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

Letter

Background

The United States is the largest consumer of crude oil and petroleum products. In 2007, the U.S. share of world oil consumption was approximately 24 percent. While DOE projects that U.S. demand for oil will continue to grow, domestic production has generally been in decline for decades, leading to greater reliance on imported oil. U.S. imports of oil have increased from 32 percent of domestic demand in 1985 to 58 percent in 2007.

In managing the SPR, the Secretary of Energy is authorized by the Energy Policy and Conservation Act, as amended, to place in storage, transport, or exchange, (1) crude oil produced from federal lands; (2) crude oil which the United States is entitled to receive in kind as royalties from production on federal lands; and (3) petroleum products acquired by purchase, exchange, or otherwise. The act also states that the Secretary shall, to the greatest extent practicable, acquire petroleum products for the SPR ina manner that minimizes the cost of the SPR and the nation’s vulnerability to a severe energy supply interruption, among other things. until being repealed in 2000, the act provided the Secretary discretion authority to require importers and refiners of petroleum products to store and maintain readily available inventories, and it directed the Secretary to establish and maintain regional petroleum reserves under certain circumstances.

42 U.S.C. § 6240(b).

SPR has sold or exchanged oil on several other occasions, including providing small quantities of oil to refiners to help them through short- term localized oil shortages.

Oil markets have changed substantially in the 34 years since the establishment of the SPR. At the time of the Arab oil embargo, price controls in the United States prevented the prices of oil and petroleum products from increasing as much as they otherwise might have, contributing to a physical oil shortage that caused long lines at gasoline stations throughout the United States. Now that the oil market is global, the price of oil is determined in the world market primarily on the basis of supply and demand. In the absence of price controls, scarcity is generally expressed in the form of higher prices, as purchasers are free to bid as high as they want to secure oil supply. In a global market, an oil supply disruption anywhere in the world raises prices everywhere. Releasing oil reserves during a disruption provides a global benefit by reducing oil prices in the world market.

In response to various congressional directives, DOE has studied the issue of including refined petroleum products at various times since 1975. After the initial SPR plan was developed, the issue was reviewed again in whole, or in part, in 1977, 1982, 1989, and 1998. Except for the 1998 report, DOE concluded that including refined petroleum products as part of the SPR was unnecessary and too expensive. The 1998 study dealt with establishing a home heating oil reserve and while it did not conclude that a reserve should or should not be established, it did find the construction of such a reserve would have net negative benefits. The 2000 amendments to the Energy Policy and Conservation Act authorized the Secretary to establish a Northeast Home Heating Oil Reserve, which was created and filled that same year. Although this reserve is considered separate from the SPR, it is authorized to contain 2 million barrels of heating oil and currently holds nearly that amount. The Reserve is an emergency source of heating oil to address a severe energy supply interruption in the Northeast. According to DOE, the intent was to create a reserve large enough to allow commercial companies to compensate for interruptions in supply of heating oil during severe winter weather, but not so large as to dissuade suppliers from responding to increasing prices as a sign that more supply is needed. To date, the Northeast Home Heating Oil Reserve has not been used to address an emergency winter shortage situation.

Some of the Arguments For and Against Including Refined Petroleum Products in the SPR

Some of the arguments for including refined petroleum products in the SPR are: (1) the United States’ increased reliance on foreign imports and resulting exposure to supply disruptions or unexpected increases in demand elsewhere in the world, (2) possible reduced refinery capacity during weather related supply disruptions, (3) time needed for petroleum product imports to reach all regions of the United States in case of an emergency, and (4) port capacity bottlenecks in the United States which limit the amount of petroleum products that can be imported quickly during emergencies. Some of the arguments against including refined petroleum products in the SPR are: (1) the surplus of gasoline in Europe, (2) the high storage costs of refined products, (3) the use of ‘boutique’ fuels in the United States, and (4) policy alternatives may diminish U.S. reliance on oil.

Some of the Arguments for Including Refined Petroleum Products in the SPR

First, in our December 2007 report, we found that while the United States was largely self-sufficient in gasoline in 1970, in fiscal year 2007, we imported over 10 percent of our annual consumption of gasoline and smaller percentages of jet fuel and some other products. We also found that along with an increased reliance on imports the United States is exposed to supply disruptions or unexpected increases in demand anywhere else in the world. Because the SPR contains only crude oil, if an unexpected supply disruption occurs in a supply center for the United States, the government’s emergency strategy would rely on sufficient volumes of the SPR and a refinery sector able to turn out products at a pace necessary to meet consumer demands in a crisis. Any growth in demand in the United States would put increasing pressure on this policy, and for much of the past 25 years, demand for refined petroleum products in the United States and internationally has outpaced growth in refining capacity.

Second, in our August 2006 report, we found that the ability of the SPR to reduce economic damage may be impaired if refineries are not able to operate at capacity or transport of oil to refineries is delayed. For example, petroleum product prices still increased dramatically following Hurricanes Katrina and Rita, in part because many refineries are located in the Gulf Coast region and power outages shut down pipelines that refineries depend upon to supply their crude oil and to transport their refined petroleum products to consumers. DOE reported that 21 refineries in affected states were either shut down or operating at reduced capacity in the aftermath of the hurricane. In total, nearly 30 percent of the refining capacity in the United States was shut down, disrupting supplies of gasoline and other products. Two pipelines that send petroleum products from the Gulf coast to the East Coast and the Midwest were also shut down as a result of Hurricane Katrina. For example, Colonial Pipeline, which transports petroleum products to the Southeast and much of the East Coast, was not fully operational for a week after Hurricane Katrina. Consequently, average retail gasoline prices increased 45 cents per gallon between August 29 and September 5, short-term gasoline shortages occurred in some places, and the media reported gasoline prices greater than $5 per gallon in Georgia. The hurricane came on the heels of a period of high crude oil prices and a tight balance worldwide between petroleum demand and supply, and illustrated the volatility of gasoline prices given the vulnerability of the gasoline infrastructure to natural or other disruptions.

Third, because some foreign suppliers are farther from the U.S. demand centers they serve than the relevant domestic supply center, the time it takes to get additional product to a demand center experiencing a supply shortfall may be longer than it would be if the United States had its own product reserves. For example, imports of gasoline to the West Coast may come from as far away as Asia or the Middle East, and the transport time and therefore cost is greater. To the extent that imported gasoline or other petroleum products come from far away, the lengthening of the supply chain has implications for the ability to respond rapidly to domestic supply shortfalls. Specifically, if supplies to relieve a domestic regional supply shortfall must come from farther away, the price increases associated with such shortfalls may be greater and/or last longer. In this sense, the West Coast and the middle of the country are more vulnerable to price increases or volatility than is the Northeast, which can receive shipments of gasoline from Europe, often on voyages of less than a week.

Fourth, the receipt of petroleum products may be delayed because port facilities are operating at or near capacity. For example, one-fourth of the ports in a U.S. Maritime Administration (MARAD) survey described their infrastructure impediments as “severe.” Officials from the interagency U. S. Committee on the Maritime Transportation System, which includes MARAD, the National Oceanic and Atmospheric Administration, and the U.S. Army Corps of Engineers, told us that U.S. ports and waterways are constrained in capacity and utilization, and anticipate marine supply infrastructure will become more constrained in the future. Officials at the Ports of Los Angeles, Long Beach, Oakland, Houston, Savannah, and Charleston reported congestion and emphasized in a 2005 report that they are experiencing higher than projected growth levels. In fact, one European product transporter we spoke with said that the European response to Hurricanes Rita and Katrina were hindered because East Coast ports in the United States could not handle the number of oil tankers carrying petroleum products from Europe, with some tankers waiting for as long as 2 weeks at port.

Some of the Arguments Against Including Refined Petroleum Products in the SPR

First, a key impetus for global trade in petroleum products has been a structural surplus in production of gasoline and a deficit in production of diesel in Europe. This surplus of gasoline is largely the result of a systematic switch in European countries toward automobiles with diesel- powered engines, which are more fuel efficient than gasoline-powered engines. European regulators promoted diesel fuel use in Europe by taxing diesel at a lower rate, and European demand for diesel vehicles rose. The European refining and marketing sector responded to this change in demand by importing increasing amounts of diesel, and exporting a growing surplus of gasoline to the United States and elsewhere. The United States has purchased increasing amounts of gasoline, including gasoline blendstocks, from Europe in recent years. These imports have generally had a strong seasonal component, with higher levels of imports during the peak summer driving months and lower imports during the fall and winter. The major exception to this seasonality came in the months of October 2005 through January 2006, when imports surged in response to U.S. shortfalls resulting from Hurricanes Katrina and Rita in August and September 2005, respectively. Experts and company representatives told us they believe this structural imbalance within the European Union will continue for the foreseeable future, and perhaps widen, resulting in more exports of European gasoline and blending components to the United States.

Second, in its prior reports on the subject, DOE found that refined petroleum product reserves are more costly than crude oil to store and must be periodically used and replaced to avoid deterioration of the products. Although DOE officials said some refined products can be stored in salt caverns just as the SPR crude oil is currently stored, these caverns are predominantly found on the Gulf Coast. In order to store refined product in other parts of the United States, storage tanks may need to be built, which is costlier than centralized salt cavern storage. According to DOE, stockpiling oil in salt caverns costs about $3.50 per barrel in capital costs. Storing oil in aboveground tanks, by comparison, can cost $15 to $18 per barrel. One of the maintenance costs of refined petroleum products that is not associated with crude oil storage is turnover, or replacement costs, because refined products deteriorate more quickly. Turnover of the product is required to ensure quality. For example, DOE found that when gasoline is stored in above-ground tanks, the turnover time is 18 to 24 months. Conversely, DOE found that crude oil could be stored for prolonged periods without losing quality. The more frequent the turnover, the higher the throughput and administrative costs.

Third, while the language in the Energy Policy and Conservation Act addresses refined petroleum products as well as crude oil, DOE conducted a study in 1977 that found geographically dispersed, small reserves of a variety of petroleum products would be more costly than a centralized crude oil reserve. For example, many states have adopted the use of special gasoline blends—or ‘boutique’ fuels, which could pose a challenge in incorporating refined products in the SPR. Unless requirements to use these fuels were waived during emergencies, as they were in the aftermath of Hurricanes Katrina and Rita, boutique fuels could need to be strategically stored at multiple regional, state, or local locations due to reduced product fungibility. Conversely, crude oil provides flexibility in responding to fluctuations in refined product market needs as regional fuel specifications and environmental requirements change over time. Furthermore, the switching of seasonal blends to meet environmental requirements and product degradation would require inventory turnover as compared to crude oil storage, which does not require the same level of turnover.

Fourth, there are several policy choices that might diminish the growth in U.S. demand for oil. First, research and investment in alternative fuels might reduce the growth of U.S. oil demand. Vehicles that use alternative fuels, including ethanol, biodiesel, liquefied coal, and fuels made from natural gas, are now generally more expensive or less convenient to own than conventional vehicles, because of higher vehicle and fuel costs and a lack of refueling infrastructure. Alternative-fuel vehicles could become more viable in the marketplace if their costs and fuel delivery infrastructure become more comparable to vehicles fueled by petroleum products. Second, greater use of advanced fuel-efficient vehicles, such as hybrid electric and advanced diesel cars and trucks, could reduce U.S. oil demand. The Energy Policy Act of 2005, as amended, directs the Secretary of Energy to establish a program that includes grants to automobile manufacturers to encourage domestic production of these vehicles. Third, improving the Corporate Average Fuel Economy (CAFE) standards could curb demand for petroleum fuels. After these standards were established in 1975, the average fuel economy of new light-duty vehicles improved from 13.1 miles per gallon in 1975 to a peak of 22.1 miles per gallon in 1987. More recently, the fuel economy of new vehicles in the United States has stagnated at approximately 21 miles per gallon. However, CAFE standards have recently been raised to require auto manufacturers to achieve a combined fuel economy average of 35 miles per gallon for both passenger and non-passenger vehicles beginning in model year 2020. Any future increases could further decrease the U.S. oil demand.

Lessons Learned from the Management of the Existing SPR that May Be Relevant to Refined Petroleum Products

The following three lessons learned from the management of the existing crude oil SPR highlight some of the issues that may need to be considered in acquiring refined petroleum products.

Select a cost-effective mix of products. To fill the SPR in a more cost- effective manner, we recommended in August 2006 that DOE include in the SPR at least 10 percent heavy crude oils, which are generally cheaper to acquire than the lighter oils that comprise the SPR’s volume. Including heavier oil in the SPR could significantly reduce fill costs because heavier oil is generally less expensive than lighter grades. For example, if DOE included 10 percent heavy oil in the SPR as it expands to 1 billion barrels, that would require DOE to add 100 million barrels of heavy oil, or about one-third of the total new fill. From 2003 through 2007, Maya—a common heavy crude oil—has traded for about $12 less per barrel on average than West Texas Intermediate—a common light crude oil. If this price difference were to persist over the duration of the new fill period, DOE would save about $1.2 billion in nominal terms by filling the SPR with 100 million barrels of heavy oil. Similarly, refined petroleum products included as part of the SPR may comprise a number of different types of products (e.g., gasoline, diesel, and jet fuel) and possibly different blends of products (e.g., different grades and mixtures of gasoline); DOE will need to determine the most cost-effective mix of products in light of existing legal and regulatory requirements to use specific blends of fuels.

Consider using a dollar-cost-averaging acquisition approach. Also in our August 2006 report, we recommended that DOE consider filling the SPR by acquiring a steady dollar value of oil over time, rather than a steady volume as has occurred in recent years. This “dollar-cost-averaging” approach would allow DOE to take advantage of fluctuations in oil prices and ensure that more oil would be acquired when prices are low and less when prices are high. In August 2006, we reported that if DOE had used this approach from October 2001 through August 2005, it could have saved approximately $590 million in fill costs. We also ran simulations to estimate potential future cost savings from using a dollar-cost-averaging approach over 5 years and found that DOE could save money regardless of the price of oil as long as there is price volatility, and that the savings would be generally greater if oil prices were more volatile. We would expect a dollar-cost-averaging acquisition method to also provide positive benefits when acquiring refined petroleum products.

Maximize cost-effective storage options. According to DOE, salt formations offer the lowest cost, most environmentally secure way to store crude oil for long periods of time. Stockpiling oil in artificially created caverns, deep within rock-hard salt, has historically cost about $3.50 per barrel in capital costs. In comparison, storing oil in above-ground tanks can cost $15 to $18 per barrel. Similarly, for those refined petroleum products that can be stored below ground, salt formations may offer a cost-effective storage option. However, possible storage options would need to be evaluated hand-in-hand with the need to (1) turn over the refined stocks periodically because their stability deteriorates over time, and (2) transport the refined petroleum products quickly to major population centers where the products will be used.

Mr. Chairman, this concludes my prepared statement. I would be pleased to answer any questions that you or other Members of the Committee may have at this time.

GAO Contacts and Staff Acknowledgments

For further information about this testimony, please contact Frank Rusco at (202) 512-3841 or ruscof@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this statement. Individuals making key contributions to this testimony include Jeffery D. Malcolm, Assistant Director, and Holly Sasso. Also contributing to this testimony were Josey Ballenger, Philip Farah, Quindi Franco, Michelle Munn, Benjamin Shouse, Karla Springer, and Barbara Timmerman.

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