Strategic Petroleum Reserve: Issues Regarding the Inclusion of Refined Petroleum Products as Part of the Strategic Petroleum Reserve
Published: 2009-05-12T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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 cost-effectiveness 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.
section_title: What GAO Found
paragraphs: Since the SPR, the largest emergency 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. (1) 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. (2) 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. (3) 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.

section_title: Letter
paragraphs: 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.
However, a Federal Energy Administration (FEA) study in 1977 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.
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. 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.
The Energy Policy Act of 2005 directed DOE to increase the SPR inventory  to 1 billion barrels. 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. 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.
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,  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; 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.
subsections: section_title: Background
paragraphs: 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. The act also states that the Secretary shall, to  the greatest extent practicable, acquire petroleum products for the SPR ina manner that minimizes the cost of the SPR and the nation’s vulnerability  to a severe energy supply interruption, among other things. until being repealed in 2000, the act provided the Secretary discretion 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.
42 U.S.C. § 6240(b).
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.
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. 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. The Reserve is an emergency source  of heating oil to address a severe energy supply interruption in the  Northeast. 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.
section_title: Some of the Arguments For and Against Including Refined Petroleum Products in the SPR
paragraphs: 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.
subsections: section_title: Some of the Arguments for Including Refined Petroleum Products in the SPR
paragraphs: First, in our December 2007 report, 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. 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.
Second, in our August 2006 report, 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.
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.
section_title: Some of the Arguments Against Including Refined Petroleum Products in the SPR
paragraphs: 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 gasoline-powered  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.  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. 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 non-passenger vehicles beginning in  model year 2020. Any future increases could further decrease the U.S. oil  demand.
section_title: Lessons Learned from the Management of the Existing SPR that May Be Relevant to Refined Petroleum Products
paragraphs: 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, which are generally cheaper  to acquire than the lighter oils that comprise the SPR’s volume. 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. 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.
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.
Mr. Chairman, this concludes my prepared statement. I would be pleased  to answer any questions that you or other Members of the Committee may  have at this time.
section_title: GAO Contacts and Staff Acknowledgments
paragraphs: For further information about this testimony, please contact 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. Individuals making key contributions to this testimony  include Jeffery D. Malcolm, Assistant Director, and Holly Sasso. Also  contributing to this testimony were Josey Ballenger, Philip Farah, Quindi  Franco, Michelle Munn, Benjamin Shouse, Karla Springer, and Barbara  Timmerman.
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