barrels
------------------------------------------------------------------------
estimated annual cost                         $75.00 million per year
------------------------------------------------------------------------
operating life                                30.0 years
------------------------------------------------------------------------
inflation escalator                           3%
------------------------------------------------------------------------
discount rate                                 5%
------------------------------------------------------------------------
nominal operating costs                       $3.68 billion over
                                               operating life
------------------------------------------------------------------------
present value of operating costs              $1.69 billion over
                                               operating life
------------------------------------------------------------------------

      
    By way of contrast, our refineries are configured for about 75% 
light products. Therefore, 75% of a new refinery would be able to 
produce the capacity required to deliver 30 million barrels in a given 
year, or about $82,000 bbl. At current refinery construction costs of 
$30,000/bbl/d (a high estimate), an equivalent new refinery would cost 
about $3.2 billion.
    A new refinery owned by anybody--public or private--at a time of 
gasoline demand contraction does not seem a particularly good policy 
option, either, but I offer this analysis as an example of the 
efficiency with which the oil industry might deliver a similar result 
through new investment.
    Question 4. In terms of incentive to deliver, are there advantages 
to a government run supply of fuel as opposed to a privately held fuel 
supply?
    Answer. It is unlikely that a U.S. Government gasoline sector would 
possess any natural advantages relative to its 150-year-old private 
petroleum sector, and certainly not within the early years of 
operation.
    With the exception of several extremely well-run national oil 
companies in the Middle East, most government-run fuels businesses 
operate less efficiently than U.S. companies.
    Nations with nationalized petroleum sectors typically must pay 
premiums to acquire foreign technology expertise to manage their 
producing assets.
    And that's upstream, where producers can still earn significant 
profits with natural resources in their care acquire market-derived 
scarcity premiums; the downstream presents a far more challenging 
commercial environment.
    Refining and marketing is a low-margin, high-volume business that 
penalizes inefficiency.
    Last but not least, the U.S. government would probably face 
challenging commercial conflicts of interest with some of its necessary 
upstream trade partners that could interfere with profitable business 
decisions. For example: would the U.S. be perceived to be ``dumping'' 
if it did not establish taxes that closed the gap between pump prices 
here and abroad; and, if foreign governments imposed these taxes, how 
would the nation avoid further eroding its balance-of-trade deficit 
already much worsened by petroleum import dependency?
    In short, replacing 150 years of learning and hundreds of billions 
of dollars of global infrastructure could be done, but it would 
probably come at a cost that would need to be paid back through fuels 
taxes, eroding the very advantage the nation enjoys in products prices 
relative to other OECD economies that derives from the efficiency of 
its own, private suppliers.
    Question 5. With respect to gasoline the sheer number of boutique 
fuels required by state and federal laws makes it practically 
impossible to store all the different types of fuels. For example, 
Colonial Pipeline, a major pipeline supplying products to the Southeast 
and Eastern U.S. has 60 different grades of gasoline and 26 different 
distillate fuels that will be shipped in 2009.
    What types of fuels will the Department of Energy require to be 
stored, and is there, in your opinion, a need to provide a fuel waiver 
on the boutique fuel requirements to ensure that the market disruption 
gets resolved in a timely manner?
    Answer. In my view, it would stand to reason that any disruption 
that merits deployment of strategic reserves is likely to also require 
deployment of any available resources as soon as possible. In this 
vein, it would make sense to establish a single ``emergency spec'' of 
gasoline predicated on an automatic waiver of Clean Air Act rules in 
the event it must be used.
    Question 6. Given the make-up of our product pipeline distribution 
system, a product reserve located in the Gulf States will not be able 
to provide any relief to consumers west of the Rocky Mountains. Would 
it be the intent of the Department of Energy to establish a number of 
product reserves?
    Answer. I do not know the intent of the Department of Energy, but 
if price were no object, it would make sense to site reserves as close 
to possible to destination markets that might run short of refined 
products supplies. Multiple reserves would cost substantially more than 
a single reserve, particularly given the requirement to actively manage 
inventories, but they would solve some of the transportation problems 
that would persist in the event of electrical failures that affect 
pipelines.
    Question 7. For many members of Congress, the most logical need for 
this regional product reserve would occur in the wake of a natural 
disaster similar to the hurricanes in 2005 and 2008. However, in 
looking back on those hurricanes the most critical problem with product 
supply was not a supply shortage, but the prolonged loss of electric 
power and associated impediments to the product distribution system.
    How do we address the electric power problems and ensure that the 
product reserve is used to provide short-term relief after a natural 
disaster and not be used solely as a political tool to lower gasoline 
prices when the price is high?
    Answer. Electric power problems that impact refineries and 
pipelines will impact everything else, too. There are few easy 
refinery-specific remedies, short of paying refiners to install 
cogeneration capacity that turns their facilities into largely grid-
independent, multi-purpose industrial facilities, and to purchase 
generators to support that cogeneration capacity.
    Otherwise, I would suggest that the best course of action remains 
the current trajectory towards a more robust, interoperable and 
resilient electrical grid that takes advantage of available generating 
capacity and incorporates renewable (intermittent) sources in a 
productive way by pairing them with conventional generation and/or 
storage technologies.
    Question 8. As members of the International Energy Agency (IEA), 
the United States is required to hold the equivalent of 90 days of oil 
imports. Since the IEA's International Energy Program was created in 
1974, oil reserves have only been released into the market twice and 
refined products have only been released once. 
    Since the US is part of this program, given the limited use of the 
IEA's response mechanism, what is the benefit to the tax payer to 
create a costly Refined Product Reserve?
    Answer. Risks require expensive countermeasures, either through 
assurance (parallel infrastructure) or insurance (usually financial 
mechanisms). When the cost of assuring or insuring exceeds the cost of 
a disruption, mitigation makes little sense.
    Assessing the costs of a disruption falls outside my modest 
capabilities as an energy specialist, but it makes sense to ask the 
question: ``Do we really need this?'' given the many competing uses of 
taxpayer dollars. Inasmuch you and your esteemed colleagues are faced 
with the unenviable task of prioritizing our outlays to maximize social 
welfare, let me offer this perspective.
    The fact that existing reserves have met their chartered purpose 
suggests that the insurance was, in fact, worthwhile. On the other 
hand, the frequency of payouts is such that it might be irrational to 
layer on more insurance at this juncture.
                                 ______
                                 
    Responses of Didier Houssin to Questions From Senator Murkowski
    Question 1. This morning, the RAND Corporation released a report 
stating that the absence of a publicly-stated policy on when the 
Strategic Petroleum Reserve will be used has the potential to trigger 
panic hoarding if market participants fear a major supply disruption, 
bringing on the very conditions that the Strategic Petroleum Reserve 
was supposed to ameliorate.
    Should DOE commit to providing certainty in the marketplace by 
writing and holding a publicly stated policy on when the Strategic 
Reserve will be drawn down?
    Answer. Yes, we believe that a clearly stated policy and 
transparent process for using the Strategic Reserves would be in every 
stakeholder's interest. This should clearly indicate that the reserves 
are only to be used in a supply disruption. As for when a release is 
triggered, we believe that an assessment of each individual situation 
is better than a mathematical trigger that forces action when drawdown 
might not be warranted--and perhaps invites speculation by market 
players. A volumetric trigger which may seem appropriate now, might not 
be appropriate in the future as the availability of alternative supply, 
seasonal demand fluctuations and industry stock levels all contribute 
to determining what level of a supply disruption necessitates the use 
of the strategic reserves.
    We also believe a price based trigger is undesirable. In the 
absence of a physical disruption, high prices might come about due to 
fundamentals, such as demand growth outpacing production capacity. Yet 
a price based trigger could force the reduction of emergency stocks 
which would not alter market fundamentals. Any impact on prices would 
be temporary at best, and the strategic reserves would be drained and 
no longer available to respond to a physical disruption.
    It is the ability to act effectively in a crisis which avoids panic 
and fear. Consumers should be reassured that the reserves are there in 
the case of a disruption; the emergency stocks offer a safety net for 
when the normal supply chain breaks down, helping industry to adapt to 
the disruption and continue to supply the local gas station. Thus there 
is no need for consumers to run to the local filling station on hearing 
news reports of the next hurricane hitting Gulf coast refiners ; the 
government is there if industry needs help to fill the gap. It should 
also be clear that the reserves are there for a supply disruption and 
not to manage prices at the pump.
    Industry should also be assured that the reserves are there to help 
them to maintain product supply to their customers in the unforeseen 
crisis event. At the same time, it should be clear that the strategic 
product reserves are not there so that they can save costs by holding 
less product stocks; the reserves are there for the unforeseen event 
such as natural disasters or accidents which block the normal supply 
flow, not to meet seasonal demand spikes. They are a temporary solution 
until industry can get the disrupted supply flow back on-line. At the 
same time, the reserves should not be a disincentive for necessary 
investment by industry.
    I would add that this is not unlike the case for holding crude oil 
in the SPR, which provides the safety net for the oil industry and 
serves the purpose of mitigating disruptions whether from a global 
disruption stemming from geopolitical tensions or a localized 
disruption caused by an accident or natural disaster. The policy of 
using the SPR for physical disruption provides this safety net, 
reassuring market participants without resulting in refiners holding 
less adequate levels of stocks or dissuading the oil industry to make 
necessary investments.
    Question 2. During a supply disruption, the presence of a products 
reserve could create uncertainty about whether, when, and how much 
would be drawn down. High gasoline prices send a signal to the market 
participants and encourage product imports. Could the uncertainties 
surrounding a product reserve actually result in greater market 
volatility and discourage necessary imports of petroleum products? How 
do we need to address these unintended market consequences if we 
proceed forward with a regional product reserve?
    Answer. A clear and publicly stated policy of releasing emergency 
reserves only in the case of a physical disruption, when markets are no 
longer able to assure supplies, would significantly help to remove 
uncertainty surrounding their use. Oil markets should be the first 
recourse in a disruption, where the oil industry looks to find 
alternative supply routes and sources, including of course imports of 
refined products. It is only when the industry cannot supply the market 
due to exceptional circumstances that the reserves should come in to 
fill the gap. The mere existence of the strategic product reserves, 
ready to be brought to the market in a disruption, can help reduce 
volatility by reducing speculation on shortages.
    Question 3. Can you provide an estimated range of cost for the 
establishment and continued operation of a 30 million barrel refined 
product reserve as proposed?
    Answer. The cost of establishing the storage capacity would of 
course depend on issues such as whether above ground tanks or salt 
caverns are used, if storage capacity is newly built or if already 
existing capacity is bought or rented. Such decisions will depend on 
the given conditions of whichever region or regions are chosen for the 
reserves, and thus difficult to estimate in advance.
    The acquiring of the volumes will depend on markets at the time of 
filling. In today's market, 30 million barrels of gasoline would cost 
some $ 2.1 billion; the same amount of diesel would be about $1.8 
billion. If the reserves mirrored somewhat the consumption patterns in 
the US (for example, 50% gasoline, 40% diesel and 10% jet/kerosene), 
the cost of acquiring the products at today's prices would be around $ 
2.08 billion [ prices based on today, US Gulf gasoline $77/bbl, diesel 
$61.50/bbl and jet/kerosene $62.50/bbl].
    As stated in my testimony before the Senate Committee, European 
countries have running costs of about $3 per barrel. If the running 
costs in the US were the same, this would suggest an annual cost of $90 
million to maintain the strategic product reserves. More likely, the 
annual operating costs would be lower because of economies of scale in 
the US compared to Europe.
    Question 4. In terms of incentive to deliver, are there advantages 
to a government run supply of fuel as opposed to a privately held fuel 
supply?
    Answer. The true advantage of the strategic reserves is the nature 
of their use as oil is held outside of the normal supply system which 
can be brought to markets in a disruption. Either a government or 
privately run entity for fulfilling this role would be valid. Indeed, 
an industry based SPR could also be a solution. This is the case in 
some IEA member countries, such as Germany, where there is an 
obligation on refiners and oil importers to be members of the 
stockholding agency which manages the country's emergency reserves.
    Question 5. With respect to gasoline the sheer number of boutique 
fuels required by state and federal laws makes it practically 
impossible to store all the different types of fuels. For example, 
Colonial Pipeline, a major pipeline supplying products to the Southeast 
and Eastern U.S. has 60 different grades of gasoline and 26 different 
distillate fuels that will be shipped in 2009.
    What types of fuels will the Department of Energy require to be 
stored, and is there, in your opinion, a need to provide a fuel waiver 
on the boutique fuel requirements to ensure that the market disruption 
gets resolved in a timely manner?
    Answer. The boutique fuel specifications are a challenge to the 
supplying of fuels to the US market. These add to the costs of normal 
operations of companies, which ultimately gets passed on to the 
consumer, and can limit the ability to respond to a fuel shortage in 
one area with fuels available in another.
    The choice of what product specifications to hold in the reserves 
should be linked to the choice of a strategic location. The reserves 
should match the specifications of the area in which they are 
considered most likely to be released. However, that is not to say that 
the reserves would only be for this area, and waivers on fuel 
requirements should be a part of the emergency response policy in place 
to effectively use the reserves in a crisis.
    In a disruption, the market should be given as much flexibility as 
possible to properly allocate the additional supply that the strategic 
reserves are making available. Just as during the 2005 response, when 
the US EPA waved regulation to allow ``winter blend'' gasoline use 
throughout the country, fuel specification waivers should be used if 
necessary to facilitate the release of strategic product stocks.
    Question 6. Given the make-up of our product pipeline distribution 
system, a product reserve located in the Gulf States will not be able 
to provide any relief to consumers west of the Rocky Mountains. Would 
it be the intent of the Department of Energy to establish a number of 
product reserves?
    Answer. We believe the reserves should be located in various 
strategic locations to be defined by the DOE according to assessed 
regional vulnerabilities and not necessarily concentrated in one 
location. However, if the product markets over several regions are 
fluid, aided by the above mentioned specification waivers, a product 
release in one area of the country would be beneficial to other areas 
further away.
    Question 7. For many members of Congress, the most logical need for 
this regional product reserve would occur in the wake of a natural 
disaster similar to the hurricanes in 2005 and 2008. However, in 
looking back on those hurricanes the most critical problem with product 
supply was not a supply shortage, but the prolonged loss of electric 
power and associated impediments to the product distribution system.
    How do we address the electric power problems and ensure that the 
product reserve is used to provide short-term relief after a natural 
disaster and not be used solely as a political tool to lower gasoline 
prices when the price is high?
    Answer. A clear policy for using the reserves only for responding 
to a physical supply disruption should be put in place to avoid the 
reserves being used as a political tool for lower gasoline prices. The 
supply of electricity necessary to deliver the product reserves should 
be assured through measures such as having back-up generators on site 
to pump the products out of storage. However the issue of power supply 
is different in the case of refineries, where it is much more difficult 
to start back up a refinery after an emergency shutdown. In the case of 
products, as these do not need further processing, deliveries to 
consumers can be made through a variety of routes, include road, rail 
and barge, which are less prone to impediments related to power 
outages.
    Question 8. As members of the International Energy Agency (IEA), 
the United States is required to hold the equivalent of 90 days of oil 
imports. Since the IEA's International Energy Program was created in 
1974, oil reserves have only been released into the market twice and 
refined products have only been released once.
    Since the US is part of this program, given the limited use of the 
IEA's response mechanism, what is the benefit to the tax payer to 
create a costly Refined Product Reserve?
    Answer. While the IEA has only taken coordinated action on two 
occasions in its 35 year history to deal with global supply 
disruptions, strategic reserves have also been used by individual 
member countries in order to deal with domestic supply issues. For 
example, the US SPR has drawn on its stocks 10 times in the last decade 
in order to deal with localized disruptions of crude supplies to 
refiners.
    Of course, oil supply security, like any insurance system, has a 
price and strategic product stocks more so. While the IEA 90 day 
stockholding requirement does not specify what form of oil should be 
held, the advantage of holding refined products is in the case of a 
disruption to the refining industry. The reliance on strategic reserves 
of crude oil is contingent on refiners' abilities to ramp up 
utilization rates or restart shut-in refineries. In the hurricane 
seasons of 2005 and 2008 a significant amount of the refinery capacity 
in the US Gulf coast was taken off-line for an extended period of time. 
The release of strategic product reserves can bring relief to consumers 
in a much shorter time under such circumstances. The SPR, by expanding 
from its current level through the addition of refined products, could 
significantly enhance security of supply.
                                 ______
                                 
    Responses of John D. Shages to Questions From Senator Murkowski
    Question 1. This morning, the RAND Corporation released a report 
stating that the absence of a publicly-stated policy on when the 
Strategic Petroleum Reserve will be used has the potential to trigger 
panic hoarding if market participants fear a major supply disruption, 
bringing on the very conditions that the Strategic Petroleum Reserve 
was supposed to ameliorate.
    Should DOE commit to providing certainty in the marketplace by 
writing and holding a publicly stated policy on when the Strategic 
Reserve will be drawn down?
    Answer. It would be a very good idea for the public and market 
participants to understand the policy of each administration toward its 
use of the Strategic Petroleum Reserve, and a public policy statement 
would reduce ambiguity. An appropriate statement would be precise on 
philosophy but would not supply certainty for market participants, 
because certainty implies a commitment to market intervention or 
nonintervention which may not be appropriate in all circumstances. In 
addition, a trigger would effectively cap futures prices, limit 
inventory building and discourage high cost production. For example, 
the Bush administration's SPR policy was unequivocal; the SPR would 
only be used in the event of a disruption that caused an observable 
shortage that could not be addressed by the market. It was very 
specific that the SPR would never be used to affect changes in market 
price. While this policy was clear, it did not provide latitude for the 
Administration to address the 2007-08 surge in oil prices that was a 
leading cause of the world wide recession because that surge was not 
marked by a definable disruption. Similarly, any equally rigid policy, 
such as a $100 trigger price for drawdown might discourage investment 
in methane hydrates, oil shale, coal to liquids, cellulosic ethanol, 
solar photovoltaics and a broad array of unconventional fuels.
    I highly recommend that an administration's policy statement on the 
SPR include a promise that in the event of a severe price change that 
threatens economic stability, the administration would act either in 
conjunction with the International Energy Agency or on its own to 
stabilize prices. However, I also strongly recommend that no specific 
price or price differential be included in that policy statement, and 
the decision to use the SPR be made only after consideration of the 
facts at the time.
    Question 2. During a supply disruption, the presence of a products 
reserve could create uncertainty about whether, when, and how much 
would be drawn down. High gasoline prices send a signal to the market 
participants and encourage product imports. Could the uncertainties 
surrounding a product reserve actually result in greater market 
volatility and discourage necessary imports of petroleum products? How 
do we need to address these unintended market consequences if we 
proceed forward with a regional product reserve?
    Answer. The same arguments were made against a two million barrel 
heating oil reserve when it was created in 1999. The ten year history 
of the Department of Energy's management of the Northeast Home Heating 
Oil Reserve should assure refiners, importers and suppliers that the 
intent of modest refined product reserves is for relief in the event of 
a disruption to supply that cannot be satisfied by the provision of 
more supplies as prices rise. The evidence is clear that in the past 
ten years the Heating Oil Reserve has never been used to supplement 
supply despite regular demands that it be released every time the price 
of heating oil rose to an uncomfortably high level.
    As a result of this management philosophy there is no evidence 
suppliers have let the existence of the Northeast Home Heating Oil 
Reserve be a consideration as they have built their winter inventories, 
and there have not been any shortages in the last decade. I would 
expect the same industry response to any other refined product 
reserves, and as a result I would not expect any change in the level of 
price volatility in either the prompt or futures markets for these 
products. Furthermore, most other countries belonging to the 
International Energy Agency hold some portion of their stockpiles as 
refined products, and there is no evidence that their commercial 
inventories are inadequate or that they suffer from greater price 
volatility than the United States. A clear statement of intent to stay 
with this proven philosophy on minimum intervention should be all that 
is necessary to prevent market participants from changing their 
behavior once the new refined product reserves actually exist.
    Finally, it is important to note that in the case of the Southeast 
United States, all product supply moves though the Colonial and 
Plantation pipelines. In 2005 and 2008, the willingness of importers to 
respond to price signals was not an issue. The price signals were there 
for imports to increase, but the infrastructure to move the products 
from the coastal areas inland did not exist or was impaired by the 
hurricanes. These instances were classic cases of high prices being 
unable to illicit supply to meet demand; consequently the only option 
was for prices to rise high enough to destroy demand to allow markets 
to balance.
    Question 3. Can you provide an estimated range of cost for the 
establishment and continued operation of a 30 million barrel refined 
product reserve as proposed?
    Answer. There are so many variables that will determine the answer 
to this question that the range would nearly meaningless until the 
Department of Energy determines a plan for implementation. For example, 
the Northeast Home Heating Oil Reserve is located in private storage 
terminals and managed by those terminals. The cost of that storage 
fluctuates depending upon the level of private inventories and the 
market price of storage. Today that storage is costing about $4.80 per 
barrel per year, but that reflects the fact that inventories are very 
high and storage space is at a premium. In other years the cost has 
been approximately half that amount. If the plan proposed by DOE is to 
use private facilities, the range of costs would be comparable to those 
of the Heating Oil Reserve.
    If instead the Department proposes to include the refined product 
storage facilities as part of the Richton Dome expansion, the marginal 
capital cost above the cost of crude oil storage would probably add 5 
percent or more to the cost of that site, which given the uncertainty 
associated with the site's cost could range from +$100 million to +$200 
million. However, after the initial capital costs the marginal 
operating and maintenance costs would be pennies per year.
    There is also the possibility that the government could decide to 
build steel tank storage, which would be less costly over time than 
leasing but much more expensive than underground storage. It would also 
require a capital cost substantially greater than the other two 
options.
    A consideration that makes point-in-time cost estimates unreliable 
is that the capital cost of oil field facilities is very volatile. At 
this time, the cost of engineering services, construction services and 
steel pipes is very low due the slow economy. If the plan to develop 
new facilities is delayed until the price of oil rises and domestic oil 
field activity is again booming as it was in 2007-08, the cost of 
construction could double from today's cost estimates. An immediate 
implementation of any construction plan would save the government 
capital costs and would help with the currently desired economic 
stimulus versus a delayed start.
    Question 4. In terms of incentive to deliver, are there advantages 
to a government run supply of fuel as opposed to a privately held fuel 
supply?
    Answer. Yes, the incentives for the government to sell oil are 
different from and complement the incentives that motivate the private 
sector. As with most energy programs in a free market economy, the 
government has a role to play when private markets fail, or the 
consequences of balancing supply and demand by price changes are 
unacceptable for reasons such as economic stability. Petroleum is a 
special case in that efficient free markets are the general rule on a 
day-to-day basis but with fairly frequent instances of cartel 
interventions, wars, and Acts of God disrupting supply. While the 
private sector builds inventories and systems redundancies to take 
advantage of statistically predictable disruptions, the financial 
incentives are just not there to guard against disruptions caused by 
random events such as the hurricanes that disrupted supplies in 2005 
and 2008. Therefore, while it is generally preferable to allow profit 
incentive to drive private enterprise to supply markets, there is a 
role for government stockpiling. The government's incentive to use its 
stocks would obviously be to protect the welfare of people. In 
addition, but less obvious, the government wants to protect the free 
market system which would be highly criticized if it cannot supply 
essential products such as heating oil and transportation fuels, and 
which would become vulnerable to oppressive and inefficient regulation 
in the event it should fail to supply essential fuels at reasonable 
prices. Preservation of the market approach for supplying and balancing 
demand is well worth the modest cost of insuring against unlikely but 
potentially devastating disruptions.
    Question 5. With respect to gasoline the sheer number of boutique 
fuels required by state and federal laws makes it practically 
impossible to store all the different types of fuels. For example, 
Colonial Pipeline, a major pipeline supplying products to the Southeast 
and Eastern U.S. has 60 different grades of gasoline and 26 different 
distillate fuels that will be shipped in 2009.
    What types of fuels will the Department of Energy require to be 
stored, and is there, in your opinion, a need to provide a fuel waiver 
on the boutique fuel requirements to ensure that the market disruption 
gets resolved in a timely manner?
    Answer. In all likelihood the Department will store no more than 
two types of gasoline plus diesel fuel. In that case if a state needs a 
release of gasoline from the Strategic Petroleum Reserve inventory, and 
that fuel does not meet the state specification, the state will have to 
grant a waiver (as delegated by the U.S. Environmental Protection 
Agency). Just as with the crude oil, such waivers may be agreed to by 
the effected states in advance of the actual emergency. While fuel 
specification is an issue, it is dealt with by industry every day and 
there is no reason to think that the Department will not be able to 
overcome this hurdle.
    Question 6. Given the make-up of our product pipeline distribution 
system, a product reserve located in the Gulf States will not be able 
to provide any relief to consumers west of the Rocky Mountains. Would 
it be the intent of the Department of Energy to establish a number of 
product reserves?
    Answer. I cannot answer for the Department, however, I would 
encourage the Department to consider a product reserve in the Southwest 
to protect that region of the country from an Act of God that might 
affect the ability of the Los Angeles, California area refineries to 
service the Morgan Kinder pipeline, which is the sole source of 
products to a large portion of the Southwest.
    Question 7. For many members of Congress, the most logical need for 
this regional product reserve would occur in the wake of a natural 
disaster similar to the hurricanes in 2005 and 2008. However, in 
looking back on those hurricanes the most critical problem with product 
supply was not a supply shortage, but the prolonged loss of electric 
power and associated impediments to the product distribution system.
    How do we address the electric power problems and ensure that the 
product reserve is used to provide short-term relief after a natural 
disaster and not be used solely as a political tool to lower gasoline 
prices when the price is high?
    Answer. It is critical that the location(s) of the product reserve 
be beyond the immediate areas impacted by Gulf of Mexico hurricanes. It 
may also be wise to supply the storage site(s) with their own auxiliary 
power systems so that the reserve can be delivered to buyers regardless 
of the status of the general power system. One reason that the Richton 
Dome site in Mississippi is repeatedly mentioned as a possible site is 
that it is 80 miles inland from the Gulf of Mexico, which is sufficient 
to avoid major hurricane damage, and it would be connected into the 
Colonial Pipeline at a point where power has been available soon after 
recovery from hurricanes begins. After the 2008 hurricanes, the 
Colonial Pipeline was operable well before the Gulf Coast refineries 
were able to come on line and begin providing it with refined products, 
so that a refined product reserve inventory would have filled the gap.
    Question 8. As members of the International Energy Agency (IEA), 
the United States is required to hold the equivalent of 90 days of oil 
imports. Since the IEA's International Energy Program was created in 
1974, oil reserves have only been released into the market twice and 
refined products have only been released once. 
    Since the US is part of this program, given the limited use of the 
IEA's response mechanism, what is the benefit to the tax payer to 
create a costly Refined Product Reserve?
    Answer. The Strategic Petroleum Reserve is and has always been an 
insurance policy against disruptions. As with standard health 
insurance, the hope is that nothing will ever happen that causes you to 
collect on the policy. Furthermore, as with health insurance, we do not 
expect the events to occur that will cause us to collect on the policy, 
and if they do not, the health insurance might be viewed as a bad 
investment---all premium payments with no return. The true question of 
whether or not to have health insurance is ``Can you afford to get sick 
without it?'' Similarly, the United States cannot afford petroleum 
supply shortages and the accompanying prolonged price surge without 
disrupting our whole economy and our way of life. This was dramatically 
shown in the spring, summer and fall of 2008 when fuel prices helped to 
break our economy's back. For the people of the southeast U.S., the 
fuel shortages that disrupted life and drained the regional economy of 
cash during the fall of 2008, the pain was palpable. The clear benefit 
of releasing reserves of refined products in September 2008 would have 
been to allow the Southeast to be on the same economic footing as the 
rest of the country. Judicious use of the crude oil in the Strategic 
Petroleum Reserve in 2007-08 might have reduced the severity and 
duration of the current economic recession at the national level, 
saving millions of jobs, and hundreds of billions of dollars of gross 
domestic product. It could have been a case of insurance paying for 
itself handsomely, and if a refined product reserve had existed its 
benefits would have easily covered its costs.
                                 ______
                                 
      Responses of Frank Rusco to Questions From Senator Murkowski
    Question 1. This morning, the RAND Corporation released a report 
stating that the absence of a publicly-stated policy on when the 
Strategic Petroleum Reserve will be used has the potential to trigger 
panic hoarding if market participants fear a major supply disruption, 
bringing on the very conditions that the Strategic Petroleum Reserve 
was supposed to ameliorate. Should DOE commit to providing certainty in 
the marketplace by writing and holding a publicly stated policy on when 
the Strategic Reserve will be drawn down?
    Answer. In developing our August 2006 report on the Strategic 
Petroleum Reserve (SPR) we contracted with the National Academy of 
Sciences to convene a group of 13 experts to collect opinions on the 
impacts of past SPR fill and use and on recommendations for the future, 
as well as on the benefit of the SPR on reducing economic losses in the 
event of oil supply disruptions.\1\ With regard to using the SPR, 
experts generally supported providing broad discretion about when to 
use the SPR, although they questioned some past presidential decisions 
about SPR use. The Energy Policy and Conservation Act, as amended, 
allows broad presidential discretion and provides only general guidance 
for the SPR's use, making its use a matter of judgment by the 
President.\2\ While the President's discretion over the release of oil 
introduces some uncertainty into the market, it also has certain 
advantages. Members of our group of experts told us that uncertainty 
around SPR use can be valuable. For example, the President can use the 
SPR as a bargaining tool in diplomatic negotiations during energy 
crises, enabling him to encourage behavior by oil-producing nations 
that could be beneficial to the United States.
---------------------------------------------------------------------------
    \1\ GAO, Strategic Petroleum Reserve: Available Oil Can Provide 
Significant Benefits, but Many Factors Should Influence Future 
Decisions about Fill, Use, and Expansion, GAO-06-872 (Washington, D.C.: 
Aug. 24, 2006).
    \2\ Pub. L. No. 94-163, Sec.  161, 89 Stat. 888-89 (1975), codified 
as amended at 42 U.S.C. Sec.  6241.
---------------------------------------------------------------------------
    Experts also described several key factors to consider when making 
future decisions about using the SPR, including using the SPR without 
delay when it is needed to minimize economic damage. Expert group 
members encouraged early use of the SPR as a first line of defense 
against oil supply disruptions, noting that recent changes in the oil 
industry--including diminished spare crude oil production capacity, 
refining capacity, and product inventories--have removed sources of 
supply security that have covered short-term supply losses in the past. 
Additionally, some experts believe that much of the harm to the U.S. 
economy occurs in the early phases of a disruption, before the economy 
has a chance to adjust to higher prices.
    We have found that it is important for markets to have some 
information about potential government intervention, but to temper how 
much information to provide. The concern about providing a detailed 
description of when the SPR would be used is twofold: first, such 
information could provide the ability of market participants to ``game 
the system'' with respect to availability and pricing and second, it 
could restrict the government from either acting or refraining from 
releasing from the SPR in response to the facts and circumstances at a 
certain time. Because of this, it may be better to provide only broad 
guidance on the potential usage and provide the administration 
flexibility to determine when to release.
    Question 2. During a supply disruption, the presence of a products 
reserve could create uncertainty about whether, when, and how much 
would be drawn down. High gasoline prices send a signal to the market 
participants and encourage product imports. Could the uncertainties 
surrounding a product reserve actually result in greater market 
volatility and discourage necessary imports of petroleum products? How 
do we need to address these unintended market consequences if we 
proceed forward with a regional product reserve?
    Answer. There are a number of potential risks and benefits that 
could result from including refined products in the SPR. We have not 
done work to specifically examine whether creating a refined product 
reserve would affect volatility. However, it is clear that a product 
reserve will add complexity to the market and market participants will 
have to take this complexity into consideration as they make key 
decisions about pricing as well as imports and other supply factors. 
How the reserve is used will have a great impact on whether such a 
reserve would result in greater volatility, much of which will remain 
unknown for some time after the reserve is established.
    Question 3. Can you provide an estimated range of cost for the 
establishment and continued operation of a 30 million barrel refined 
product reserve as proposed?
    Answer. I am unable to provide an estimate of the cost to establish 
and operate the proposed refined product reserve at this time. We have 
not done any work in this area and many of the key factors that will 
determine the cost have not been resolved. S. 967, which was introduced 
by Senator Bingaman on May 4, 2009, would direct the Secretary of 
Energy to develop a plan to include refined petroleum products in the 
SPR. As envisioned in the proposed legislation, the plan would address 
the issues that need to be resolved such as, what types of the refined 
products to store and how and where to store them. Furthermore, the 
proposed legislation directs the Secretary of Energy to include in the 
plan ``the estimated costs of establishment, maintenance, and operation 
of the refined petroleum product component of the Reserve.''
    Question 4. In terms of incentive to deliver, are there advantages 
to a government run supply of fuel as opposed to a privately held fuel 
supply?
    Answer. We have not examined the implications of overt and 
extensive government intervention into the supply of fuel and as such 
do not have an informed opinion as to the comparative advantages of 
this approach versus a market-driven supply.
    Question 5. With respect to gasoline the sheer number of boutique 
fuels required by state and federal laws makes it practically 
impossible to store all the different types of fuels. For example, 
Colonial Pipeline, a major pipeline supplying products to the Southeast 
and Eastern U.S. has 60 different grades of gasoline and 26 different 
distillate fuels that will be shipped in 2009. What types of fuels will 
the Department of Energy require to be stored, and is there, in your 
opinion, a need to provide a fuel waiver on the boutique fuel 
requirements to ensure that the market disruption gets resolved in a 
timely manner?
    Answer. We agree that the proliferation of boutique fuels poses a 
challenge in incorporating refined products in the SPR. I highlighted 
this issue in my testimony as one of the arguments against including 
refined products in the SPR.\3\ Under the provisions of S. 967, the 
plan that the Secretary of Energy would be required to develop would 
address what specific types of fuels would be stored as part of a 
refined product reserve. Unless the requirements to use special 
gasoline blends--or `boutique' fuels--were waived during emergencies, 
as they were in the aftermath of Hurricanes Katrina and Rita, boutique 
fuels could need to be strategically stored at multiple regional, 
state, or local locations due to reduced product fungibility.
---------------------------------------------------------------------------
    \3\ GAO, Strategic Petroleum Reserve: Issues Regarding the 
Inclusion of Refined Petroleum Products as Part of the Strategic 
Petroleum Reserve, GAO-09-695T (Washington, D.C.: May 12, 2009).
---------------------------------------------------------------------------
    Question 6. Given the make-up of our product pipeline distribution 
system, a product reserve located in the Gulf States will not be able 
to provide any relief to consumers west of the Rocky Mountains. Would 
it be the intent of the Department of Energy to establish a number of 
product reserves?
    Answer. Under the provisions of S. 967, the plan that the Secretary 
of Energy would be required to develop would address ``storage facility 
options for the storage of refined petroleum products, including the 
anticipated location of existing or new facilities.'' At this time I do 
not know if the Department of Energy would store the refined products 
in one location or in a number of locations spread out across the 
country if the requirement to establish a refined product reserve is 
enacted.
    Question 7. For many members of Congress, the most logical need for 
this regional product reserve would occur in the wake of a natural 
disaster similar to the hurricanes in 2005 and 2008. However, in 
looking back on those hurricanes the most critical problem with product 
supply was not a supply shortage, but the prolonged loss of electric 
power and associated impediments to the product distribution system. 
How do we address the electric power problems and ensure that the 
product reserve is used to provide short-term relief after a natural 
disaster and not be used solely as a political tool to lower gasoline 
prices when the price is high?
    Answer. With respect to the challenges of electric power outages, 
the hurricanes had a number of impacts on the distribution of refined 
products, including inundation of refineries, damage to pipelines and 
related equipment, as well as the loss of electric power. In the U.S. 
electric power outages are rare, in general, and widespread outages are 
exceedingly rare. To the extent that facilities such as transshipment 
locations and pipelines require the ability to operate during a time 
when the electric power supplies are disrupted, it is possible to 
maintain back-up power supplies via diesel generators or others. A 
number of the witnesses at the hearing were emphatic that if refined 
products are included as part of the SPR, they should not be used 
simply to lower gasoline prices when prices are high. However, GAO has 
no position on this question at this time.
    Question 8. As members of the International Energy Agency (IEA), 
the United States is required to hold the equivalent of 90 days of oil 
imports. Since the IEA's International Energy Program was created in 
1974, oil reserves have only been released into the market twice and 
refined products have only been released once. Since the U.S. is part 
of this program, given the limited use of the IEA's response mechanism, 
what is the benefit to the tax payer to create a costly Refined Product 
Reserve?
    Answer. GAO has not formed a position as to the overall costs and 
benefits of a strategic reserve, whether held as crude oil or as a 
combination of crude oil and petroleum products. In my testimony, we 
identified both potential benefits and costs associated with holding 
petroleum products as part of the SPR.\4\ However, the SPR, the 
reserves held by IEA member countries, and the possible U.S. refined 
product reserve can be thought of as similar to insurance policies. It 
is possible that the value of an insurance policy is great enough, in 
terms of the peace of mind it provides, that it is worth holding even 
if it is never used. Generally, the amount people are willing to pay 
for insurance depends on their feelings about risk. As such, it would 
be very difficult to assess the national costs and benefits of the SPR 
in general, or a petroleum product reserve specifically, because the 
benefits depend on the public's collective feelings about the risk of 
facing a potential crude oil or petroleum product supply disruption.
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    \4\ GAO-09-695T.
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                                 ______
                                 
   Responses of David F. Johnson to Questions From Senator Murkowski
    Question 1. This morning, the RAND Corporation released a report 
stating that the absence of a publicly-stated policy on when the 
Strategic Petroleum Reserve will be used has the potential to trigger 
panic hoarding if market participants fear a major supply disruption, 
bringing on the very conditions that the Strategic Petroleum Reserve 
was supposed to ameliorate.
    Should DOE commit to providing certainty in the marketplace by 
writing and holding a publicly stated policy on when the Strategic 
Reserve will be drawn down?
    Answer. The SPR has a well defined release policy which is stated 
in the Energy Policy and Conservation Act (EPCA), the authorizing 
legislation for the Strategic Petroleum Reserve (SPR). Section 161 of 
EPCA requires that, before crude oil from the SPR can be drawn down and 
sold, the President must find that ``drawdown and sale are required by 
a severe energy supply interruption or by obligations of the United 
States under the international energy program.''
    EPCA defines ``severe energy supply interruption'' as a national 
energy supply shortage which the President determines: ``(A) is, or is 
likely to be, of significant scope and duration, and of an emergency 
nature; (B) may cause major adverse impact on national safety or the 
national economy; and (C) results, or is likely to result, from (i) an 
interruption in the supply of imported petroleum products, (ii) an 
interruption in the supply of domestic petroleum products, or (iii) 
sabotage or an act of God.'' EPCA further states that a severe energy 
supply interruption is ``deemed to exist'' if the President finds that 
an emergency situation exists and various other factors are met.
    It is impossible to define in advance precisely what set of factors 
or circumstances might lead to a Presidential finding that a severe 
energy supply interruption exists. However, in adhering to the release 
conditions that require an actual or imminent severe supply 
interruption as defined in EPCA, the DOE avoids interfering with 
petroleum markets when a severe energy supply interruption does not 
exist.
    Question 3. Can you provide an estimated range of cost for the 
establishment and continued operation of a 30 million barrel refined 
product reserve as proposed?
    Answer. We have not yet fully evaluated the projected costs for the 
establishment or the continued operation of a 30 million barrel refined 
product reserve. The costs of such a project could vary significantly 
based on the choice of storage location(s) and medium; the distribution 
system for inventories; types and varieties of product stored; the 
methodology for managing the reserve; and the timeframe for 
development.
    Question 4. In terms of incentive to deliver, are there advantages 
to a government run supply of fuel as opposed to a privately held fuel 
supply?
    Answer. In the event of a severe supply interruption, Government 
ownership of a refined product reserve would ensure that the Government 
directly controls when petroleum products would be released into the 
market. A release decision would be based on the objective to minimize 
or prevent product shortages. Government owned inventories would be 
maintained to protect against potential disruptions.
    Question 5. With respect to gasoline the sheer number of boutique 
fuels required by state and federal laws makes it practically 
impossible to store all the different types of fuels. For example, 
Colonial Pipeline, a major pipeline supplying products to the Southeast 
and Eastern U.S. has 60 different grades of gasoline and 26 different 
distillate fuels that will be shipped in 2009.
    What types of fuels will the Department of Energy require to be 
stored, and is there, in your opinion, a need to provide a fuel waiver 
on the boutique fuel requirements to ensure that the market disruption 
gets resolved in a timely manner?
    Answer. We have not yet fully evaluated which products might be 
appropriate for storage in the proposed 30 million barrel refined 
product reserve.
    The Environmental Protection Agency issues waivers of State or 
Federal fuel requirements, as appropriate, after consultation with, and 
concurrence by, DOE. Whether or not a waiver should be granted from 
boutique fuel requirements would be determined on a case-by-case basis 
in light of specific circumstances existing at the time the request for 
a waiver is made.
    Question 6. Given the make-up of our product pipeline distribution 
system, a product reserve located in the Gulf States will not be able 
to provide any relief to consumers west of the Rocky Mountains. Would 
it be the intent of the Department of Energy to establish a number of 
product reserves?
    Answer. The Department hasn't fully evaluated how the reserve would 
be designed or products would be stored under the provisions of the 
bill.
    Question 7. For many members of Congress, the most logical need for 
this regional product reserve would occur in the wake of a natural 
disaster similar to the hurricanes in 2005 and 2008. However, in 
looking back on those hurricanes the most critical problem with product 
supply was not a supply shortage, but the prolonged loss of electric 
power and associated impediments to the product distribution system.
    How do we address the electric power problems and ensure that the 
product reserve is used to provide short-term relief after a natural 
disaster and not be used solely as a political tool to lower gasoline 
prices when the price is high?
    Answer. Loss of electrical power at refineries, terminals, and 
pipeline pumping stations significantly contributed to refined product 
shortages in the southeastern United States following Hurricanes 
Katrina and Rita in 2005. In addition, some facilities experienced more 
damage from wind and water in 2005. Following these storms, some major 
product pipelines invested in generators to power critical pumping 
stations. In 2008, refined product shortages that followed Hurricanes 
Gustav and Ike were more the result of lost refinery output when 
refineries shut down as a precaution prior to the storms.
    The Colonial and Plantation pipelines were both operational several 
days following Hurricane Gustav, but operated at reduced flows due to 
refineries not being able to provide products into the lines. Given 
their complexity, it takes much longer to inspect and restart a 
refinery once it has been shut down. As a result, there is a gap 
between when refined products pipelines can resume operations and when 
refiners can supply products to the pipelines.
    The Administration has not yet assessed the need to add a refined 
products component to the Strategic Petroleum Reserve (SPR). However, 
the Energy Policy and Conservation Act (EPCA) establishes the release 
criteria for the existing SPR. EPCA requires the President issue a 
finding of a severe energy supply interruption before oil can be 
released from the SPR. This requirement helps minimize the likelihood 
that the SPR will be used for political purposes or solely in response 
to high prices.
    Question 8. As members of the International Energy Agency (IEA), 
the United States is required to hold the equivalent of 90 days of oil 
imports. Since the IEA's International Energy Program was created in 
1974, oil reserves have only been released into the market twice and 
refined products have only been released once.
    Since the US is part of this program, given the limited use of the 
IEA's response mechanism, what is the benefit to the tax payer to 
create a costly Refined Product Reserve?
    Answer. The International Energy Agency (IEA) has conducted two 
coordinated emergency releases since it was established in 1974. Both 
crude oil and refined products were released in 1991 (Persian Gulf War) 
and 2005 (Hurricanes Katrina and Rita). Additionally, IEA member 
countries have adopted the practice of conducting exchanges and loans 
to address short-term or localized disruption events. In this capacity, 
additional refined products have been released to the market.
    Neither the costs nor benefits of establishing a regional refined 
products reserve have been analyzed. Further study of this issue is 
needed.

    [Response to the following question was not received at the 
time the hearing went to press:]

          Question For David F. Johnson From Senator Murkowski
    Question 2. During a supply disruption, the presence of a products 
reserve could create uncertainty about whether, when, and how much 
would be drawn down. High gasoline prices send a signal to the market 
participants and encourage product imports. Could the uncertainties 
surrounding a product reserve actually result in greater market 
volatility and discourage necessary imports of petroleum products? How 
do we need to address these unintended market consequences if we 
proceed forward with a regional product reserve?

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