Strategic Petroleum Reserve: Available Oil Can Provide Significant Benefits, but Many Factors Should Influence Future Decisions about Fill, Use, and Expansion
Published: 2006-08-24T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Congress authorized the Strategic Petroleum Reserve (SPR), operated by the Department of Energy (DOE), to release oil to the market during supply disruptions and protect the U.S. economy from damage. The reserve can store up to 727 million barrels of crude oil, and currently contains enough oil to offset 59 days of U.S. oil imports. GAO answered the following questions: (1) What factors do experts recommend be considered when filling and using the SPR? (2) To what extent can the SPR protect the U.S. economy from damage during oil supply disruptions? (3) Under what circumstances would an SPR larger than its current size be warranted? As part of this study, GAO developed oil supply disruption scenarios, used models to estimate potential economic harm, and convened 13 experts in conjunction with the National Academy of Sciences.
section_title: What GAO Found
paragraphs: The group of experts recommended a number of factors to be considered when filling and using the SPR. They generally agreed that filling the reserve 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, would ensure that more oil will be acquired when prices are low and less when prices are high. Experts also suggested allowing oil producers to defer delivery of oil to the reserve at times when supply and demand are in tight balance, with oil producers providing additional oil to the SPR to pay for the delay. Regarding use of the SPR, experts described several factors to consider when making future use decisions, including using the reserve without delay when it is needed to minimize economic damage. During oil supply disruptions, releasing oil from the SPR could greatly reduce damage to the U.S. economy, based on our analyses and expert opinions. Particularly when used in conjunction with reserves in other countries, the SPR can replace the oil lost in all but the most catastrophic oil disruption scenarios we considered, lasting from 3 months to 2 years. DOE uses one model to estimate the optimal size of the SPR and another to estimate the economic effects of oil supply disruptions. Both models predict positive effects from using the SPR, but the magnitude of such benefits differ. The substantial differences between the results of these two models could lead DOE to provide inconsistent advice about expanding and using the reserve. Furthermore, factors beyond the SPR's ability to replace oil affect the extent to which the SPR can protect the U.S. economy from damage. For example, SPR crude is not compatible with all U.S. refineries. During a disruption of heavy sour crude oil, refineries configured to use this type of oil would have to reduce production of some petroleum products when refining the lighter oil in the SPR, decreasing the reserve's effectiveness at preventing economic damage. If demand for oil increases as expected, a larger SPR would be necessary to maintain the existing level of protection for the U.S. economy. The Energy Information Administration recently projected increases in U.S. demand for petroleum of approximately 12 percent by 2015 and 24 percent by 2025, compared with the 2005 level. In this regard, a 2005 study prepared for DOE found that the benefits of expanding the reserve to 1.5 billion barrels exceed the costs over a range of future conditions. However, many factors that influence the SPR's ideal size are likely to change over time. For example, although projections show increasing oil demand, the level of demand depends on many factors, including rates of economic growth, the price of oil, policy choices related to alternatives to oil, and technology changes. Consequently, periodic reassessments of the SPR's size in light of new information could be helpful as part of the nation's energy security planning.

section_title: Letter
paragraphs: Oil is the world’s most important energy resource. The world consumes  approximately 83 million barrels of oil per day, accounting for nearly   40 percent of world energy consumption. In 2004, the most recent year for  which data are available, 40 percent of the energy used in the United States  and 96 percent of the energy used in the U.S. transportation sector were  derived from oil, the majority of which was imported. In 2004, the United  States imported 65 percent of its crude oil supply, or approximately 10  million barrels per day. Supply and demand for oil are in tight balance  today, with only about 1 million barrels per day of spare oil production  capacity, meaning that even small disruptions in supply can cause large  increases in prices. Unusually high prices for petroleum products due to a  strike at Venezuela’s national oil company in 2002 to 2003 and Hurricanes  Katrina and Rita in 2005 demonstrated this effect.
Because of the central role that oil plays in the U.S. economy, sudden  increases in its price can cause economic damage. Increases in crude oil  price are reflected in the prices of products made from crude oil, such as  gasoline, diesel, home heating oil, and petrochemicals such as fertilizer.  Furthermore, because petroleum products are an important part of the  production of many goods and services, the prices of these goods and  services also increase. These price increases can reduce the total amount  of goods and services that consumers can afford, thus reducing economic  activity. Past studies have shown that oil price shocks can cause hundreds  of billions of dollars of damage to the U.S. economy.
To help protect the U.S. economy from damage caused by oil supply  disruptions, Congress authorized the Strategic Petroleum Reserve (SPR) in  1975, following the Arab oil embargo of 1973 to 1974. The SPR is owned by  the federal government and operated by the Department of Energy (DOE).
It can store up to 727 million barrels of crude oil in salt caverns located at  sites in Texas and Louisiana. Since 1976, the United States has spent about  $45.2 billion in 2005 dollars to build, maintain, fill, and manage the SPR. In  addition, the United States and 25 other nations that are members of the  International Energy Agency 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. In June 2006,  the SPR contained about 689 million barrels, equal to 59 days of U.S. oil  imports. In addition to government reserves, private industry inventory  varies over time, but DOE estimates that private inventory contains an  amount equal 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 to exceed the United States’ 90-day reserve  requirement.
Under conditions prescribed by the Energy Policy and Conservation Act, as  amended, the President and the Secretary of Energy have discretion to  authorize release of the oil in the SPR to minimize significant supply  disruptions. 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. 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.
Refineries are configured to refine specific types of crude oil. Crude oil is  generally classified according to two parameters: density and sulfur  content. Less dense crudes are known as “light,” while denser crudes are  known as “heavy.” Crudes with relatively low sulfur content are known as “sweet,” while crudes with higher sulfur content are known as “sour.” In  general, heavier and more sour crudes require more complex and  expensive refineries to process the oil into usable products, but are less  expensive to purchase than light sweet crudes. Many refiners in the United  States have upgraded their facilities in recent years to process heavy sour  crude. The SPR contains about 40 percent sweet crude and 60 percent sour  crude, stored in separate caverns. Both crude types in the SPR are  considered “light.”
Oil markets have changed substantially in the 31 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.
Use of the SPR during an oil supply disruption mitigates damage to the  economy by replacing the oil lost, thereby reducing the price spike and the  resulting economic damage. Such damage is typically reflected in a  temporary reduction in gross domestic product (GDP), the total market  value of all goods and services produced in the U.S. economy in a given  year, compared with what it would have been without the disruption. The  reduction in GDP caused by an oil supply disruption and the resulting price  increases depends on several factors, including the size and duration of the  disruption; the availability of oil market “cushions,” such as excess oil  production capacity and private inventories; and the importance of oil to  economic activities. Severe oil supply disruptions in the past, such as the  Arab oil embargo, caused sudden spikes in oil prices accompanied by  economic losses of billions of dollars in the United States and other major  oil-consuming economies. More recent disruptions, such as the Venezuelan  strike in 2002 to 2003, have involved smaller quantities of oil for shorter  durations and caused less economic damage. Two offices within DOE—the  Office of Petroleum Reserves and the Energy Information Administration  (EIA)—use models to analyze the effects of oil supply disruptions and SPR  use on the economy. The Office of Petroleum Reserves is in charge of the  day-to-day operations of the SPR, and it uses a model to calculate the  effects of oil supply disruptions and SPR use as part of a study of the net  benefits of expanding the reserve. EIA is a statistical agency that uses a  separate model to estimate the impact of oil supply disruptions and to  advise officials about their potential consequences.
From 1977 to 1992, Congress appropriated money to purchase oil from the  market to fill the SPR. Since 1999, oil for the SPR has been obtained  through the royalty-in-kind program. Through this program, the  government receives oil instead of cash for payment of royalties on leases  of federal land in the Gulf of Mexico. Because oil produced in the Gulf  generally does not meet the specifications to be stored in the SPR, DOE  trades this oil with contractors who provide oil that can be stored in the  SPR. Recently, the Energy Policy Act of 2005 directed DOE to increase the  SPR inventory to 1 billion barrels and required DOE to select sites for the  expansion to accommodate the inventory no later than 1 year after  enactment, or by August 2006.
Historically, DOE has added oil to the SPR in response to specific concerns  about oil supply security. For example, when DOE acquired oil for the SPR  after the Arab oil embargo of 1973 to 1974 and the Iranian revolution in  1979, the goal was to rapidly create a reserve large enough to be useful in  case of a severe oil supply disruption. During the mid- to late-1990s when  oil prices were relatively low, there were no significant oil security  concerns and little oil was added to the SPR. In contrast, following the  terrorist attacks of September 11, 2001, the President directed that oil be  added to the SPR, even though it already contained enough oil to meet  potential near-term supply disruptions. The stated goal was to maximize  long-term protection against oil supply disruptions. Some have criticized  filling the SPR at that time because they believe doing so increased the  price of oil.
The President has the primary authority to decide when to use the SPR.  Additionally, the Secretary of Energy is authorized to carry out exchanges  from the SPR and test drawdowns to evaluate SPR procedures. 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. 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.
In conducting our review, we answered the following questions: (1) Based  on past experience, what factors do experts recommend be considered  when filling and using the SPR? (2) To what extent can the SPR protect the  U.S. economy from damage during oil supply disruptions? (3) Under what  circumstances would an SPR larger than its current size be warranted?
In addressing these questions, we developed six hypothetical oil supply  disruption scenarios. These scenarios are set in today’s oil market, with  global crude oil demand of approximately 83 million barrels per day and  U.S. demand of approximately 21 million barrels per day. The scenarios are  as follows:  A hurricane in the U.S. Gulf Coast disrupts oil supplies by up to   1.5 million barrels per day for 6 months, similar to the disruptions  caused by Hurricanes Katrina and Rita in 2005.
A strike among oil workers in Venezuela disrupts oil production by up to  2.2 million barrels per day over 5 months, similar to a strike that  occurred in 2002 to 2003. Production then remains 0.2 million barrels  per day below its prestrike level for an additional 19 months.
Iran stops exporting oil for 18 months, removing 2.7 million barrels per  day from the market.
A terrorism event at an oil facility in Saudi Arabia disrupts up to   6 million barrels per day over 8 months.
Closure of the Strait of Hormuz, which is a vital oil shipping lane located  at the entrance to the Persian Gulf, disrupts 17 million barrels per day  for 1 month. Supply then recovers over the next 2 months.
Saudi Arabia stops oil production, removing 10 million barrels per day  from the market for 18 months. Production then recovers over the  following 6 months.
We selected these hypothetical scenarios to illustrate the potential benefits  of strategic reserves in a wide range of different situations, not because we  consider these scenarios likely.
To collect expert opinions on the impacts of past SPR fill and use and  recommendations for the future, we convened a group of experts in  conjunction with the National Academy of Sciences and interviewed  experts from industry and academia. We convened the group to allow the  experts to exchange and challenge ideas, but the group was not designed to  reach consensus on the issues discussed. We also reviewed records and  reports from DOE and the International Energy Agency and interviewed  officials from these agencies and other oil industry experts.
To analyze the ability of the SPR to reduce economic damage caused by oil  supply disruptions, we reviewed the economic literature on the impact of  oil supply disruptions and used two DOE simulation models to estimate the  reduction of harm to U.S. GDP that would result from releasing oil from the  SPR and international reserves during our oil supply disruption scenarios.  These two models estimate the increase in oil prices and the reduction in  GDP that are likely to occur during an oil supply disruption of a given size.  Although the models provide useful information, they make assumptions  and do not include some factors that could influence the reserve’s  operation, such as the compatibility of SPR oil with U.S. refineries.  Therefore, we interviewed oil industry experts, members of our group of  experts, and representatives from companies that comprise 76 percent of  the refining capacity of the United States to learn about issues with SPR  operation not included in the models that affect the extent to which the  SPR can protect the economy.
To learn about the circumstances under which a larger SPR would be  warranted, we reviewed U.S. stockholding obligations to the International  Energy Agency, estimates of future U.S. oil demand, and a 2005 study  performed by a contractor for DOE that analyzed the expected costs and  benefits of expanding the SPR. We also reviewed studies and interviewed  members of our National Academy of Science group of experts and other  oil market experts about factors that influence the ideal size of the SPR.  Our intent was to present useful information and discussion of key  considerations about expanding the SPR, not to make recommendations  about whether the SPR should be expanded.
We did not independently verify information about security, drawdown  rates, or other operational factors reported by the Office of Petroleum  Reserves, nor did we analyze or verify strategic reserves held by other  countries that belong to the International Energy Agency. A more detailed  description of our scope and methodology is included in appendix I. We  performed our work between March 2005 and July 2006 in accordance with  generally accepted government auditing standards.
subsections: section_title: Background
paragraphs: Oil is vitally important to the world and U.S. economy, accounting for  nearly 40 percent of world primary energy consumption. As shown in  figure 1, although world oil consumption has increased significantly over  the past 20 years, oil’s share of primary energy consumption has remained  fairly constant. EIA projects similar trends for the next 20 years, with total  world energy consumption increasing 2 percent annually through 2025 and  oil comprising about 38 percent of all energy consumption in 2025.
Oil is also the largest primary source of energy in the United States,  accounting for about 40 percent of all energy consumed in 2004. As shown  in figure 2, two-thirds of the oil consumed in the United States is used for  transportation. About 96 percent of energy used for transportation in the  United States comes from oil. The transportation sector is almost  exclusively dependent on oil because there are no significant competitive  alternatives. EIA projects that transportation will comprise an even larger  part of U.S. oil use in the future, about 72 percent in 2030, because it  expects the growth in demand for transportation to far exceed increases in  fuel efficiency.
As shown in figure 3, the United States’ demand for imported crude oil  increased rapidly after 1970, when domestic crude oil production peaked.  Although the percentage of imported crude oil decreased from about   45 percent in 1977 to about 26 percent in 1985 due to a reduction in demand  for oil, imported crude oil increased again to 65 percent by 2004 due to a  combination of increases in consumption and decreases in domestic  production.
The United States created the SPR because the country’s reliance on oil  imports makes it vulnerable to disruptions in oil supply. Strategic oil  reserves like the SPR are particularly important now because oil market  cushions, such as excess oil production capacity and private inventories,  have decreased in recent years. Although estimates of spare production  capacity are uncertain, experts believe that spare production capacity  dropped to around 1 million barrels per day in 2004, close to a 20-year low.  Additionally, private inventories of oil and oil products have been on a long- term declining trend, in part because of a trend toward just-in-time  inventory. The absence of these market cushions means that less oil is  available in the market to mitigate price spikes during oil supply  disruptions. Thus, a supply disruption that takes even a small amount of oil  off the market could cause the price of oil to rise dramatically.
One factor limiting excess oil production capacity is recent steep increases  in world consumption of oil. Together, the United States and Western  Europe accounted for 44 percent of the 80 million barrels of oil per day of world oil consumption in 2003. The United States is the world’s largest oil  consumer, accounting for about 25 percent of the world’s oil consumption,  despite having only 5 percent of the world’s population. In addition to the  high levels of consumption in the United States and Western Europe, oil  consumption has also been rising rapidly in Asia and Oceania, as shown in  figure 4. For example, according to a recent study by the International  Monetary Fund, China and India accounted for 35 percent of incremental  oil consumption between 1993 and 2003, even though they accounted for  only 15 percent of world economic output over the period. China has  overtaken Japan as the second largest oil consumer in the world, second to  the United States.
Since 1976, the United States has spent about $26.3 billion—$45.2 billion  when valued in year 2005 dollars—to build, maintain, fill, and manage the  SPR. The largest cost has been the cost of filling the reserve. Since filling  began in 1977, $20.0 billion has been spent to obtain oil ($35.1 billion in  2005 dollars). This amount includes $15.7 billion of oil purchased with  funds appropriated from 1977 through 1992, and $4.3 billion of oil received  in lieu of government royalty payments since 1999.
Since 1999, oil for the SPR has been obtained through the royalty-in-kind  transfer program, in which royalties from government oil leases in the Gulf  of Mexico are taken in the form of oil, rather than in cash. The Department  of the Interior’s Minerals Management Service, which collects the royalties,  contracts for delivery of the royalty oil to designated market centers.  Because the oil delivered to these market centers often does not meet SPR  quality specifications and is distant from the SPR storage sites, DOE  awards complementary contracts to exchange royalty oil at the market  center for SPR-quality oil delivered to the SPR facilities. However, the  logistics of Gulf of Mexico oil production from federal leases limits the rate  at which royalty oil can be economically delivered to the SPR sites.
The SPR oil is stored in salt caverns at the following four facilities: Bayou  Choctaw and West Hackberry in Louisiana, and Big Hill and Bryan Mound  in Texas. These caverns range in size from 6 million to 35 million barrels  and were created by solution mining, in which water injected into an  underground salt formation dissolves the salt and creates a cavern.  According to DOE, salt caverns offer the lowest cost, most environmentally  secure way to store crude oil for long periods of time. Storing oil in  aboveground tanks generally costs 5 to 10 times as much. Also, because the  salt caverns are 2,000 to 4,000 feet below the surface, geologic pressure will  seal any crack that develops in the salt formation, ensuring that no crude  oil leaks from the cavern. An additional benefit is the natural temperature  difference between the top of the caverns and the bottom, which keeps the  crude oil continuously circulating in the caverns, ensuring that the oil in the  cavern is of consistent quality.
Areas near the Gulf of Mexico were a logical choice for locating the SPR. In  addition to the more than 500 salt domes concentrated along the Gulf  Coast, many U.S. refineries and distribution points for tankers, barges, and  pipelines are available. The four SPR storage areas are connected via  pipelines to the Gulf Coast and the Midwest refining regions. Oil can be  transferred via tanker to the Louisiana Offshore Oil Port, which is a major  facility in the Gulf of Mexico that is connected via pipeline to over 50  percent of the United States refining capacity. The location of the SPR is  less advantageous for distributing oil to or receiving it from the western  United States.
Past drawdowns of the SPR have occurred for a wide variety of reasons.  The SPR has sold oil twice under emergency conditions, 17.3 million  barrels in 1991 at the beginning of Operation Desert Storm and 11.0 million  barrels in 2005 after Hurricane Katrina. In response to problems ranging  from a blocked pipeline to a potential shortage of commercial heating oil  stocks, exchanges of crude oil from the SPR with private companies have  occurred eight times, ranging in size from 500,000 barrels to 30 million  barrels. The largest exchange occurred in the fall of 2000 in response to  concerns about low inventories of heating oil in the Northeast. In these  exchanges, the borrowing parties returned the amount of oil borrowed plus  additional volumes of oil as interest. In two cases, conducted for  operational reasons, the SPR exchanged 11.0 million barrels of lower  quality oil for 8.5 million barrels of higher quality oil and 2.7 million barrels  of crude oil for 2.0 million barrels of heating oil. DOE has also conducted  two test sales to demonstrate the readiness of the SPR, in 1985 and 1990. In  addition, sales to reduce the federal deficit occurred mainly in 1996.
section_title: Based on Historical Experience, Experts Suggested Alternative Practices for SPR Fill and Points to Consider for Use
paragraphs: Recent concerns about filling the SPR and long-standing concerns about its  use can be addressed in ways that improve SPR effectiveness, according to  numerous energy and oil market experts. A number of persons have raised  questions because they believe that recent efforts to fill the SPR during  tight oil supply conditions put upward pressure on oil prices. Others have  expressed concerns that the SPR has not been used in disruptions where its  use was warranted and, when used, has not been used early enough after a  disruption has occurred. In addressing these concerns, experts with whom  we spoke suggested alternative practices to consider when filling the SPR  to reduce fill costs, as well as various points to consider when deciding  whether to use the SPR.
subsections: section_title: Experts Suggested Practices to Reduce the Cost of Filling the SPR
paragraphs: While early SPR fill activity focused on establishing an oil reserve large  enough to be useful during a supply disruption, more recent fill activity has  focused on maximizing long-term protection against disruptions. Although  several oil analysts and experts believe that filling the SPR from late 2001  through 2005 during a time of tight supply and demand conditions caused  the price of oil to increase by several dollars per barrel, most of the experts  with whom we spoke believe that filling the SPR at that time had minimal  impact on oil prices because the volume was so small compared with world  oil demand. Experts suggested SPR fill practices that could reduce the cost  of filling the SPR. They recommended that DOE acquire a fixed dollar value  of oil per time period, rather than a fixed volume of oil per time period, and  allow industry more flexibility in the timing of oil deliveries to the SPR.
subsections: section_title: Early Fill Activity Was Generally Focused on Making the SPR Large Enough to Respond to Disruptions
paragraphs: Prior to 1984, several pieces of legislation set forth minimum fill rates for  the SPR, in an effort to increase the volume of the reserve to a level large  enough to be useful during an oil supply disruption. However, the actual  rate of fill often fell short of these goals. Several studies completed around  this time reported that, given the SPR’s small size, it should be reserved for  severe disruptions since it is a one-time source of crude oil, which must be  replenished after a drawdown. They advised that only after the SPR  contained a minimum of 250 million to 500 million barrels of oil would it be  advisable to use it. In a September 1981 report, we echoed this concern,  believing that DOE should not suspend SPR fill, except during severe  disruptions, until the SPR reached a minimum threshold size.  Furthermore, we stated that, given the importance of the SPR, filling it  should be considered a part of U.S. base demand and should not be cut  back under tight market conditions.
Figure 5 shows the progress in filling the SPR since its inception in 1975.  Fill was suspended from September 1979 to September 1980 when oil  supplies were disrupted following the Iranian Revolution. The SPR reached  a volume of about 500 million barrels in 1985, and filling the reserve slowed  considerably after that time. SPR fill was again suspended in 1990 after the  Iraqi invasion of Kuwait. The size of the SPR did not significantly increase  again until after the September 11 terrorist attacks, when the President  ordered DOE to fill the SPR to its 700 million barrel capacity to maximize  the long-term protection against potential oil supply disruptions. The  President’s statement accompanying the fill order indicated that, although  current strategic inventories in the United States and other countries were  sufficient to meet any potential near-term supply disruption, filling the SPR  to capacity would strengthen the long-term energy security of the United  States. The President directed that the SPR be filled in a deliberate and  cost-effective manner, principally through royalty-in-kind transfers. From  April 2002 to August 2005, DOE added 138 million barrels to the SPR at a cost of $4.3 billion. The SPR received oil from the royalty-in-kind program  at average rates varying from about 60,000 to 116,000 barrels per day,  although fill was suspended twice during this period, including January to  April 2003 in response to the disruption of crude oil supplies from  Venezuela.
The President’s directive to fill SPR in 2001 became controversial. Several  oil analysts and experts believe that filling the reserve at that time caused  the world price of oil to increase by several dollars per barrel. Most of the  oil experts with whom we spoke, however, believe that filling the SPR had  minimal impact on oil prices, because the volume of oil going to the SPR  was very small, less than one-quarter of 1 percent of total world demand.
To decrease the cost of filling the SPR, many experts recommend changes  in SPR practices, including more flexible timing of oil acquisition.  Generally, all fill options must balance the cost of adding oil to the SPR  now against the benefits that the additional oil will provide in the future.  During the initial filling of the SPR, it was clear that the benefits of adding  oil outweighed the immediate costs of doing so. However, now that the SPR  holds nearly 700 million barrels of oil, there is a greater interest in finding  ways to reduce the acquisition costs.
Several experts suggested that DOE should use a predictable, transparent  long-term process to acquire oil for the SPR. For example, some experts  suggested a dollar-cost-averaging approach, where DOE would acquire a  steady dollar value of oil per time period (e.g., day or month) instead of a  relatively steady volume, as has generally been the case in recent years. A  dollar-cost-averaging approach would take advantage of fluctuations in oil  prices, since the same dollar amount will purchase more oil when prices  are low than when prices are high. To evaluate the effect of a dollar-cost- averaging approach on SPR fill cost, we estimated the potential savings of  this approach had it been used from October 2001 through August 2005.  Our results showed that if DOE had followed a dollar-cost-averaging  approach when filling the SPR during that time, it could have saved  approximately $590 million while acquiring the same amount of oil. We also  ran simulations to estimate potential future cost savings from using a  dollar-cost-averaging approach over 5 years. The simulations showed that  dollar cost averaging is likely to save money over a range of plausible paths  of future oil prices, whether prices are rising or falling and whether price  volatility is small or large. The savings due to dollar cost averaging were  generally greater when oil prices were more volatile.
As an additional measure, some experts suggested that DOE exercise  flexibility and react to market conditions when filling the SPR. They said  that DOE should not fill the SPR when the oil market is tight or when doing  so would significantly tighten the market. DOE officials told us that the  department has approved some delivery deferrals that contractors have  requested, in particular after the oil workers’ strike in Venezuela, but DOE  has also turned down some requests. In return for these deferrals, DOE  received additional barrels of oil as a premium. From October 2001 through  August 2005, payment for deferrals added 4.6 million barrels of oil to the  SPR, with a value of approximately $110 million. Some experts suggested  that DOE could expand the use of deferrals by allowing oil producers to delay oil delivery to the SPR when they believe that supply and demand are  in tight balance and current prices are higher than expected future prices.  Under these conditions, it is financially advantageous for oil producers to  delay delivery, and producers could provide additional oil to the SPR to pay  for the privilege of delaying delivery. Experts noted that there may be  considerations beyond the oil market, such as national security concerns,  that would necessitate the delivery of oil to the SPR at a particular time,  therefore, DOE would want to exercise its authority to disallow deferrals at  times when it is in the national interest that oil deliveries not be delayed.
section_title: Experts Suggested Several Points to Consider When Deciding on SPR Use
paragraphs: The law allows broad presidential discretion and provides only general  guidance for the SPR’s use, making use of the SPR a matter of judgment by  the President. SPR use decisions are largely a matter of judgment, and  members of our group of experts disagreed about the appropriateness of  past use decisions. Past drawdowns have been for widely varying purposes,  including emergency responses, test sales, and deficit reduction. In  addressing use-related issues, experts suggested several points to consider  when deciding whether to use the SPR.
subsections: section_title: SPR Legislation Allows Broad Presidential Discretion
paragraphs: The President has the primary authority to decide when to use the SPR.  The Energy Policy and Conservation Act authorizes the President to use  the SPR in the event of a severe energy supply disruption or when required  to meet the obligations of the United States to the International Energy  Agency. Amendments to this act in 1990 gave the President additional  authority to use the SPR in reaction to a circumstance that constitutes or is  likely to become a significant shortage, and where action taken would  assist in preventing or reducing the adverse impact and would not impair  national security. These amendments allow for only limited use of the  SPR—no more than 30 million barrels may be sold over 60 days, and no  sales may be made if the SPR is below 500 million barrels.
In addition to presidential authority, the Secretary of Energy is authorized  to carry out test drawdowns and sales or exchanges from the SPR to  evaluate the drawdown and sale procedures. The Secretary may not release  more than 5 million barrels of oil during such a test. DOE officials pointed  out that they follow a series of progressive steps in responding to a  disruption. They can (1) identify relevant inventories and evaluate market  impacts (with the help of EIA); (2) defer any ongoing deliveries to the SPR,  thereby making this oil available to the market; (3) make exchanges in  response to requests from individual companies facing problems; and   (4) arrange for competitive exchanges, whereby companies bid for oil from  the SPR by promising to replace it with a greater volume of oil at a  specified date in the future. DOE officials believe that this graduated  approach allows them a flexible and measured response appropriate to the  size of the disruption.
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.
section_title: Members of our Expert Group Disagreed about Past SPR Use Decisions
paragraphs: Members of our group of experts disagreed about the appropriateness of  past SPR use decisions. Since the decision about whether the SPR should  be used to ameliorate a situation is generally a matter of judgment, experts  tend to view past decisions from the perspective of hindsight.  For  example, several members of our group told us that they believed the oil  workers’ strike in Venezuela in 2002 to 2003 was a clear case in which SPR  use was appropriate, although the reserve was not used in response to the  strike. However, DOE officials stated that oil from the SPR was not needed  during the strike. They noted that other oil-producing nations had agreed to  increase production, and that the U.S. government allowed oil companies  to delay delivery of oil to the SPR—which together added significant  quantities of oil to the market.
Members of our group of experts held a range of views about the timeliness  of past use, including the SPR’s first emergency use during the Gulf War in  1991. While some said that reserve use in this instance was timely and  showed the market that supply would be available, others contended that  the United States did not use the SPR soon enough, when it could have  dampened oil price increases and prevented the U.S. economy from  slipping into a recession. However, these experts acknowledged the  difficulty of disentangling the effects of the war from the effects of the SPR  release on oil prices.
Group members were generally supportive of SPR use in response to  Hurricane Katrina in 2005. Several experts agreed that this use of SPR  demonstrated that the government understood its role as one of  complementing rather than competing with the market.
section_title: Experts Suggested Several Points to Consider When Making Decisions about SPR Use
paragraphs: Despite the lack of clear consensus regarding previous decisions to use the  SPR, experts in our group suggested several points that policymakers  should consider when deciding whether to use the SPR: (1) that recent  increases in the size of the SPR should result in a greater willingness to use  it during a disruption, (2) that more extensive experience with the SPR  during oil supply disruptions may enable better understanding of the  features of each disruption that determine whether SPR use is warranted,  and (3) that using the SPR without delay when it is needed will minimize  economic damage. DOE officials told us that, while they do not have a  formal checklist, they consider all relevant features when considering SPR  use during a disruption, including the features noted by our group of  experts.
First, experts in our group and in interviews noted that the SPR is much  larger today than in the past, and that this change allows the SPR to be used  with less concern about keeping enough oil in the reserve for future  disruptions. Members of our expert group pointed out that today’s larger  reserve diminishes the value of holding oil back during a disruption as a  hedge against possible future disruptions, and they noted greater  willingness to use reserves in response to disruptions now than in the past.
Second, more extensive experience with the SPR during past disruptions  may enable better understanding of the unique features of future oil  disruptions that warrant a release of oil from the SPR. In a 1993 report, we  stated that U.S. policy emphasized initially relying on free market forces in  oil supply disruptions. However, the report observed that this policy  provides little specific guidance on how long market forces should be  allowed to operate before the SPR is used or what conditions should  dictate its use. Experts in our group agreed that the SPR should be used to  supply oil during disruptions where the market cannot make up for lost  supply. Experts also identified a variety of specific features of disruptions  that could help determine when SPR use is warranted. These features  included the volume of oil disrupted, the type of oil disrupted, the  availability of spare oil production capacity, the source of the disruption  and its distance from the United States, and the time of year that the  disruption occurs (with implications for gasoline supplies in the summer  and heating oil in the winter).
Economic experts have described additional points to consider when  making decisions about using the SPR during a disruption.
Experts noted that not all oil price increases are equally damaging to the  economy. Economic research shows that rapid oil price increases, or  price shocks, are much more harmful to the economy than oil price  increases along a steady upward path. For example, one expert noted  that although average world crude oil prices increased by more than   $30 per barrel between 2001 and 2005, there was no price shock, and the  U.S. economy remained strong, growing at about 3.5 percent annually  during this period.
Under some conditions, decision makers could use monetary policy to  partially offset economic damage from an oil price shock. The Federal  Reserve might be able to prevent some economic damage by allowing a  one-time increase in the money supply to stimulate spending and spur  GDP growth. However, not all economists agree that monetary policy  would be effective, or that monetary policy could offset the impacts of a  disruption without having other negative impacts on the economy.
Third, avoiding delay in using the SPR when its use is warranted will  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.
Avoiding delay in SPR use is also important because even when spare  production capacity is available in the world to take the place of disrupted  oil supply, this oil will take time to reach the United States. EIA estimates  that the majority of the world’s spare oil production capacity is located in  Saudi Arabia and takes about 30 to 40 days to reach the United States. For  this reason, experts told us that spare capacity would be unlikely to  mitigate the early stages of a domestic disruption or a disruption affecting a  nearby oil supplier, such as Venezuela, whose oil takes about 5 to 7 days to  reach the Gulf Coast of the United States.
section_title: SPR Use during Disruptions Can Provide Substantial Benefits, but the Magnitude of These Benefits Is Uncertain
paragraphs: At their current capacities, the SPR and international reserves can replace  the oil lost in all but the most catastrophic disruptions. Doing so protects  the economy from significant damage, according to the results of two DOE  models, although these models disagree about the magnitude of the  avoided damage. Additionally, several factors beyond the SPR’s ability to  replace oil could decrease or increase the economic benefit of the reserve,  such as the compatibility of SPR oil with some U.S. refineries.
subsections: section_title: SPR and International Reserves at Their Current Size Can Replace the Oil Lost in All but the Most Catastrophic Disruptions
paragraphs: In June 2006, the SPR contained 689 million barrels of oil that can be  released at a maximum initial rate of 4.4 million barrels a day, a rate that  can replace about 44 percent of U.S. oil imports. As shown in figure 6, the  maximum drawdown rate gradually decreases after 90 days as the storage  caverns are emptied. If the SPR is drawn down more slowly, it could  release a million barrels of oil per day for nearly 1½ years, or at smaller  rates for an even longer period.
In addition to the reserves in the United States, members of the  International Energy Agency have about 2.7 billion barrels of public and  industry reserves, of which about 700 million barrels are government- controlled for emergency purposes. These government-controlled  reserves can release a maximum of about 8.5 million barrels of oil and  petroleum products per day, diminishing quickly to about 4.5 million  barrels per day after 30 days, about 3.5 million barrels per day after 60 days,  and slightly more than 1 million barrels per day after 90 days. Reserves of  refined petroleum products, such as gasoline or diesel, can be useful during  oil supply disruptions, but they are more expensive to store than crude oil. We did not independently verify the potential drawdown rates of  international reserves.
The SPR, either alone or in combination with these international reserves,  can replace the oil lost in four of the six hypothetical disruption scenarios  that we developed for this review. The six scenarios are (1) a hurricane in  the U.S. Gulf Coast, (2) a strike among oil workers in Venezuela, (3) an  embargo of Iranian oil supply, (4) a terrorism event at an oil facility in Saudi  Arabia, (5) closure of the Strait of Hormuz, and (6) a shutdown of Saudi  Arabian oil production. For each scenario, we assume that world excess  crude oil production capacity and world fuel-switching capabilities, which  together total 850,000 barrels per day, are available immediately to help  offset a disruption. We also assume that private inventories of crude oil  are neutral during a disruption—holders of private inventory neither draw  down their inventories nor hoard oil. (See app. II for a more detailed  description of our scenarios.)
As shown in table 1, the SPR is large enough and has enough drawdown  capacity to completely replace the oil lost during our Gulf Coast hurricane  and Venezuelan strike scenarios, which reduce world oil supply by   155 million barrels over 6 months and 307 million barrels of oil over   24 months, respectively. The SPR could eliminate these hypothetical  disruptions by releasing 24 million and 87 million barrels of oil,  respectively, and world spare capacity and fuel switching would make up  the remaining 131 million and 220 million barrels.
The SPR alone is not large enough to replace all of the oil lost in our Iranian  embargo scenario, and it does not have enough drawdown capacity to  completely replace the oil lost during our Saudi terrorism scenario. Our  Iranian embargo scenario assumes a disruption of almost 1.5 billion barrels  of oil over 18 months. Even if the United States were to release all of the oil  in the SPR and if excess production capacity and fuel switching were  available in the amount assumed here, there would still be a net disruption  of slightly more than 300 million barrels. In our Saudi terrorism scenario,  the drawdown capacity of the SPR would be insufficient to replace the oil  lost during the 1st month of the disruption. For the SPR to replace the oil  during the 1st month with no assistance from international reserves,  maximum SPR drawdown capacity would need to be increased by almost   1 million barrels per day, to a total drawdown capacity of approximately  5.2 million barrels per day. In both of these cases, however, a coordinated  international response could replace all of the disrupted oil.
Even with a coordinated response, the SPR and international oil reserves  are not adequate to replace the disrupted oil from our catastrophic Strait of  Hormuz closure and Saudi shutdown scenarios. The drawdown capacity of  international reserves is inadequate to replace the very large amount of oil  that could be disrupted if the Strait of Hormuz were closed. We assume that  a closure of the Strait of Hormuz could disrupt 17 million barrels of oil per  day during the 1st month—more than 12 million barrels per day beyond  what the SPR could release on its own and more than 4 million barrels per day beyond what could be released during a coordinated international  response. In contrast, the volume of oil in international reserves is  inadequate to replace the oil lost during our Saudi shutdown scenario.  Even if all of the oil in the SPR were used in a unilateral response, the net  disruption would still be more than 4.9 billion barrels over 2 years, an  amount equal to about 16 percent of the crude oil consumed in the world in  2004. Assuming a coordinated international response, the net disruption  would still be over 4.1 billion barrels over 2 years, an amount equal to more  than 13 percent of the crude oil consumed in the world in 2004.
section_title: SPR Use during Disruptions Can Prevent Substantial Economic Damage
paragraphs: The SPR can reduce economic damage during oil supply disruptions by  replacing some or all of the disrupted oil, moderating the resulting oil price  increase and its negative effect on U.S. economic activity, as measured by  GDP. As previously noted, DOE uses two different economic models to  estimate the impact of oil supply disruptions on oil prices and GDP: one  used by the Office of Petroleum Reserves and one used by EIA. We used  both of these models to estimate the reduction in economic damage  (avoided damage) that could result from releasing oil from the SPR and  international reserves during our six hypothetical disruption scenarios.  (See app. II for additional description of these models and the assumptions  used in our analysis.)
Table 2 shows the oil price increases that the Office of Petroleum Reserves’  model estimates for our six disruption scenarios if reserves were not used,  if the SPR were used alone, and if the SPR were used as part of a  coordinated international response. This model estimates oil prices each  month during a disruption and assumes that completely replacing the oil  lost in a disruption eliminates the resulting price increase. Thus, this model  predicts no price increase in situations where the SPR or international  reserves can completely replace the disrupted oil, although experts told us  that a price increase would likely occur in this instance due to market  psychology. For those scenarios where some, but not all, of the oil can be  replaced, the model estimates smaller oil price increases than if reserves  were not used. For example, the model estimates that oil prices could rise  by up to $47 per barrel during our Saudi terrorism scenario if reserves were  not used. However, if SPR oil were released into the market, the estimated  maximum price increase would be only $7 per barrel. If oil from  international reserves were also released into the market, the model  estimates there would be no price increase, because the reserve oil would  completely replace the disrupted oil.
To estimate how much economic damage could be avoided by using the  SPR and international reserves during our oil supply disruption scenarios,  we first estimated the damage that would occur if no reserves were used.  We then estimated the damage to GDP, if any, from the disruptions if the  SPR were used, either alone or in conjunction with international reserves.  The difference between the estimates with and without reserve use is the  avoided damage to GDP resulting from use of the reserve. As shown in  table 3, the Office of Petroleum Reserves’ model estimates that the ability  of the SPR alone to curb rising oil prices reduces damage to GDP by a  range of $7 billion for our 6-month Gulf Coast hurricane scenario to   $142 billion for our 8-month Saudi terrorism scenario. In all but the two  smallest scenarios, the model shows that a coordinated international  response can provide a greater reduction in damage, ranging from $118  billion for the 3-month closure of the Strait of Hormuz to $201 billion for  our 18-month Iranian embargo scenario. In our 24-month Saudi shutdown  scenario, the model shows that economic damage of approximately   $662 billion occurs even if international reserves were used in response to  the disruption.
The damage caused by each disruption and the portion of that damage that  can be avoided by releasing reserves depend on the nature of the  disruption. For example, the SPR and international reserves cannot  eliminate all of the economic damage that could be caused by our Strait of  Hormuz closure scenario because, even though the duration is short, it  involves a disruption of a very large quantity of oil that the reserves cannot  replace. Additionally, the models show that replacement of a portion of the  oil lost in the Saudi Arabian shutdown scenario results in less benefit to the  economy than completely replacing the oil lost in the smaller Iranian  embargo scenario.
The way in which oil is released from the reserves also impacts how  effective the reserves are in preventing damage to GDP. In each scenario,  the results previously described include the assumption that release begins  immediately and occurs at a steady rate for the entire length of the  disruption. The results also include the assumption that the rate of release  either completely replaces the oil lost or is the maximum sustainable rate  for the entire disruption. Delaying the release of reserves in response to a  disruption is harmful in every scenario, and the harm is greater the longer  release is delayed. This effect is particularly large in scenarios where more  oil is lost at the beginning of the disruption, such as the closure of the Strait  of Hormuz or the Saudi terrorism scenarios. Replacing the oil lost during  the disruption at the maximum rate possible instead of a steady rate gives a  different result only in our largest disruption scenario, the Saudi shutdown.  The maximum release strategy is advantageous in this scenario because the  model assumes that the economic damage from the disruption is worse at  the beginning, before the economy has had a chance to adjust. Since  international reserves are emptied to respond to this scenario, releasing  more oil at the beginning provides more benefit than releasing at a steady  rate.
Table 4 shows the oil price increases that the EIA model estimates for our  six oil supply disruption scenarios for the same three circumstances  described for the Office of Petroleum Reserves’ model: if reserves were not  used, if the SPR were used alone, and if the SPR were used as part of a  coordinated international response. The EIA model estimates a range of  price impacts for each quarter of the disruption, rather than a single value  for each month as in the Office of Petroleum Reserves’ model. Both models  consider the amount of oil disrupted when calculating oil price increases,  but the EIA model also estimates the impact of the disruption on market  psychology. For example, an EIA official stated that disruptions caused by  violent events would have larger price impacts than disruptions caused by  peaceful events, such as a strike or natural disaster. Furthermore, the EIA  model assumes that even if reserves can replace all of the oil lost in a  disruption, oil prices may still increase because of‘ market psychology. For  these reasons, in some cases, the EIA model predicts larger price increases  when reserves are used than the Office of Petroleum Reserves’ model. For  example, for the Saudi terrorism scenario, the EIA model predicts a price  increase of $18 to $39 if the SPR were used alone (see table 4), while the  Office of Petroleum Reserves’ model predicts a maximum price increase of  only $7 (see table 2).
As shown in table 5, the EIA model estimates that the ability of the SPR  alone to mitigate increases in oil prices reduces damage to GDP by $0.4  billion to $1.0 billion for our Gulf Coast hurricane scenario up to $15 billion  to $38 billion for our Iranian embargo scenario. As with the Office of  Petroleum Reserves’ model, the EIA model also shows that a coordinated  international response reduces more economic harm in each scenario,  except those where the SPR can replace the oil alone. As it does with oil  price increases, the EIA model estimates a range of GDP damage for each  scenario, rather than the single value that the Office of Petroleum Reserves’  model produces.
section_title: DOE Models Yield Significantly Different Estimates of the Economic Damage Avoided by Using the SPR
paragraphs: Under every scenario, the EIA model predicts much smaller avoided harm  to GDP than the Office of Petroleum Reserves’ model. For example, in the  Iranian embargo scenario, the Office of Petroleum Reserves’ model  estimates that using international reserves could prevent $201 billion in  economic harm, while the EIA Model predicts $23 billion to $60 billion in  avoided harm. This difference occurs primarily because the EIA model  assumes that oil price increases cause less harm to GDP, meaning that  there is less economic harm for the SPR and other reserves to mitigate. The  estimates of the effect of oil price spikes on GDP from the Office of  Petroleum Reserves and EIA models are, respectively, near the high end  and low end of the spectrum of such estimates in the economic literature.  Officials from the Office of Petroleum Reserves and EIA acknowledged  that they hold different views about how oil supply disruptions impact the  economy. An EIA official also told us that EIA is currently updating its  model, although the assumptions about how oil price changes impact GDP  have not changed substantially.
This discrepancy in results between the two models is potentially  problematic because the results of the two models are used to support  different decisions about the SPR. The Office of Petroleum Reserves’  model has been used to estimate the net benefits of expanding the SPR, as  described in the following section of this report. The larger economic  impacts predicted by the Office of Petroleum Reserves’ model would justify  a larger SPR than if the model predicted smaller economic impacts. The  EIA model is used to estimate the impact of oil supply disruptions and to  advise officials about their potential consequences. The smaller economic  impacts predicted by the EIA model could lead to recommendations that  the SPR not be used as often or for as many oil supply disruptions as would  be the case if the model found larger economic impacts. The results of  these two models pull decision makers in opposite directions, making it  important to clarify the differences between the two models and to ensure  that policymakers are aware of the different views within DOE.
section_title: Other Factors, in Addition to the SPR’s Ability to Replace Oil, May Affect the Extent to Which the SPR Can Protect the U.S. Economy from Damage
paragraphs: The purpose of the SPR is to protect the economy from harm during oil  supply disruptions by replacing the disrupted oil. However, factors beyond  the amount of oil that SPR can replace affect the extent to which SPR can  protect the U.S. economy from damage. For example, during some  situations, such as a hurricane, typical transportation routes for oil could  be blocked, reducing the benefits of releasing SPR oil. Also, the benefits of  releasing SPR oil could also diminish if the type of oil in the SPR is not a  good substitute for the disrupted oil, or if refining capacity is damaged. On  the other hand, the SPR can provide economic benefits to the United States  when it is used as a tool for diplomacy and as a deterrent against  intentional disruptions, even when no oil is released.
subsections: section_title: Transport of Oil to Refineries May Be Difficult during Some Disruptions
paragraphs: During a drawdown, SPR oil is shipped through marine terminals or  pipelines. Shipping time from the SPR to different parts of the country  varies, as shown in table 6. The oil pipeline network and marine shipping  allow SPR oil to reach every region of the United States, except for the  Rocky Mountains. Canada provides the only imported oil to the Rocky  Mountain region, and DOE believes that a disruption of Canadian oil is  unlikely.
The ability of the SPR to reduce economic damage may be impaired if  transport of oil to refineries is delayed. For example, the SPR was large  enough to replace the oil lost from recent Hurricanes Katrina and Rita, but  petroleum product prices still increased dramatically following the  hurricanes, in part because power outages shut down pipelines that  refineries depend upon to supply their crude oil and to transport their  refined petroleum products to consumers. 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, short-term gasoline shortages occurred in some places, and  the media reported gasoline prices greater than $5 per gallon in Georgia.
section_title: SPR Oil Is Not Fully Compatible with Some Refineries
paragraphs: The crude oils stored in the SPR are compatible with many refineries in the  United States. However, some U.S. refineries process crude oils heavier  than those stored in the SPR. Of the 8.3 million barrels of non-Canadian oil  imported into the United States per day in 2004, 3.5 million barrels, or  about 40 percent, were heavy oil. Refineries that process heavy oil may  have difficulty operating at normal capacity if their supply of heavy oil is  disrupted. A December 2005 DOE report identified 74 refineries that are  connected to the SPR that receive non-Canadian imports of oil, and the  report found that the types of oil currently stored in the SPR would not be  fully compatible with 36 of those refineries, or slightly less than 50  percent.27,  DOE estimated that if these refineries had to use SPR oil, U.S.  refining throughput would decrease by 735,000 barrels per day, or 5  percent. DOE estimated that production of distillate fuels, such as diesel  and jet fuel, would decrease substantially from heavy oil refineries, but  DOE estimated that production of gasoline would increase.
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, DOE may have underestimated how much heavy oil  should be in the SPR to maximize compatibility with refiners and minimize  oil acquisition cost. First, DOE determined the least amount of heavy oil  that could be added to improve the compatibility of the SPR oil inventory  with U.S. refineries. However, because heavy oil is less expensive to  purchase than the lighter oils currently stored in the SPR, a cost-benefit  analysis may show that a larger amount of heavy oil is beneficial, while still  maintaining compatibility with U.S. refining capacity. Second, the DOE  report 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 they used only SPR oil. For example, an official from one  refinery stated that if it used solely SPR oil in its heavy crude unit, it would  produce 11 percent less gasoline and 35 percent less diesel.  Representatives from other refineries said that they might need to shut  down portions of their facilities if they could not obtain heavy oil. A  refining industry expert explained that a reduction in gasoline production  would likely occur when some heavy oil refineries processed light oil,  because the light oil would not provide enough feed to units designed to  convert heavier products into gasoline.
DOE, Office of the Deputy Assistant Secretary for Petroleum Reserves, Strategic  Petroleum Reserve Crude Compatibility Study (December 2005).
section_title: Releasing Oil from the SPR Is Less Helpful If U.S. Refining Capacity Is Damaged
paragraphs: In addition to disrupting crude oil supplies, disasters such as hurricanes  and terrorist acts can disrupt supplies of petroleum products by damaging  refineries. Crude oil must be processed in refineries to be useful. Following  Hurricanes Katrina and Rita, nearly 30 percent of the refining capacity in  the United States was shut down, disrupting supplies of gasoline and other  products. Because the SPR contains only crude oil, it cannot replace  petroleum products if a disruption in refining occurs. However, some  countries in the International Energy Agency hold petroleum products in  their reserves, and they released these products after Hurricanes Katrina  and Rita. DOE reported that these releases of petroleum products helped  reduce prices for gasoline and diesel after the hurricanes.
section_title: SPR Can Provide Benefits to the U.S. Economy Without Releasing Oil
paragraphs: Several members of our group of experts and other experts noted that the  SPR has value to the United States economy in addition to physically  replacing oil during supply disruptions. First, the ability of the SPR to  replace supply during disruptions may deter adverse behavior on the part  of oil-producing nations. Since the SPR can replace a large amount of  disrupted oil, cutting off supply would not have the intended negative  economic consequence. Second, the SPR could be used as a negotiation  tool to encourage producers to increase oil production when needed.  Third, experts told us that they believe the SPR may reduce oil prices by  lowering the risk premium sometimes included in the price of oil. Oil prices  can increase because of fear of a disruption, and some experts told us that  the existence of the SPR may quell this fear.
section_title: A Larger SPR Is Warranted If Demand for Oil Grows as Expected
paragraphs: If demand for oil in the United States increases as expected, a larger SPR  will be necessary to maintain the economy’s present level of protection  from oil supply disruptions. Expansion of the SPR could also be required  under the U.S. agreement with the International Energy Agency. In  addition, a recent study prepared for DOE shows that the benefits of  expanding the SPR to as much as 1.5 billion barrels would exceed the costs  over a range of future conditions, although expanding the reserve to this  size would take approximately 18 years. However, factors influencing the  SPR’s ideal size are likely to change over time, including factors such as oil  demand and the likelihood of oil supply disruptions.
subsections: section_title: Oil Demand Projections Support a Larger SPR
paragraphs: Future oil demand in the United States has an important impact on the  benefits of expanding the SPR, and current projections support the interest  in a larger SPR. Under the base case in the EIA’s most recent Annual  Energy Outlook, published in February 2006, U.S. demand for petroleum  will rise from 21.1 million barrels per day in 2005 to 23.6 million barrels per  day in 2015 and 26.1 million barrels per day in 2025, increases of 12 percent  and 24 percent, respectively. As a result, the volume of imported oil and  petroleum products is projected to increase over time to meet this demand,  from 12.5 million barrels per day in 2005 to 13.2 million barrels per day in  2015 and 15.7 million barrels per day in 2025.
The amount of protection that the SPR provides to the U.S. economy is  generally measured in days of net import protection. The SPR contained  enough crude oil in 2005 to offset about 58 days of imports. Using the most  recent EIA forecast, we calculate that the net import protection that the  SPR provides at its current size will decrease to 53 days in 2015 and 45 days  in 2025.
The United States’ agreement with the International Energy Agency could  also require an expanded SPR as imports of oil and oil products increase, if  private inventories do not increase enough to cover the difference in  demand. As we previously mentioned, the United States agrees to hold  inventories of oil and petroleum products totaling 90 days of net imports as  part of its obligation to the International Energy Agency, and the United  States meets its obligation with a combination of public and private  inventories. Privately held inventories of oil and petroleum products vary,  but in 2005 DOE assumed these inventories could offset 58 days of imports.  In total, the SPR and private inventories could offset 127 days of imports in  2005. As shown in figure 7, DOE estimates that without SPR or private  inventory expansion, the United States will drop below its 90-day  stockholding obligation in 2025. With the expansion of the SPR to 1 billion  barrels included in the Energy Policy Act of 2005, DOE estimates that the  United States will remain in compliance with its 90-day obligation through  2030. As figure 7 shows, the number of days of net import protection  provided by private inventory of oil and petroleum products has generally  decreased since the mid-1980s, and DOE officials expect this trend to  continue. Holding inventory is costly to private companies, so they have an  incentive to keep their inventory as low as possible.
section_title: DOE Estimates That Long- term Benefits of SPR Expansion to 1.5 Billion Barrels Exceed Costs
paragraphs: To evaluate the costs and benefits of expanding the SPR to a capacity of up  to 1.5 billion barrels, DOE’s Oak Ridge National Laboratory (ORNL)  prepared a study for DOE in late 2005. This study relies on the same  model that the Office of Petroleum Reserves used, as discussed in the  previous section, to estimate the reduction in economic damage from using  the SPR during oil supply disruptions. The study shows that the benefits of  expanding the reserve to 1.5 billion barrels exceed the costs over a 45-year  horizon. The study estimates the costs and benefits of SPR expansion  through 2050 because of the long construction time for additional SPR  capacity and the large up-front investment required. The costs of  constructing and filling the additional capacity dominate the analysis until  2020, while benefits of the additional capacity accrue from 2021 through  the end of the analysis in 2050. The study uses EIA forecasts of oil price and  demand through 2025, and a linear extrapolation of these forecasts from  2025 through 2050. Any analysis of costs and benefits so far in the future is  inherently uncertain. However, this study is the only one of its kind to  analyze the future net benefits of SPR expansion.
The costs of expanding the SPR to 1.5 billion barrels consist of capital costs  to acquire and construct the facilities, the cost of crude oil to fill the new  capacity, and ongoing maintenance and security costs for the additional  facilities. DOE estimates that expanding the physical structure of the SPR  to 1.5 billion barrels would take approximately 18 years and cost  approximately $5.4 billion, in 2004 dollars. DOE assumed that expanding  the reserve to this size would involve purchasing or constructing additional  storage capacity at three existing SPR sites: West Hackberry and Bayou  Choctaw in Louisiana, and Big Hill in Texas. The remaining expansion  would be accomplished by constructing new storage sites at three sites  selected from five potential sites in Texas, Louisiana, and Mississippi. The  ORNL study’s authors estimate the cost of filling the additional SPR  capacity at $23.0 billion, in 2004 dollars. This estimate is based on the base- case oil price forecast from the 2005 Annual Energy Outlook because the  2006 volume was not yet published when the ORNL study was completed.  The 2006 Outlook forecasts higher crude oil prices than the 2005 Outlook.  Using the most recent base-case forecast, the ORNL authors estimated a fill  cost of $36.2 billion in 2004 dollars. These calculations assume that the new  SPR capacity is filled as it is completed at a maximum fill rate of 100,000  barrels per day, a fill rate achievable using the royalty-in-kind program.
The ORNL study does not separately consider the costs and benefits of the  expansion to 1 billion barrels authorized in the Energy Policy Act of 2005.  DOE estimates that expanding to this size would take approximately   15 years and cost at least $1.3 billion, in 2004 dollars, based on selection of  the lowest-cost expansion options. This cost includes, as we previously  described, purchasing or constructing additional capacity at three existing  SPR sites and constructing a new storage site at one of the five potential  locations. We estimate that filling the additional capacity would cost  approximately $13.4 billion in 2004 dollars, using the base-case cost  estimate in the 2006 Annual Energy Outlook.
The ORNL study estimates that the benefits of expanding the reserve to   1.5 billion barrels exceed the costs over a range of assumptions about  future demand and oil prices. Expanding the SPR to 1.5 billion barrels is  estimated to be cost-beneficial for each of the demand and world oil price  forecasts in EIA’s 2005 Annual Energy Outlook. The 2005 Outlook contains  four forecasts of the world oil market: a base-case forecast, a lower-price  forecast, and two higher-price forecasts. A different level of oil demand is  associated with each of these price forecasts. The estimated net benefits of  expanding the SPR are greatest in the EIA forecast when oil demand is  highest and oil prices are lowest, and least when oil demand is lowest and  prices are highest. The ORNL study used the 2005 forecasts because, as we  previously mentioned, it was completed before the 2006 Outlook was  published. The 2005 Outlook forecasts higher oil demand and lower oil  prices than the 2006 edition, but the author of the ORNL study noted that  the highest-price case included in the 2005 report closely resembles the  2006 base case. Thus, SPR expansion appears to be cost-beneficial for the  2006 base-case forecast, but the study does not include oil prices as high as  those in the 2006 high-price forecast, which would tend to decrease the  benefits of a larger reserve.
Beyond assumptions about future oil demand and price, the ORNL study  makes a number of additional assumptions, including important  assumptions about the probability of disruptions and the impact of oil price  increases on GDP.
The likelihood of oil supply disruptions in the future is uncertain and  difficult to assess. The ORNL study considers two different estimates of  the probability of oil supply disruptions: one that DOE created in 1990  and a second that the Stanford Energy Modeling Forum created in  2005. The benefits of expanding the SPR to 1.5 million barrels exceed  the costs for both disruption probability estimates, but the benefits are  larger for the 2005 Stanford Energy Modeling Forum estimate because  this estimate (1) considers longer disruptions than those considered in  the 1990 estimate and (2) recognizes that excess capacity will not be  available from a part of the world where supply is disrupted.
The measure of how much a given increase in oil price reduces GDP is  known as the GDP elasticity of oil price. GDP loss avoided when the  SPR is used during oil supply disruptions is a measure of the benefit of  the SPR. The ORNL study used a range of GDP elasticity estimates and  the results of the model runs indicate that, over that range, expanding  the SPR is cost-beneficial. Some economists, however, believe that the  GDP elasticity is lower than the bottom of the range of elasticity  estimates used by the ORNL study. For example, the model we  described in the previous section that EIA uses to estimate the impacts  of oil supply disruptions uses values for this GDP elasticity derived from  the Global Insight Macroeconomic Model that are one-quarter to one- half the size of the smallest value considered in the ORNL study. A  smaller value for the GDP elasticity would reduce the calculated  benefits of expanding the SPR.
section_title: Factors Influencing the SPR’s Ideal Size Are Likely to Change Over Time
paragraphs: Many factors influence the ideal size of the SPR, including world demand  for oil and the probability and potential size of oil supply disruptions.  Although current projections anticipate increasing future demand for oil in  the United States and world, future oil demand conditions are uncertain.  Predicting future demand is difficult because it depends on many factors,  including the rates of economic growth, the price of oil, policy choices, and  technology changes.
The rate of world economic growth strongly influences oil demand. Strong  economic growth in China has increased its demand for oil and petroleum  products, contributing to rising world oil prices since 2004. In that year,  China became the world’s second largest consumer of oil, behind the  United States, and its demand for oil grew at an annual rate of 15 percent.  Conversely, the financial crisis in Asia in mid-1997 dramatically slowed the  rate of oil demand growth in the region at that time, and oil demand even  decreased between 1997 and 1998 in some countries. This change in  demand contributed to lower oil prices in 1998 and early 1999, according to  some experts.
Future demand for oil will also depend on its price. As we previously  described, crude oil prices are set in the world marketplace, and are largely  outside the control of U.S. policymakers. High oil prices can encourage  conservation and investment in fuel-efficient technologies and alternative  fuels, reducing demand, while low oil prices can have the opposite effect.
Members of our group of experts suggested several policy choices that  might diminish growth in U.S. demand for oil. First, they suggested that  research and investment in alternative fuels might reduce the growth of  future 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, expert  group members suggested that 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 directs the  Secretary of Energy to establish a program that includes grants to  automobile manufacturers to encourage domestic production of these  vehicles. Third, several members of our group of experts suggested  improving the Corporate Average Fuel Economy (CAFE) standards to curb  demand for petroleum fuels in the United States. 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. New  CAFE standards for light trucks, including minivans and sport-utility  vehicles, were announced by the administration in March 2006, which  include larger vehicles that were not regulated under past standards. Other  experts have questioned the need for enhanced CAFE standards, noting  that today’s higher gasoline prices will bring about more efficient use of  gasoline. Additionally, studies from the Congressional Budget Office  suggest that a tax on gasoline could reduce demand at lower cost to the  economy than enhanced CAFE standards.
The size of the SPR needed to protect the U.S. economy also depends on  the likelihood of oil supply disruptions. A number of factors in today’s  energy market cause particular concern, including a reduction in global  surplus oil production capacity in recent years, the fact that much of the  world’s supply of oil is produced in relatively unstable regions, and rapid  growth in world oil demand that has led to a tight balance between demand  and supply. However, factors influencing disruption probability are likely to  change over time.
As we described in the previous section, international reserves augment  the SPR’s ability to replace oil during supply disruptions. Since a release of  oil anywhere in the world during a disruption can lower oil prices  everywhere, strategic reserves in other countries are beneficial to the  United States and influence the SPR’s ideal size. Along these lines, some  members of our group of experts stressed the importance of international  reserves to U.S. oil security and suggested that the United States and the  International Energy Agency should encourage construction of strategic  reserves abroad to be used during oil supply disruptions and should offer  technical assistance to countries that want to construct such reserves.  Officials from DOE and the International Energy Agency described efforts  to support construction of reserves in other countries, including  sponsoring workshops and providing other assistance. Experts pointed out  that encouraging the construction of strategic reserves is particularly  important in developing countries that are significant oil consumers and  that are not currently members of the International Energy Agency, such as  China. EIA forecasts that through 2025, demand in China will increase at a  much faster rate than demand in more developed countries.
Projections of future oil demand and oil market conditions are inherently  uncertain, but these projections are key to any estimate of the optimal or  necessary size of the SPR. If demand for oil grows as projected, keeping the  SPR at its current size may put the economy at greater risk from the  negative effects of oil supply disruptions. However, the estimates of world  oil demand used in current studies could be too high or too low, resulting in  high or low estimates of the SPR’s optimal size. Therefore, as time passes  and oil markets change, periodic reassessments by DOE of the appropriate  size of the SPR could be helpful as part of the nation’s long-term energy  security planning.
section_title: Conclusions
paragraphs: The SPR is a valuable asset for protecting the U.S. economy, providing  benefits as a source of oil during supply disruptions and as a tool of  diplomacy in foreign policy discussions. Our work shows that the SPR,  particularly in conjunction with reserves held by the other countries of the  International Energy Agency, can replace the oil lost during all but the most  catastrophic disruption scenarios and, thus, can reduce the negative  consequences of oil supply disruptions on the U.S. economy. However, our  work also describes issues that could impact the cost and effectiveness of  the SPR, including the conditions under which the reserve is filled, how  DOE estimates the economic impacts of using the reserve, and the type of  crude oil in the reserve. Expanding the reserve makes sense and will be  necessary to maintain the economy’s present level of protection if demand  for oil in the United States increases as expected. However, factors that  influence the ideal size of the SPR are likely to change over time and will  warrant periodic reassessments.
Since the SPR’s inception, it has been filled and used in response to world  events and changing conditions. Although some experts claimed that  acquiring oil for the SPR after the terrorism events of September 2001  caused substantial increases in oil prices, the majority of experts we talked  with believe that this increase was minimal because the volume of oil going  to the SPR was very small relative to world oil demand. Experts believe  that changes in SPR practices—including following a “dollar-cost- averaging” approach, where the government acquires a fixed dollar value of  oil for the SPR over a specified time period, and allowing oil producers  more flexibility in the timing of delivery for oil acquired for the SPR—could  reduce the future cost of filling the SPR.
Different parts of DOE have very different opinions on the amount of  economic harm oil supply disruptions can cause and, thus, implicitly about  the ideal size and use of the SPR. The estimates of the effect of price spikes  on GDP that these different parts of DOE use are, respectively, near the  high end and low end of the spectrum of such estimates in the economic  literature. The two models have been used to support different kinds of  decisions—the Office of Petroleum Reserves’ model has been used to  support decisions about whether to expand the SPR, while the EIA model  has been used to advise policymakers about the potential economic  consequences of oil supply disruptions. Clarifying the differences between  these models and how the models are used to provide policy advice would  help ensure that DOE provides consistent transparent advice about the size  and use of the SPR.
The SPR protects the economy during oil supply disruptions by replacing  the oil lost. For the SPR to be most effective, refiners need to be able to  efficiently use the oil in the reserve in the absence of other sources of  supply. The two types of crude oil currently stored in the SPR can be  effectively used by most refineries during a supply disruption, but the lack  of heavy sour oil in the SPR poses problems to refiners who use this type of  oil. Adding some heavy sour oil to the SPR could provide a source of supply  to these refiners during a disruption, while still leaving enough oil of other  types for other refiners. A 2005 DOE study supports this finding,  concluding that separately storing approximately 10 percent heavy sour  crude in the SPR could provide oil supply to refiners who process heavy  sour oil during a disruption and better protect the economy. Additionally,  adding some heavy sour oil to the SPR could decrease the cost of filling the  SPR, since this oil is generally less expensive than the lighter grades  currently stored in the reserve.
Although another 2005 study for DOE shows that expanding the SPR could  be warranted, factors influencing the ideal size of the SPR are likely to  change over time. Many factors influence the ideal size of the SPR,  including oil demand levels and the likelihood of oil supply disruptions.  Because these factors are very dynamic, decisions about expanding the  SPR will always be made under uncertainty. Nonetheless, as the world  changes, periodically revisiting decisions about SPR size would allow  policymakers to use new information to refine their views on the SPR’s  proper size.
section_title: Recommendations for Executive Action
paragraphs: The Secretary of Energy should take the following four steps to improve  the operation of the current SPR and to improve decisions surrounding the  SPR’s use and expansion. Specifically, the Secretary should:  Study how to best implement experts’ suggestions to fill the SPR more   acquiring a steady dollar value of oil for the SPR over the long term,  rather than a steady volume, to ensure a greater volume of fill when  prices are low and a lesser volume of fill when prices are high and   providing industry with more flexibility in the royalty-in-kind  program to delay oil delivery to the SPR during times when supply  and demand are in tight balance and current prices are higher than  expected future prices.
Conduct a new review about the optimal oil mix in the SPR that would  examine the maximum amount of heavy sour oil that should be held in  the SPR, in addition to the minimum amount determined in DOE’s prior  report. The Secretary should ensure that DOE, at a minimum,  implements its own recommendation to have at least 10 percent heavy  sour oil in the SPR.
Clarify the differences in structure and assumptions between the  models used by the Office of Petroleum Reserves and EIA and clarify to  policymakers how the models are used when providing advice to  Congress and the executive branch.
Periodically reassess the appropriate size of the SPR in light of changing  oil supply and demand in the United States and the world.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to DOE for review and comment. DOE  generally agreed with the conclusions and recommendations presented in  the draft report, but provided additional information regarding the  implementation of two of our recommendations. Additionally, DOE  explained EIA’s efforts to update its model of the economic impacts of oil  supply disruptions. In reviewing our draft report, DOE also provided  technical and clarifying comments, which we incorporated as appropriate.  DOE’s written comments are reproduced in appendix III.
In response to our recommendation to study how to implement experts’  suggestions to fill the SPR more cost effectively, DOE noted that decisions  on when to acquire oil are extremely complex and subject to many  strategic and tactical considerations in addition to cost. We agree that SPR  oil acquisition decisions must consider cost, market conditions, national  security concerns, and other issues. DOE also stated that dollar cost  averaging as a means to improve the cost-effectiveness of SPR fill could be  employed only when DOE is purchasing oil, and noted that recent oil  acquisition has been accomplished by the transfer of royalty oil from the  Interior Department. However, we believe that dollar cost averaging when  acquiring oil through the royalty-in-kind program is possible, although it  would require that DOE vary the amount of oil it accepts from royalties and  perhaps purchase some oil at times of low prices. Because of the potential  for cost savings, we continue to believe that DOE should study such an  approach. Finally, regarding this recommendation, DOE stated that it  believes that the value of deferring oil deliveries to the SPR during the  period of 2002 to 2004 would have been less than $590 million. To clarify,  we did not attempt to value deferrals that DOE might have approved during  this time period. Instead, the $590 million of potential savings referred to in  the report reflects the potential savings from applying a dollar-cost- averaging approach from October 2001 through August 2005, not to the  savings that could have occurred from deferring oil delivery.
In response to our recommendation to consider storing heavy sour oil in  the SPR, DOE stated that it does not believe the advantages of holding a  heavier crude stream would justify replacing any of the current inventory.  Instead, it believes that studying and implementing this recommendation  should wait until the SPR is expanded. Neither our work nor DOE’s recent  study explored the costs and benefits of adding heavy sour oil to the SPR.  We believe that DOE should study the costs and benefits of adding heavy  sour oil with and without SPR expansion. Without such analysis, DOE does  not have data to determine whether replacing of any of the current  inventory with heavy sour oil is economically justified.
Regarding the last two recommendations, DOE agreed that officials will  work together to better articulate the different approaches and  perspectives contained in their modeling of the effects of oil supply  disruptions on the economy, and committed to periodic reassessments of  the SPR’s ideal size. DOE also described an ongoing update of the EIA  model for assessing the impacts of supply disruptions. The new model is  more complex than the older model, but according to EIA, its estimates of  the GDP impacts of supply disruptions will remain smaller than those  estimated by the Office of Petroleum Reserves’ model.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution of it until 21 days from  the report date. At that time, we will send copies of this report to interested  congressional committees, the Secretary of Energy, and other parties. We  will also make copies available to others upon request. In addition, the  report will be available at no charge on the GAO Web site at  http://www.gao.gov.
If you or your staffs have any questions about this report or need additional  information, please contact me at (202) 512-6877 or wellsj@gao.gov.  Contact points for our Offices of Congressional Relations and Public  Affairs may be found on the last page of this report. GAO staff who have  made major contributions to this report are listed in appendix IV.
section_title: Scope and Methodology
paragraphs: We addressed the following questions during our review: (1) Based on past  experience, what factors do experts recommend be considered when filling  and using the Strategic Petroleum Reserve (SPR)? (2) To what extent can  the SPR protect the U.S. economy from damage during oil supply  disruptions? (3) Under what circumstances would an SPR larger than its  current size be warranted?
In addressing these objectives, we conducted a comprehensive literature  review of economic and public policy material relevant to the SPR’s fill and  use, and to its ability to provide energy security for the U.S. economy. To  identify articles for our literature review, we searched databases using key  terms. We also obtained recommended reading lists of studies from several  experts on issues related to the questions we addressed. We considered the  methodological soundness of the articles and studies included in our  literature review and determined that the findings of these studies were  sufficiently reliable for our purposes. In addition, we conducted interviews  with academics and experts, as well as industry representatives and  officials from several offices within the Department of Energy (DOE),  including the Energy Information Administration (EIA) and the Office of  Petroleum Reserves. We also conducted interviews with academics and  experts at institutes that study energy security issues. We selected these  individuals on the basis of their expertise in energy security and SPR policy  as represented by their presentations or publications. We present data and  forecasts from EIA that have been deemed sufficiently reliable for our  purposes.
Additionally, we contracted with the National Academy of Sciences to  convene a group of 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 in reducing economic losses in the event of oil supply  disruptions. We worked closely with the National Academies to identify  and select 13 group members (see table 7) who could adequately respond  to our general and specific questions about current practices for filling and  using the SPR and about the economic benefit the SPR could provide at its  current size and at a larger size. In keeping with National Academies’  policy, the group members were invited to provide their individual views,  and the group was not designed to reach a consensus on the issues that we  asked them to discuss. The group members convened at the National  Academies in Washington, D.C., on December 1, 2005. The views expressed  by the group members do not necessarily represent the views of GAO or  the National Academies. After the group of experts met, we analyzed a  transcript of the discussion to identify principal themes and group  members’ views. Although we were able to secure the participation of a  balanced, highly qualified group of experts, the group was not  representative of all potential views. Nevertheless, it provided a rich  dialogue on current practices for filling and using the SPR and on what  considerations are pertinent to identifying the best fill and use policies, as  well as on how the SPR, at its current size and at a larger size, can protect  the economy from significant losses in the event of oil supply disruptions.
To learn what factors experts recommend be considered when making  decisions about SPR fill and use, we reviewed records and reports from  DOE and the International Energy Agency. We also reviewed available  literature on the political and economic implications of various ways of  filling and using the SPR, and interviewed experts from government,  academia, and private industry on issues of SPR fill and use.
To estimate the potential savings of using a dollar-cost-averaging approach  to fill the SPR, we calculated the cost of using this approach for SPR oil  acquisitions between October 2001 and August 2005. In addition, we ran  simulations to project potential savings from a dollar-cost-averaging  approach going forward over 5 years. Specifically, we evaluated 12 possible  paths that future oil prices may take. First, starting from an initial price of  $70 per barrel, we allowed prices to increase or decrease on average by  varying degrees—the price paths increased or decreased at average rates of  1, 5, and 10 percent per year. Second, for each of these 6 possible price  paths, we allowed prices to fluctuate to account for potential price  volatility—for each of the 6 possible price paths, we allowed for a low- and  high-price volatility case. Specifically, prices for each month were drawn  randomly from a normal distribution, with standard deviations of $15 for  the low volatility case and $50 for the high case. For each of these 12  scenarios, we then simulated future prices for 60 months and compared the  average price per barrel under dollar cost averaging versus acquiring oil at  a steady rate. We ran 1,000 simulations for each of the 12 scenarios and  found that in all but 10 of the resulting 12,000 simulations, dollar cost  averaging saved money. These simulations are not intended to measure the  magnitude of savings. To do so would require using actual projections of oil  prices and price volatility, something that was beyond the scope of this  report.
We did not independently verify information about security, drawdown  rates, or other operational factors of the SPR or other strategic reserves  held by countries that belong to the International Energy Agency.
To analyze the ability of the SPR to reduce economic damage caused by oil  supply disruptions, we present the results of two DOE models used to  estimate the reduction of harm to U.S. gross domestic product (GDP) that  would result from releasing oil from the SPR and international reserves  during six hypothetical oil supply disruption scenarios. Oak Ridge National  Laboratory (ORNL) produced one of these models under contract with  DOE’s Office of Petroleum Reserves. ORNL officials produced model  results for us. EIA produced the second model. We produced model results  using the EIA model, and then verified these results with EIA officials. (See  app. II for a more detailed discussion of the hypothetical oil supply  disruption scenarios and the economic modeling effort.) Additionally, we  conducted semistructured interviews with representatives from the  refining industry. We spoke with representatives from companies that  comprise 76 percent of the refining capacity of the United States to learn  about their views on SPR operations. We also reviewed studies of the  potential for oil supply disruptions to occur and to reduce U.S. GDP.
To learn about the circumstances under which an SPR larger than its  current size could provide additional energy security benefits, we reviewed  an ORNL study that analyzed the expected costs and benefits of expanding  the SPR, U.S. stockholding obligations to the International Energy Agency,  and estimates of future U.S. oil demand. Finally, we also reviewed studies  and interviewed expert group members and other oil market experts about  factors that influence future demand for oil in the United States and  alternatives for reducing U.S. economic losses in the event of oil supply  disruptions.
section_title: Economic Modeling of Oil Supply Disruptions
paragraphs: We present in this appendix the results of models that economists at ORNL  and EIA created to simulate the effects of six hypothetical oil disruption  scenarios. These scenarios illustrate the impacts of a variety of oil supply  disruptions and the extent to which the SPR and international reserves  could replace oil and protect the economy from losses. Both models make  a number of assumptions in simulating the effects of disruptions on the  economy, and some of these assumptions differ between models.
subsections: section_title: Oil Supply Disruption Scenarios
paragraphs: To study the capabilities of the SPR and international reserves to replace  oil and prevent economic damage during oil supply disruptions, we  developed six hypothetical oil supply disruption scenarios. The six  scenarios are as follows:  A hurricane along the United States Gulf Coast decreases domestic oil  production. This scenario is closely based on Hurricanes Katrina and  Rita, which struck the U.S. Gulf Coast in August and September, 2005,  and temporarily stopped a large percentage of the offshore crude oil  production in the Gulf of Mexico. The disruption in production  continued for several months as damaged offshore production  platforms, pipelines, and onshore facilities were repaired.
A strike occurs among oil workers in Venezuela. This scenario is based  on the oil worker strike that occurred in Venezuela in 2002 to 2003.  Although that strike lasted only 63 days, oil production was well below  normal for several months and did not recover to its prestrike level.
Iran stops exporting oil for 18 months. Although none of Iran’s   2.7 million barrels per day of exported crude oil go directly to the United  States, removing this oil from the market would raise prices  everywhere, thus impacting the U.S. economy.
Terrorists attack the Abqaiq oil-processing facility in Saudi Arabia,  which handles more than half of Saudi Arabia’s 10.4 million barrels per  day of oil output. This facility is the largest oil-processing plant in the  world, removing water, gas, sulfur, and other impurities before the oil is  exported. This scenario assumes that a terrorist attack cripples the  facility for 1 month, and then production recovers over 7 additional  months as the facility is repaired. Terrorists attempted to attack this  facility in February 2006, but security forces turned back the attack.
Terrorist or military action closes the Strait of Hormuz, which connects  the Persian Gulf with the Arabian Sea. Our scenario assumes that  military action closes the Strait completely for 1 month, removing   17 million barrels per day of crude oil from the market. Oil supply then  recovers over 2 months as the Strait is cleared and oil reaches the  market through alternate routes.
A catastrophic loss of oil production in Saudi Arabia occurs, eliminating  exports of oil for 18 months. Oil production then recovers over the next  6 months. Since Saudi Arabia is the world’s largest exporter of crude oil,  this is nearly a worst-case scenario for world oil supplies.
For each scenario, table 8 shows the amount of crude oil disrupted during  each month over a 2-year period.
We selected these scenarios to illustrate the potential benefits of strategic  reserves in disruptions of different size and duration, not because they are  likely to occur. These scenarios are set in today’s oil market, with global  crude oil demand of approximately 83 million barrels per day and U.S.  demand of approximately 21 million barrels per day.
section_title: Modeling of Economic Impacts
paragraphs: We used two DOE models to estimate the economic effects of our six  disruption scenarios. EIA developed one model and economists at ORNL  developed the other, under contract to DOE’s Office of Petroleum  Reserves. Both models estimate U.S. GDP loss from oil supply disruptions  by linking disruptions to oil price spikes and linking price spikes to GDP  losses. We used both models to estimate the economic effects of our  hypothetical disruptions under three conditions: that is, no reserves are  used in response to the disruption, the SPR is used alone, and the SPR is  used in conjunction with international reserves.
In both models, we assumed that world excess crude oil production  capacity and world fuel-switching capabilities, together totaling 850,000  barrels per day, are available immediately to help offset a disruption. We  also assumed that private inventories of crude oil are neutral during a  disruption—holders of private inventory neither draw down their  inventories nor hoard oil. Finally, we assumed that SPR and international  reserves are used immediately at their maximum sustainable rate or at a  rate large enough to replace disrupted oil supply.
subsections: section_title: EIA Model
paragraphs: EIA’s Division of Energy Markets and Contingency Information has  developed “rules of thumb” for estimating the oil price and U.S.  macroeconomic impacts of oil supply disruptions, based on simulations  from the Global Insight Macroeconomic Model of the U.S economy. The  assumptions relating disruptions to oil price spikes are summarized in the  “price rules of thumb” and the assumptions relating price spikes to GDP  losses are summarized in the “economic rules of thumb.”
EIA measures the response of world oil prices to a hypothetical supply  disruption as the projected quarterly average increase in the price of West  Texas Intermediate oil. EIA’s oil market analysis is based on competitive  forces producing a market price on the basis of market fundamentals and  market psychology during an oil supply disruption. The “price rules of  thumb” are based on net disruption sizes and the current and expected  future oil price level before the disruption. These rules of thumb provide a  range of oil prices around an average price, and do not try to quantify the  size of price spikes that could occur during disruptions. EIA estimates that  a supply disruption when the price of oil is around $40 per barrel results in  an oil price increase of between $4 and $6 per barrel for each 1 million  barrels per day of oil that is disrupted. However, if the price of oil is about  $50 per barrel, EIA estimates a price increase of between $5 and $7 per  barrel for each 1 million barrels per day of oil that is disrupted. For a  disruption of a given size, the higher the predisruption oil price, the bigger  the price increase needed to balance supply and demand after the  disruption. Additionally, EIA adds a “market psychology price premium” to  the price calculated using the rules of thumb in situations where it believes  market psychology will further increase the price.
To translate oil price increases into GDP losses, EIA uses “economic rules  of thumb,” based on simulations from the Global Insight Macroeconomic  Model of the U.S. economy. These rules estimate that a sustained increase  of 10 percent in the price of oil could result in a 0.05 to 0.l percent  reduction in real U.S. GDP relative to its baseline value (the forecasted  GDP without an oil disruption). EIA states that, for price increases greater  than 10 percent, the GDP impacts would increase linearly with the price  impacts, so that a doubling of the price impacts would result in a doubling  of the GDP impacts. The EIA model’s GDP responsiveness estimates are  derived from the Global Insight model that EIA uses for its long-run  forecasts of energy market and overall economic activity. EIA notes that  additional factors, such as the effect of high oil prices on the rest of the  world’s economy, the reaction of the Federal Reserve to ameliorate the  economic damage of high oil prices, and the change in the value of the  dollar against foreign currencies, may also influence the economic impact  of an oil price spike.
section_title: Office of Petroleum Reserves’ Model
paragraphs: Economists at ORNL, under contract to DOE’s Office of Petroleum  Reserves, developed a model to estimate the costs and benefits of  expanding the size and drawdown capability of the SPR. Economists at  ORNL used a portion of this model to estimate the GDP impacts of our oil  supply disruption scenarios. The model estimates the economic impacts of  oil supply disruptions by first calculating the remaining oil shortfall after  world excess oil production capacity has been utilized. Then the model  assumes that world oil price increases sufficiently for world oil demand to  contract enough to equal the now-reduced supply. On the basis of a review  of the literature, the modelers assume a short-run price elasticity of  demand for oil between -0.10 to -0.25. The elasticity gets larger as the duration of the supply shock gets larger and longer. The short-run oil  demand elasticities then are used to determine the increase in the world  price of oil. The GDP elasticity of oil price is then used to infer the losses in  economic output that would follow a sudden, unanticipated oil price shock.  The modelers draw on results from econometric studies of the sensitivity  of the U.S. economy to oil price spikes to select a GDP elasticity, expressed  in percentage terms, of -5.4 percent for a 100 percent spike in oil price.
To estimate the benefits of expanding the size and drawdown capability of  the SPR, the model simulates the impact of oil supply disruptions against  DOE’s baseline paths for oil prices, world oil demands, U.S oil demands,  and U.S. oil supplies. The primary benefit from the SPR is the GDP loss  avoided when it is used to prevent or lessen the effects of oil price spikes.  Their cost-benefit approach uses a simple model of the oil market and the  U.S. economy to (1) assess the potential causes and likelihood that oil  supply disruptions will occur, (2) account for the size of existing strategic  oil stocks and expected degree of international cooperation on their use,  (3) estimate the cost to the U.S. economy of oil supply disruptions and the  incremental ability of additional SPR stocks and drawdown capability to  reduce these costs, (4) estimate the costs of buying and storing oil in the  SPR, and (5) determine the net benefit and efficient size of the SPR. The  model uses a Monte Carlo simulation of the world oil market over the next  several decades to model the likelihood of future oil supply disruptions.
section_title: Similarities and Differences between the EIA Model and Office of Petroleum Reserves’ Model
paragraphs: In assessing the economic costs of disruptions, the Office of Petroleum  Reserves’ model makes a number of assumptions similar to those made by  EIA, in particular, assumptions about the responsiveness of oil price to  supply disruptions. However, the Office of Petroleum Reserves’ model  assumes a considerably greater degree of responsiveness of the  macroeconomy to oil price spikes than the EIA model. The Office of  Petroleum Reserves’ model assumes for its base case that a sudden  doubling in the price of oil could reduce GDP in the following year by about  5.4 percentage points below what it otherwise would have been. This  contrasts with the EIA model result that a sudden doubling of the price of  oil would cause about a 0.5 to 1.0 percent reduction in the level of real GDP  relative to its value if an oil price increase did not occur.
Some experts have suggested that the EIA model and Office of Petroleum  Reserves’ model have assumptions that could be responsible for  differences in their estimates of the responsiveness of GDP to disruptions.  In the Office of Petroleum Reserves’ model, the responsiveness of GDP to  an oil price shock incorporates a controversial assumption, that U.S.  monetary authorities would not intervene and increase the money supply  to accommodate the price shock. Some experts have suggested that, by  increasing the money supply, monetary authorities could restore  consumers’ purchasing power to its predisruption level and eliminate or  moderate the GDP loss. Experts have also suggested deficiencies in the  model that EIA uses for its estimates of the responsiveness of GDP to oil  price shocks. A number of experts believe that large-scale macroeconomic  models, such as the EIA model, underestimate the effects of oil price  shocks on the economy. They question whether these models can  distinguish between a price shock and a more gradual price increase. In  contrast, the econometrically based estimates used by Office of Petroleum  Reserves’ model and others are derived from models of oil price shocks.
section_title: Comments from the Department of Energy
section_title: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Dan Haas, Assistant Director;  Dennis Carroll; Samantha Gross; Mike Kaufman; Marietta Mayfield; Cynthia  Norris; Alison O’Neill; Paul Pansini; Jena Sinkfield; Anne Stevens; and  Barbara Timmerman made key contributions to this report.