Geotimes Logo POLITICAL SCENE  June 1999 

Does SPR Spell Relief for the Domestic Oil Industry?

by David R. Wunsch

Overproduction by many of the major oil-producing countries, compounded with a decrease in worldwide demand, has created an oversupply of petroleum in global markets. One consequence is that nearly all U.S. oil storage facilities are at or near capacity. Even as OPEC and other oil-producing countries instigate additional production cuts, the volume buffer resulting from the oversupply will sustain artificially depressed prices for the foreseeable future.
   To address this issue, the Clinton administration proposed on Feb. 11 to refill the nation’s Strategic Petroleum Reserve (SPR) with crude oil from outer continental shelf (OCS) leases located along the Gulf of Mexico coast, replacing the volume drawn down during the Gulf War in the early 1990s and from government sales that occurred in FY 1996. This proposal is an effort to remove at least nominal amounts of surplus crude oil volumes from the market supply and to help ensure national security by increasing the federal reserves. The proposal would also benefit the U.S. tax payer. Oil currently stored in the SPR was purchased at prices that averaged about $27 per barrel. Adding oil to the SPR at the current price of nearly $15 per barrel would result in a net decrease in the average price per barrel of oil stored in the SPR.

Congressional Interest in the SPR Issue

Exercising its congressional oversight role, the House Subcommittee on Energy and Mineral Resources held a hearing on April 15 to evaluate the administration’s plan. The subcommittee does not directly oversee the SPR program at the Department of Energy (DOE); but the subcommittee does oversee the Minerals Management Service (MMS), and the administration’s plan would use royalty-in-kind (RIK) oil, which federal lease holders deliver to MMS to fulfill their
royalty obligations. The subcommittee called the hearing to learn the details of the SPR proposal. Its interest in the SPR proprosal sprouts from its mission to follow up on efforts taken in the last (105th) Congress to explore the feasibility of broad-based RIK programs for both onshore and OCS oil production.
   Under RIK, producers give the federal government a percentage of the oil they produce, rather than pay a royalty based on a specified market value. RIK is the preferred method of royalty payment by many domestic oil and gas producers, who argue that it would eliminate the contentious royalty valuation issues that have existed between the U.S. government and oil producers operating on federal lands. At a subcommittee hearing during the 105th Congress, officials from the Department of the Interior (which includes MMS) testified that DOE doesn’t need additional authority from Congress to accept royalties in-kind. Accepting RIK oil into the SPR would also demonstrate that intra-government transfer between the Departments of Energy and the Interior can be accomplished despite administrative impediments.

Technical Background

Congress authorized the SPR in 1975 to protect the United States from disruptions to its energy supply and to enhance national security. The reserve consists of four discrete storage depots located along the Texas-Louisiana coast that are connected by a complex array of oil transmission pipelines. Each storage site comprises several geologic repositories that were created by selectively dissolving large (e.g., 10-million-barrel) cavities in salt domes. One of the more impressive DOE graphics used to illustrate the size of these repositories shows the World Trade Center fitting comfortably within just one of the caverns.
   The cumulative volume of the repositories is 700 million barrels. The current inventory is 562 million barrels, and consists of approximately 202 million barrels of sweet (less than 0.5 percent sulfur) and 359 million barrels of sour (0.5 to 1.99 percent sulfur) crude oil. At a maximum drawdown of 4.2 million barrels per day (b/d), this inventory could provide approximately 60 days of reserve based on current consumption rates. Water is used to displace the oil when the cavities are not completely full, which causes additional dissolution of the host salt deposit upon each emptying of the storage cavern and can result in a volume increase reaching 15 percent.
   Oil withdrawals have been made in the past to test the infrastructure of the SPR, as well as for emergency measures during Operation Desert Storm. More recently, controversial crude oil sales took place in FY 1996 to generate revenue for deficit reduction that was included in the Omnibus Fiscal Year 1996 Appropriations bill (P.L. 104-134). The administration’s SPR refill plan would use RIK oil to replenish 28 million barrels at a rate of 100,000 b/d. This addition of oil, however, only replaces the oil previously withdrawn in 1996 and does not completely fill the reserve.
   The proposal to partially fill the SPR with RIK oil has raised some concerns from the petroleum industry, especially about the physical transfer of petroleum to the SPR. For example, all of the supply pipelines come from unloading facilities located along the Gulf coast, and there are no inland supply lines or truck-loading facilities for transporting future payments from producers operating on inland federal leases. In addition, crude-oil quality characteristics such as sulfur and acid content and viscosity can constrain the acceptability of RIK payments.
   Rick Furiga, Deputy Assistant Secretary of Energy for the Strategic Petroleum Reserve, and Walter Cruickshank, MMS Associate Director for Policy and Management Improvement, testified that the RIK program for the SPR will be conducted in two phases. In Phase I, DOE will collect 50,000 barrels per day from a small number of the largest producers through the end of July 1999. During Phase 2, DOE will take the remainder of the 28 million barrels by competitive solicitation from all eligible producers. According to the testimony, the problem of crude-oil quality differentials will be overcome through oil exchanges such that, in the event of a national emergency, sufficient quantities of high-quality crude will be available to refiners connected to the SPR pipeline. Regarding industry’s concern that the SPR is equipped to take off-shore oil only, Furiga testified that there are no plans to expand the collection infrastructure to accept nonpipeline delivery.
   Of highest concern to the domestic oil industry is the effect that removal of RIK oil from the market will have on the recently low prices of crude oil. But the effect probably won’t be much, as the DOE estimates that the partial filling of the SPR with 28 billion barrels of RIK oil might offer minor relief at best, by adding approximately $0.25 to the price per barrel on the market.
   In addition to the technical questions answered during the subcommittee’s hearing, two important findings were also revealed. First, the refilling of the SPR presents a unique opportunity to demonstrate the federal government’s ability to accept royalty oil in-kind. Second, DOE revealed very sobering projections that by 2010, the United States’ increasing consumption of foreign oil would limit the SPR to providing the nation with only 44 days of import protection if the foreign oil supply was again disrupted as it was during the 1973 oil embargo. That finding suggests that even a full SPR may not be enough to meet our national security needs.

David R. Wunsch
AGI Congressional Science Fellow

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