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Five Critical Questions About the U.S. Strategic Petroleum Reserve

by Blake Clayton
January 10, 2013

Constant chatter about an impending oil release from the U.S. Strategic Petroleum Reserve (SPR) was a prominent feature of the oil market last year. Much of the speculation was driven by the ongoing loss of crude from Iran, due to sanctions, and the possibility of a confrontation with Tehran over its nuclear program, which could have cut off traffic through the vital Strait of Hormuz.

The market’s SPR talk has died down, but Washington is likely to face some important questions in the near future about the country’s emergency oil reserves, driven by evolving domestic supply-demand conditions. Here are five:

– Size

Some analysts are calling for the SPR to be downsized in light of the country’s declining net import levels, thanks to growing domestic production and declining consumption. The 695 million barrels of crude oil in the SPR are currently around 80 days’ worth of net imports (at 2012 net petroleum imports of 8.72 mb/d). If current trends hold, net imports could fall to roughly 6 mb/d within 3-4 years. That would mean that trimming down the SPR to the International Energy Agency (IEA)-mandated 90-days of net imports (using government stocks alone) could free up around 155 million barrels of SPR oil, which could be sold on the open market to generate substantial public revenue.

– Location

It may make sense to consider adding or transferring emergency inventories to the East and West coasts, rather than having them confined to the U.S. Gulf Coast. Locating the SPR in the Gulf was a natural decision when the SPR was first created. But the turnaround in light sweet crude production in the greater Gulf region and the Upper Mississippi Valley, where SPR oil was designed to be shipped via pipeline, point to a declining need for that grade in that part of the country. In the case of a disruption in imports, the East and West coasts may benefit much more from extra oil on hand (and potentially in the form of refined products like gasoline and diesel).

– Composition

As it stands, 38 percent of the SPR is made up of sweet crude oil, much medium API in gravity. But with imports of light sweet crude into the Gulf Coast in what may be a terminal decline, displaced by indigenously-produced tight oil, and ongoing pipeline reconfigurations, the region’s crude mix is quickly changing. It may be worth considering the types of crude held in the SPR to better reflect refiners’ needs in that part of the country, which is home to roughly half of U.S. operable refining capacity. Moreover, adding refined products may be worthwhile. Hurricanes Katrina and Rita in 2005 crippled refineries in the Gulf (Katrina alone shut in 8 percent of total U.S. refinery output), and crude isn’t any good for drivers if it can’t be turned into gasoline when they need it.

– Criteria for release

Only broad criteria govern when the president can release oil from the SPR. When the White House should pull the trigger is a highly subjective decision as a result, which has caused (usually partisan) bickering in the past. Presidents Clinton and Obama both took heat for their SPR decisions, justified or not. The 2011 IEA-coordinated release seemed to up the intensity of calls for greater transparency and predictability in the agency’s decisions, which some energy experts support. Criteria could be based on a variety of variables, including the absolute or relative physical supply shortage or price increase. Estabilishing strict criteria would have trade-offs, though. If the market knows that an SPR release will be triggered at X dollars, for instance, traders may try to test Washington’s commitment, leading to suboptimal auto-releases.

– Inclusion of newer oil heavyweights

China is now one of the world’s largest strategic stockpilers of oil, not to mention the second largest consumer, and is actively growing its emergency crude holdings. Yet it remains outside of the IEA. That leaves open the risk that, in a future release, Washington could sell oil in the open market only to be absorbed into Chinese public stocks. In that scenario, the net effect on global oil supply would still be better than if the United States hadn’t released anything, but not as good as if Beijing had held off on bidding for its own account—or better yet, released its own stocks simultaneously. Finding a reliable way to bring China into future talks about coordinated stockpile drawdowns could benefit Washington and Beijing alike. The IEA and China have discussed impending releases before, as they did prior to the 2011 Libya-related release. But establishing a system for joint action, even if China remains outside IEA membership, could be a worthwhile goal, partly because the story won’t end with China. The growth of India’s strategic stocks, as well as those of other non-IEA countries,  are sure to raise similar questions down the road.

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