United States Government Accountability Office

GAO Testimony 

Before the Select Committee on Energy 

Independence and Global Warming, 

House of Representatives 

STRATEGIC PETROLEUM 

RESERVE 

Improving the CostEffectiveness of Filling the 

Reserve 

Statement of Frank Rusco, Acting Director 

Natural Resources and Environment 

For Release on Delivery

Expected at 10:00 a.m. EDT 

Thursday, April 24, 2008

 

GAO-08-726T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

April 23, 2008 

STRATEGIC PETROL EUM RESERVE 

Improving the Cost-Effectiveness of Filling the 

Reserve

Highlights of GAO-08-726T, a testimony 

before the Select Committee on Energy 

Independence and Global Warming, 

House of Representatives

The Strategic Petroleum Reserve 

(SPR) was created in 1975 to help 

protect the U.S. economy from oil 

supply disruptions and currently 

holds about 700 million barrels of 

crude oil. The Energy Policy Act of

2005 directed the Department of 

Energy (DOE) to increase the SPR 

storage capacity from 727 million 

barrels to 1 billion barrels, which it 

plans to accomplish by 2018. Since 

1999, oil for the SPR has generally

been obtained through the royaltyin-kind program, whereby the 

government receives oil instead of 

cash for payment of royalties on 

leases of federal property. The

Department of Interior’s Minerals 

Management Service (MMS) 

collects the royalty oil and 

transfers it to DOE, which then

trades it for oil suitable for the

SPR. 

As DOE begins to expand the SPR,

past experiences can help inform 

future efforts to fill the reserve in 

the most cost-effective manner. In

that context, GAO’s testimony

today will focus on: (1) factors 

GAO recommends DOE consider

when filling the SPR, and (2) the

cost-effectiveness of using oil 

received through the royalty-inkind program to fill the SPR. 

To address these issues, GAO 

relied on its 2006 report on the

SPR, as well as its ongoing review

of the royalty-in-kind program,

where GAO interviewed officials at 

both DOE and MMS, and reviewed 

DOE’s SPR policies and 

procedures. DOE provided 

comments on a draft of this

testimony, which we incorporated 

where appropriate. 

To decrease the cost of filling the reserve and improve its efficiency, GAO 

recommended in previous work that DOE should include at least 10 percent 

heavy crude oils 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 crude oil 

and the lower price of heavy crude oil, the average differential over the last 

five years. Having heavy crude oil in the SPR would also make the SPR more

compatible with many U.S. refineries, helping these refineries run more 

efficiently in the event that a supply disruption triggers use of the SPR. DOE 

indicated that, due to the planned SPR expansion, determinations of the 

amount of heavy oil to include in the SPR should wait until it prepares a new 

study of U.S. Gulf Coast refining requirements. In addition, we recommended 

that DOE consider acquiring a steady dollar value—rather than a steady 

volume—of oil over time when filling the SPR. This “dollar-cost-averaging” 

approach would allow DOE to acquire more oil when prices are low and less

when prices are high. GAO found that if DOE had used this purchasing 

approach between October 2001 through August 2005, it could have saved 

approximately $590 million, or over 10 percent, in fill costs. GAO’s 

simulations indicate that DOE could save money using this approach for 

future SPR fills, regardless of whether oil prices are trending up or down as 

long as there is price volatility. GAO also recommends that DOE consider 

giving companies participating in the royalty-in-kind program additional 

flexibility to defer oil deliveries in exchange for providing additional barrels of 

oil. DOE has granted limited deferrals in the past, and expanding their use 

could further decrease SPR fill costs. While DOE indicated that its November 

2006 rule on SPR acquisition procedures addressed our recommendations, 

this rule does not specifically address how to implement a dollar-costaveraging strategy. 

Purchasing oil to fill the SPR—as DOE did until 1994—is likely to be more 

cost-effective than exchanging oil from the royalty-in-kind program for other 

oil to fill the SPR. The latter method adds administrative complexity to the 

task of filling the SPR, increasing the potential for waste and inefficiency. A

January 2008 DOE Inspector General report found that DOE is unable to 

ensure that it receives all of the royalty oil that MMS provides. In addition, we 

found that DOE’s method for evaluating bids has been more robust for cash 

purchases than royalty-in-kind exchanges, increasing the likelihood that cash 

purchases are more cost-effective. For example, in April 2007, DOE solicited

two different types of bids—one to purchase oil for the SPR in cash and one 

to exchange royalty oil for other oil to fill the SPR. DOE rejected offers to 

purchase oil when the spot price was about $69 per barrel, yet in the same 

month, DOE exchanged royalty-in-kind oil for other oil to put in the SPR at 

about the same price. Because the government would have otherwise sold 

this royalty-in-kind oil, DOE committed the government to pay, through 

foregone revenues to the U.S. Treasury, roughly the same price per barrel that 

DOE concluded was too high to purchase directly.

To view the full product, including the scope 

and methodology, click on GAO-08-726T. 

For more information, contact Frank Rusco at 

(202) 512-3841 or ruscof@gao.gov. 
Strategic Petroleum Reserve

Mr. Chairman and Members of the Committee: 

We are pleased to be here today to participate in the Committee’s hearing 

on the Strategic Petroleum Reserve (SPR). Congress authorized the SPR in 

1975 to protect the nation from oil supply disruptions following the Arab 

oil embargo of 1973 and 1974 that led to sharp increases in oil prices. The 

federal government owns the SPR, and the Department of Energy (DOE) 

operates it. The SPR currently has the capacity to store up to 727 million 

barrels of crude oil in salt caverns in Texas and Louisiana. As of April 21, 

2008, current inventory of the SPR stood at 701.3 million barrels of oil, 

which is roughly equivalent to 58 days of net oil imports. DOE made direct 

purchases of crude oil until 1994, when purchases were suspended due to

the federal budget deficit, and in fiscal years 1996 and 1997 approximately 

28 million barrels of oil were sold to reduce the deficit. Since DOE 

resumed filling the SPR in 1999, it has obtained oil from the Department of 

the Interior’s Minerals Management Service (MMS) “royalty-in-kind” 

program. Through this program, the MMS receives oil instead of cash for

payments of royalties from companies that lease federal property for oil 

and gas development. MMS contracts for some of this royalty oil to be 

delivered to designated oil terminal locations or “market centers” where 

DOE takes possession. Because the royalty oil often does not meet SPR 

quality specifications, and because the market centers can be distant from 

SPR storage sites, DOE generally awards contracts to exchange royalty oil 

at the market center for SPR-quality oil delivered to SPR facilities. 

Obtaining oil for the SPR through the royalty-in-kind program avoids the 

need for Congress to make outlays to finance oil purchases, but the 

foregone revenues associated with using royalty-in-kind oil to trade for 

SPR oil imply an equivalent loss of revenue because MMS would otherwise 

sell the oil and deposit the revenues with the U.S. Treasury. Interior 

estimates that the forgone revenue attributable to using the royalty-in-kind 

program to fill the SPR were $4.6 billion from fiscal year 2000 through 

fiscal year 2007. 

The Energy Policy Act of 2005 directed DOE to increase the SPR storage 

capacity to 1 billion barrels and to fill it “as expeditiously as practicable

without incurring excessive cost or appreciably affecting the price of 

petroleum products to consumers.”1

 It required DOE to select sites to 

 1

Pub. L. No. 109-58 (2005). The Energy Policy and Conservation Act, Pub. L. No. 94-163 

(1975), created the SPR and authorized storage of up to one billion barrels of petroleum 

products. 

Page 1 GAO-08-726T
Strategic Petroleum Reserve

expand the SPR’s storage capacity within 1 year of enactment, by August 

2006. On February 14, 2007, Secretary of Energy William Bodman 

designated three sites for the expansion, including a 160 million barrel 

facility in Richton, Mississippi, an 80 million barrel expansion of a facility 

in Big Hill, Texas, and a 33 million barrel expansion of a facility in Bayou 

Choctaw, Louisiana. In its June 2007 SPR plan, DOE anticipated these 

expansions would begin in fiscal year 2008 and be complete in 2018.2,3

 DOE

also indicated that it would prefer to continue using the royalty-in-kind 

program to fill the additional storage capacity. DOE estimates the capital

cost for the SPR expansion at approximately $3.67 billion, and estimates 

the cost of operating and maintaining the expanded portion of the SPR at 

$35 to $40 million per year. 

As DOE begins to expand the SPR, past experiences may help inform 

future efforts to fill the SPR in the most cost-effective manner. In that 

context, our testimony today will focus on: (1) factors we recommend 

DOE consider when filling the SPR, and (2) the cost-effectiveness of using 

oil received through the royalty-in-kind program to fill the SPR. 

To address these issues, we are summarizing work from our August 2006 

report on the SPR and our ongoing review of the royalty-in-kind program.4

For our August 2006 report, we contracted with the National Academy of 

Sciences to convene a group of 13 industry, academic, governmental, and 

nongovernmental experts to collect opinions on the impacts of past SPR 

fill and use and on recommendations for the future. We also reviewed 

records and reports from DOE and the International Energy Agency. In

addition, for our ongoing review of the royalty-in-kind program for this 

committee and others, we identified and reviewed applicable laws and 

documentation on DOE policies and procedures for evaluating SPR 

purchase and exchange bids, and interviewed officials at both Interior and 

DOE. We have also drawn upon previous GAO reports on the royalty-in-

 2

DOE, Office of Petroleum Reserves, Strategic Petroleum Reserve Plan: Expansion to One 

Billion Barrels (Washington, D.C.: June 2007). 

3

In his State of the Union speech on January 23, 2007, President Bush proposed expanding 

the SPR further to 1.5 billion barrels. Secretary of Energy William Bodman indicated that 

DOE’s goal was to have this expansion completed by 2027.

4

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). 

Page 2 GAO-08-726T
Strategic Petroleum Reserve

kind program.5 We conducted our work on this testimony from January to 

April 2008 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives. 

• To fill the SPR in a more cost-effective manner, we recommended in 

previous work that DOE include in the SPR at least 10 percent heavy crude 

oils, which are more compatible with many U.S. refiners and generally 

cheaper to acquire than the lighter oils that comprise the SPR’s volume. 

DOE indicated that, due to the planned SPR expansion, such 

determinations should wait until it prepares a new study of U.S. Gulf Coast 

heavy sour crude refining requirements. In addition, we recommended that 

DOE consider acquiring a steady dollar value of oil over time and allowing

oil companies more flexibility to defer delivery of royalty-in-kind 

exchanges to the SPR when prices are likely to decline in return for 

additional deliveries in the future. In updating us on the status of this 

recommendation, DOE indicated that its November 8, 2006, rule on SPR 

acquisition procedures addressed our recommendations; however, this 

rule does not specifically address both how to implement a dollar-costaveraging strategy and how to provide industry with more deferral 

flexibility. In subsequent comment, DOE noted that the November 8, 2006, 

acquisition procedures do not address dollar-cost-averaging, but they do 

address flexibility of purchasing and scheduling in volatile markets. 

In summary 

• Filling the SPR with oil purchased in cash is likely to be more costeffective than filling the SPR through the royalty-in-kind program for 

several reasons. For example, the royalty-in-kind program adds a layer of 

administrative complexity to the task of filling the SPR, increasing the 

potential for waste or inefficiency. Moreover, DOE has evaluated the cost 

of cash purchases more thoroughly than exchanges, increasing the 

 5

GAO, Royalties Collection: Ongoing Problems with Interior’s Efforts to Ensure a Fair

Return for Taxpayers Require Attention, GAO-07-682T (Washington, D.C.: Mar. 28, 2007).

GAO, Mineral Revenues: Cost and Revenue Information Needed to Compare Different

Approaches for Collecting Federal Oil and Gas Royalties, GAO-04-448 (Washington, D.C.: 

Apr. 16, 2004). 

GAO, Mineral Revenues: A More Systematic Evaluation of the Royalty-in-Kind Pilots is

Needed, GAO-03-296 (Washington, D.C.: Jan. 9, 2003). 

Page 3 GAO-08-726T
Strategic Petroleum Reserve

likelihood that cash purchases are more cost-effective. For example, in 

May 2007, DOE rejected cash purchases for the SPR, concluding that the

current price of about $69 per barrel was unusually high. However, in the 

same month, DOE entered into contracts to exchange royalty oil, 

effectively committing the government to pay—through foregone revenues 

to the U.S. Treasury—about the same price for oil that it concluded was 

too high to purchase directly. In November, DOE entered into another 

exchange contract when oil was about $96 per barrel. 

To decrease the cost of filling the SPR and improve its efficiency, we have 

recommended in our previous work that DOE: (1) include at least 10 

percent heavy crude oil in the SPR, (2) consider acquiring a steady dollar 

value of oil, and (3) consider allowing oil companies additional flexibility 

to defer deliveries in exchange for delivering additional barrels of oil at a 

later date. The current composition of the SPR is entirely of medium to 

light grades of oil.6,7

 Including heavier oil in the SPR could significantly 

reduce fill costs because heavier oil is generally less expensive than lighter 

grades. We recommended in our August 2006 report that DOE, at a 

minimum, implement its own recommendation made in a 2005 study to

have at least 10 percent heavy oil in the SPR.8

 In addition, we found that 

DOE may have underestimated how much heavy oil should be in the SPR 

to minimize oil acquisition costs. Therefore, we further recommended that 

DOE examine the maximum amount of heavy oil that should be held in the 

SPR. To illustrate the potential magnitude of savings from including heavy 

crude oil in the SPR, we have done some simple calculations. 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 

DOE Could Improve 

the Cost-Effectiveness 

of Filling the SPR 

 6

For information on the composition of the SPR, see: DOE, Office of the Assistant 

Secretary for Fossil Energy, Strategic Petroleum Reserve: Annual Report for Calendar

Year 2006. 

7

The weight of oil is measured by its gravity index. According to DOE’s EIA, light oil is

greater than 38 degrees gravity, while intermediate oils, such as those in the SPR, are 22 to

38 degrees gravity. 

8

See DOE, Office of the Deputy Assistant Secretary for Petroleum Reserves, Strategic 

Petroleum Reserve Crude Compatibility Study (December 2005). 

Page 4 GAO-08-726T
Strategic Petroleum Reserve

million barrels of heavy oil.9 The savings could be even larger if DOE 

included more than 10 percent heavier oils in the SPR. Alternatively, DOE 

could add heavy oil to the SPR by exchanging the light oil in one or more 

of the caverns for heavier oil. DOE has the legal authority to exchange one 

type of oil for another and has done so before. For example, in 1998, DOE 

exchanged 11 million barrels of heavy crude oil stored in the Bryan Mound 

site for 8.5 million barrels of other higher value light crude oil. 

Including heavier oil would have the additional benefit of making the 

composition of SPR oil more compatible with U.S. refineries. In recent 

years, many refiners in the United States have upgraded their facilities so 

they can process heavy oil. Our analysis of DOE’s Energy Information 

Administration (EIA) data shows that, of the approximately 5.6 billion 

barrels of oil that U.S. refiners accepted in 2006, approximately 40 percent

was heavier than that stored in the SPR.10 Refineries that process heavy oil

cannot operate at normal capacity if they run lighter oils. For instance, 

DOE’s December 2005 found that the types of oil currently stored in the 

SPR would not be fully compatible with 36 of the 74 refineries considered 

vulnerable to supply disruptions. DOE estimated that if these 36 refineries 

had to use SPR oil, U.S. refining throughput would decrease by 735,000 

barrels per day, or 5 percent, substantially reducing the effectiveness of 

the SPR during an oil disruption, especially if the disruption involved 

heavy oil. To improve the compatibility of SPR oil with refineries in the 

United States, the DOE study concluded that the SPR should contain 

about 10 percent heavy oil. However, our August 2006 report found that 

DOE may have underestimated how much heavy oil should be in the SPR 

to maximize compatibility with refiners. We also found DOE may have 

underestimated the potential impact of heavy oil disruptions on gasoline 

production. Several refiners who process heavy oil told us that they would

be unable to maintain normal levels of gasoline production if forced to rely 

on SPR oil as currently constituted. For example, an official from one 

refinery stated that if it exclusively used SPR oil in its heavy crude unit, it 

 9

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, respectively. 

10According to DOE’s EIA, heavy oil has a gravity index of 22 degrees or below. According 

to EIA 2006 data, about 10 percent of the oil accepted by U.S. refiners has this gravity index 

and are considered heavy oils. An additional 30 percent of oil accepted by U.S. refiners was

22 to 30 degrees gravity, however, according to DOE, all oils stored in the SPR range from

approximately 30 to 37 degrees gravity. 

Page 5 GAO-08-726T
Strategic Petroleum Reserve

would produce 11 percent less gasoline and 35 percent less diesel. 

Representatives from other refineries told us they might need to shut 

down portions of their facilities if they could not obtain heavy oil. For 

these reasons, we recommended that DOE conduct a new review of the 

optimal oil mix in the SPR and determine the maximum volume of heavy 

oil that could be effectively put in the reserve. 

In addition, we recommended that DOE consider filling the SPR by 

acquiring a steady dollar value of oil over time, rather than a steady 

volume of oil over time as has occurred in recent years. This “dollar-costaveraging” 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 our 2006 report, we found 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 dollarcost-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 also recommended that DOE consider allowing oil companies 

participating in the royalty-in-kind program more flexibility to defer their 

deliveries to the SPR at times when filling would significantly tighten the 

market or when prices are expected to decline.

11 In return for these 

deferrals, companies would provide additional barrels of oil when they 

resumed deliveries. DOE has already approved some delivery deferrals at 

companies’ requests, such as during the winter 2002-2003 oil workers’ 

strike in Venezuela. From October 2001 through August 2005, DOE 

received an additional 4.6 million barrels of oil for the SPR valued at 

approximately $110 million as payment for these delivery deferrals. 

However, DOE has denied some deferral requests and experts have noted

that there is room to expand the use of deferrals. Experts noted DOE 

would need to exercise its authority to deny deferrals at times when it is in 

the national interest. Nonetheless, given that the SPR currently holds 

roughly 58 days of net imports, we believe there is sufficient inventory for 

some flexibility in allowing deferrals. 

 11For example, this situation could occur if futures prices are lower than current prices. 

Futures prices of oil reflect the cost of delivery at a specified place, price, and time in the

future. 

Page 6 GAO-08-726T
Strategic Petroleum Reserve

In updating us on the status of recommendations we made to DOE in our 

August 2006 report, DOE indicated that its November 8, 2006, rule on SPR 

acquisition procedures addressed our recommendations on dollar-costaveraging and deferrals. However, the new acquisition rule does not 

specifically address our recommendations to study both how to implement 

a dollar-cost-averaging strategy and how to provide industry with more 

deferral flexibility. Unless DOE addresses and adopts these 

recommendations, it will not be filling the reserve in the most costeffective manner. As to our recommendation on the optimal mix of oil in 

the SPR, DOE indicated that, due to the planned SPR expansion, such 

determinations should wait until it prepares a new study of U.S. Gulf Coast 

heavy sour crude refining requirements. We believe the SPR expansion 

offers DOE an ideal opportunity to change the SPR’s oil mix to include 

heavier oils that are less costly to acquire and better match U.S. refining 

capacity. We look forward to DOE completing its new study of U.S. Gulf 

Coast heavy crude refining requirements and believe such a study will find 

that DOE should include more than 10 percent heavier oils in the SPR. 

There are several reasons that purchasing oil—as DOE did until 1994—

may be more cost-effective than filling the SPR using the current royaltyin-kind program. For instance, there may be fewer bidders for the royalty

oil under the current exchange system than a direct cash purchase system, 

which in turn may limit competition and the exchange deals that DOE can 

negotiate. In the exchange process, a single company must be able to and 

interested in both accepting oil at the designated market centers and 

delivering other oil with specific characteristics to the SPR. This may limit 

the number of companies interested in bidding on exchange contracts. In

contrast, if DOE purchased oil, many additional companies may be 

interested in selling their oil, increasing competition and lowering prices.12

In 2007, the then Deputy Assistant Secretary for Petroleum Reserves, who 

directed activities of the SPR, told us that he agrees with this reasoning. 

The inherent limits of exchanging versus direct purchases are

compounded by the fact that DOE and Interior have not systematically 

analyzed where to send royalty oil in a way that maximizes the value of the

exchanges. The value of exchanges is a function of both the costs to 

deliver oil to market centers and the deals that DOE can negotiate at 

particular market centers. The informal process that Interior and DOE 

Purchasing Oil to Fill 

the SPR May Be More 

Cost-Effective Than 

Current Royalty-inKind Program 

 12We note that including heavier oils in addition to lighter oils would also increase the 

number of potential suppliers of oil for the SPR. 

Page 7 GAO-08-726T
Strategic Petroleum Reserve

currently use to identify market centers does not systematically analyze 

the tradeoffs between these two factors to identify market centers that 

optimize net value to the government.

In addition, royalty-in-kind exchanges add a layer of administrative 

complexity to the task of filling the SPR, increasing the potential for waste 

or inefficiency. In a January 2008 report, the DOE Inspector General 

concluded that DOE does not have an effective control system over 

receipts of royalty oil from Interior at the market centers.13 Specifically, 

the Inspector General found that DOE did not have adequate controls to 

ensure that the volumes of oil that contractors reported to have received 

from Interior at the market centers matched scheduled deliveries. As a 

result, DOE did not have assurance that it received all of the oil that 

Interior shipped, raising concerns that DOE may not have received its full

entitled deliveries to the SPR. If DOE purchased all of its oil, it would no 

longer need to exchange oil at designated market centers and would not 

need to coordinate with Interior. Moreover, rather than diverting a fraction 

of the oil collected through the royalty-in-kind program to fill the SPR, 

Interior could sell that fraction in competitive sales, as it currently does 

for the other oil it receives through the royalty-in-kind program. A senior 

Interior official said that selling the royalty oil would be simpler for 

Interior to administer than the current exchanges. 

Further, DOE’s method for evaluating bids is more robust for cash 

purchases than royalty-in-kind exchanges, increasing the likelihood that 

cash purchases are more cost-effective. In November 2006, DOE issued a 

final rule that describes how DOE will evaluate offers when it is 

purchasing oil and when it is exchanging royalty oil for other oil for the

SPR.14 This rule provides DOE with considerable flexibility in the degree of 

analysis it can conduct when evaluating offers, and, in practice, DOE’s 

method for evaluating bids for cash purchases has been more robust than 

it has for exchanges. For example, in April 2007, DOE solicited two 

different types of bids—one to purchase oil for the SPR in cash and one to

exchange royalty oil for other oil to fill the SPR.15 In deciding whether to 

purchase oil, DOE evaluated the bids it received in the context of overall 

 13DOE Office of Inspector General, Audit Report: Department of Energy’s Receipt of 

Royalty Oil, DOE/IG-0786 (Washington, D.C.: Jan. 2008). 

1410 C.F.R Part 626. 

15DOE’s solicitations to purchase oil were part of a plan to replace 11 million barrels of SPR 

oil that DOE sold in the fall of 2005 after Hurricane Katrina disrupted refinery supplies.

Page 8 GAO-08-726T
Strategic Petroleum Reserve

market trends. It concluded that the offers it received from sellers were 

priced too high, in part because the price of oil was generally high and 

because the prices of the specific type of oil DOE sought to purchase were 

unusually high relative to other oil types. As a result, DOE rejected offers 

to purchase oil when the spot price for Light Louisiana Sweet (LLS)—a 

commonly used benchmark for Gulf Coast oil—was about $69 per barrel 

and decided to delay purchasing any oil until at least the end of the 

summer driving season.16 In contrast, DOE’s method for evaluating bids for 

exchanging royalty oil focused on whether the oil DOE would receive

would be at least the same value as the oil it would exchange. It did not 

include an analysis of whether overall market conditions indicated that it 

would be more profitable for the federal government to stop or delay 

exchanges and have Interior sell the royalty oil for cash instead. In this 

case, in the same month, DOE entered into royalty oil exchange contracts 

when the spot price of LLS was about $67 a barrel, effectively committing 

the government to pay—through foregone revenues to the U.S. Treasury—

roughly the same price for oil that DOE concluded was too high to 

purchase. Moreover, in November, it awarded additional exchange

contracts when the spot price of LLS had reached $96 a barrel.17

It should also be noted that the current exchange method is less 

transparent than direct purchases because the primarily cash-based 

federal budget does not account for noncash transactions. Interior 

estimates that the royalty-in-kind program cost the federal government in 

total foregone revenue $4.6 billion from fiscal year 2000 through fiscal year 

2007. This foregone revenue was not reflected in the federal budget since 

no federal cash flows were involved. Congressional budget 

decisionmakers therefore have not had the opportunity to consider 

whether the value of the transferred oil could be reallocated to other 

competing resource needs. 

 16The spot price reflects the price for immediate settlement of oil purchases. 

17By itself, the spot price does not determine how many barrels of oil the government will 

receive through royalty exchanges. Rather, this is determined by the relative value—the 

price of the grade of oil that DOE has to exchange (the oil it receives from Interior) versus

the price of the grade of oil that it wishes to exchange for. This means that the government 

could receive the same number of barrels of SPR oil through its exchanges when spots 

prices are low or high. However, from a broader federal perspective, it would be more costeffective if the federal government deferred royalty exchanges when oil prices were high 

and sold the royalty oil for cash. It could then purchase oil when oil prices were lower,

acquiring more of the desired grade of oil for the same amount of money.

Page 9 GAO-08-726T
Strategic Petroleum Reserve

Importantly, the royalty-in-kind effort to fill the SPR creates, essentially, a 

“blind spot” where neither DOE nor Interior, the two agencies responsible 

for running the joint program, systematically examines whether exchanges 

of millions of barrels of royalty oil have been a cost-effective approach to 

filling the reserve. DOE does conduct a prospective analysis to estimate 

whether the value of the oil it will receive in the exchanges will be at least 

as valuable as the royalty oil it will exchange. However, DOE enters into 

exchange agreements that can last 6 months, and DOE’s initial estimates 

of the values of the different oil types may not hold over the duration of 

the contracts. DOE has not analyzed any of the completed exchanges to 

determine whether those exchanges performed as well as expected. 

Similarly, when evaluating the performance of the royalty-in-kind program 

overall, Interior does not analyze whether the royalty oil transfers to DOE 

are a cost-effective means to fill the reserve.18 The 60.7 million barrels of 

oil that Interior transferred to DOE from fiscal year 2004 to 2005 

accounted for 58 percent of all the royalty-in-kind oil that Interior 

collected during that time. While Interior reports to Congress each year on

the financial performance of its royalty-in-kind program, these reports 

have not included a measure of the cost-effectiveness of using royalty oil 

to fill the SPR. 

Because the SPR has reached sufficient size to address near-term supply 

disruptions, decisions about future fill practices can be made in a more 

flexible, cost-effective manner without unduly hurting our ability to 

respond to such disruptions. With oil prices recently exceeding $117 a 

barrel, there should be greater interest in finding ways to reduce fill costs. 

If it is to reach its goal of filling the expanded SPR by 2018, DOE will have 

to, in some combination, purchase or receive through royalty-in-kind 

transfers roughly 300 million barrels of oil. Our work shows that 

substantial cost savings could be achieved through increased purchasing 

of heavy oil, a dollar-cost-averaging purchasing strategy, more flexibility in

the timing of oil purchases and deliveries, and greater attention paid to the 

opportunity costs of filling the SPR with royalty oil. Based on our past 

estimates of the cost savings potential of dollar cost averaging and the 

significantly lower cost of heavier oils, DOE could save well over 10 

percent of the costs of filling the SPR to the currently authorized level—an 

Conclusions 

 18Interior does, however, have procedures in place to ensure that it pays a reasonable rate

to transport oil from the offshore federal leases, where the oil is produced, to the market 

centers where DOE takes possession of the oil. 

Page 10 GAO-08-726T
Strategic Petroleum Reserve

amount that is likely well in excess of $1 billion. During this era of dire 

national long-term fiscal challenges, it is all the more important that DOE 

make fill decisions in a cost-effective manner. 

Mr. Chairman, this concludes my prepared statement. I would be pleased

to respond to any questions that you or other members of the Committee 

may have at this time. 

For further information about this testimony, please contact me, Frank 

Rusco, at 202-512-3841 or ruscof@gao.gov. Contact points for our Offices 

of Congressional Relations and Public Affairs may be found on the last 

page of this statement. Contributors to this testimony include Ben Bolitzer, 

Chase Huntley, Heather Hill, Michael Kendix, Jon Ludwigson, Tim Minelli, 

Michelle Munn, Alison O’Neill, G. Greg Peterson, and Barbara Timmerman. 

Page 11 GAO-08-726T

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