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NS4054 Fall Term 2015 Strategic Petroleum Reserve Overview • Jason Bordoff, Senate Testimony on the U.S. Strategic Petroleum Reserve, October 6, 2015 • Main Points • First, the SPR created during the 1970s crisis remains an important national security asset – even though there has been a steep rise in U.S. oil production and a fall in imports • Second It is prudent to study whether the size, composition, location or use of the SPR should be modified to reflect changes in the global oil market since the 1970s – security concerns rather than budget problems should frame this discussion • Third there is a need to modernize the SPR’s existing infrastructure to ensure it can remain effective 2 Background I Background • As member of the IEA the U.S. is required to hold stocks of crude oil and/or petroleum products equivalent to 90 days of net imports for use in emergency situations. • Stocks can be held either in private inventories or directly by the government • Currently the SPR contains about 142 days of net petroleum import cover in 4 salt domes in Texas and Louisiana • In addition to the SPR, the U.S. government maintains in the Northwest emergency reserves of • one million barrels of heating oil, and • one million barrels of gasoline, 3 Background II • The Energy Policy and Conservation Act (EPCA) of 1975 defines the circumstances under which the SPR may be used: • Full drawdown: President can order a full drawdown of the reserve to counter a “severe energy supply interruption.” • Limited drawdown: Up to 30 million barrels if the President finds there is “a domestic or international energy supply shortage of significant scope or duration.” • Test sale or exchange: The Secretary of Energy is authorized to carry out test drawdowns and distribution of crude from the SPR not to exceed 5 million barrels. 4 Background III • To date present only three drawdowns: • 1991 during Operation Desert Storm • 2005 during Hurricane Katrina and • 2011 during the Libyan civil war • There have also been a dozen exchanges for various reasons, including the creation of the Northeast Home Heating Oil Reserve to help respon to natural disasters and outages. • There have also been three test sales to check to infrastructure and maintenance issues. 5 Problems • Recently several members of Congress have proposed selling crude oil from the SPR to raise revenue for other programs • Infrastructure needs – selling 101 million barrels of oil between 2018 and 2015 • While need for infrastructure, SPR still plays critical role in domestic energy security • Would be short-sighted and unwise way to raise needed funding. 6 Changing Environment I • SPR remains an important national security asset • SPR has created a deterrent against oil exporting countries threatening oil embargoes • Provided a tool to respond to global oil supply disruptions, and • Served to prompt OPEC to release spare capacity • Several arguments put forth on why SPR is less necessary today including • Change in oil markets over last 40 years mean that the risk of actual physical shortages of oil is far lower • The U.S. is less vulnerable to supply shortages today following the surge in domestic oil production • The dramatic collapse in oil prices since mid-2014 has consequently decreased he potential economic harm from a supply disruption, and • Improvements in technology and the growth of climate policy mean the U.S. will soon be able to get off oil. 7 Changing Environment II • Today’s oil market is different than the oil market in the 1970s • In 1970s oil price controls existed in the U.S. and most internationally traded oil was sold under long term contracts. • A disruption in contracted shipments could result in physical shortage for buyer because of • Lack of strategic and commercial stockpiles, or A large spot market where buyers could easily access alternative sources of supply • In intervening years oil market has become the most largest and liquid commodity market on earth with vibrant futures market • Vast majority of globally traded oil bought and sold for a price indexed to benchmarked crude prices including Europe (Brent), The United States (WTI) and Middle East (Dubai) 8 Changing Environment III • Given changes in oil markets – consequence of a supply disruption anywhere is a price increase everywhere • Hence risk against which the SPR needs to guard today is a global disruption to crude supply that causes domestic prices to spike regardless of whether U.S. refineries import from the disrupted countries • Oil price spices have an adverse effect on the economy • Generally a $10 per barrel increase in oil price would cause a 0.7% slower economic growth in the U.S. four quarters after the oil price rise • All but one of the 12 post war oil price shocks were accompanied by U.S. recessions • Increasingly important role for SPR may also be to manage market expectations • 2012 oil price tempered following sanctions on Iran because of the perception U.S. and allies would release oil from stockpiles 9 Changing Environment IV Surge in oil production makes U.S. less vulnerable • Net imports are only one channel by which the economy is vulnerable to oil price spikes • Since 2008 oil production in U.S. has risen 80 percent or four million barrels per day • With decline in domestic demand, this has led to a decline in oil imports from 60 to 20% of U.S. consumption • Currently the volume of oil the U.S is projected to import in 2025 is 14 million b/d lower than projections made less than a decade ago • Reduced oil imports and increased domestic production should lessen the impact on the domestic economy of global oil price swings. 10 Changing Environment V • Reduced impact does not mean there would be no impact. Several reasons that the SPR remains critical despite reduced import dependence • First, any supply disruption would still have significant distributional impacts • Gasoline price increase reduce motorists spending for other goods and services • Energy price increases also regressive given lower-income consumers spend a higher percentage of their income on energy than high income consumers • In theory other ways of addressing such distributional concerns – however doing so is unlikely 11 Changing Environment VI • Second it is far from clear U.S. oil import dependence will remain this low forever • The reduction in import dependence has been driven by both increased domestic supply and reduced demand – great uncertainty about the outlook for both. • On the supply side shale oil has shown ability to increase productivity, but unclear current rates of improvement can be maintained • Still limited experience with tight oil production, so all projections should be taken with a grain of salt • On demand side 2015 much greater increase in demand than anticipated from oil price declines 12 Changing Environment VII • The oil market is entering uncharted territory • While oil prices have fallen history teaches we should not expect them to stay there • Indeed oil prices may be even more volatile than in the past. • OPEC countries have for the time being given up their historic role as market stabilizer • Right now OPEC countries have a very narrow margin of spare capacity • In world of narrow spare capacity any disruption to global supply can have an outsized impact on price because thee is little buffer in the event of supply disruptions • With low oil prices higher political risks and thus possibility of supply shortfalls 13 Changing Environment VIII • The U.S. economy will remain heavily dependent on petroleum • Many advances in energy efficiency, together with increased attention to climate change should result in reduced fossil fuel consumption • Still very likely oil will remain the dominant transportation fuel for decades in the U.S. and globally • IEA is predicting oil consumption will increase form the current 92 million b/d to 104 million b/d by 2040 14 SPR Future I SPR should not be used as an ATM • Given evolving role of SPR in today’s changing oil markets good reasons to undertake an analysis of whether and how the SPR should be reformed • If the primary risk against which it projects is not a shortage of oil imports but a global price spike with disruptions • Should the size of the SPR be increased or deceased? • Given the changing patterns of US. Oil output and trade • Should the composition of light versus heavy oil be changed? • How should the concept of “severe energy supply disruption” be understood today? and • What does that mean about the frequency with which government officials should considser releasing or filling 15 the SPR? SPR Future II Some generalizations • Given the nature of today’s oil market, the level of stocks should no longer be based solely on import dependence. • Instead an analysis would need to assess • the impact on the macro-economy of oil price spikes • The likelihood of supply disruptions and associated price spikes, and • The impact of SPR volumes to mitigate those spikes • Compare those potential benefits to the carrying and opportunity costs of maintaining crude oil in strategic reserves • Need to rebuild country’s infrastructure, but depleting the SPR is a short-sighted way to raise those funds • Besides, prudent management buys low and sell high – not the case today 16 SPR Future III SPR revenue should be used for SPR modernization • SPR’s outdated infrastructure needs to be modernized • to ensure it can remain effective in the event of an emergency by delivering additional and incremental barrels to the market • Historically oil and refined petroleum products flowed from south to north to inland refineries • With increase in oil production in North Dakota these patterns are being reversed • To accommodate these changes in geography of U.S. crude oil supply and transportation • Have been pipeline additions and • Reversals as well • Analysis and heavy investments in infrastructure will have to take place before SPR is effective in quickly getting oil to refineries 17 Recommendations I • To ensure SPR crude oil can be effectively assessed in a future supply disruption the Quadrennial Energy Review estimated that $1.5 to $2 billion was needed to make the SPR effective • Conclusions • SPR has served as a critical piece of country’s energy security strategy since the 1970s oil crisis • Our ability to tap the SPR has been severely limited by recent changes in the U.S. oil outlook and infrastructure • Addressing these constraints should be a key priority to ensure the SPR can remain effective in an emergency 18 Recommendations II • Dramatic changes in the global oil market over the past four decades and • Changed nature of the risks against which the SPR guards mean • Mean that Congress working with the U.S. Department of Energy need to consider whether to modify the SPR’s • Size • Composition • Location, or • Use • That analysis should determine whether we sell off SPR crude, not immediate budget needs for priorities unrelated to energy security 19