The U.S. Department of Energy’s recent decision to set aside $584 million to purchase oil for the Strategic Petroleum Reserve (SPR) has added fuel to the fire of a political controversy that began in January 2007, when President Bush pledged to double the SPR’s capacity to roughly 1.5 billion barrels. Critics questioned the wisdom of adding to the SPR during a period of historically high oil prices. This spring, a bi-partisan group of six senators urged the president to suspend filling the SPR until oil prices drop.
Critics charge that purchasing oil at high prices, far from being strategic, only serves to tighten supplies and induce still higher prices. They contend that the government will pay a premium to fill the SPR (as opposed to buying it for less in the future, assuming prices will drop again), thereby driving budget deficits higher. Energy Secretary Sam Bodman and others counter that the SPR has no tangible effect on global oil prices and that filling the SPR doesn’t affect the deficit.
First, some background. The SPR, one of the U.S. government’s largest, most expensive energy assets, consists of four sites along the Gulf Coast where government-owned crude oil is stored in underground salt caverns, hollowed out salt domes deep enough to hold the Sears Tower. Established after the 1973 to 1974 oil embargo, the SPR has stored emergency crude oil since 1975. Currently holding 698 million barrels, the SPR’s four sites have a joint capacity of 727 million barrels.
The plan to double the SPR’s capacity runs counter to calls from prominent figures such as Sen. Chuck Schumer, D-N.Y., and oil expert Raymond Learsy, who say that the SPR should release oil to lower prices. Since Bush’s announcement, millions of barrels of crude oil have been added to the SPR, and in fact, the price of oil has nearly doubled, surging from less than $55 per barrel to about $90 per barrel, including a brief dance above $100. In the first month after his speech, prices rose almost 15 percent. Is President Bush’s decision partly to blame for these higher prices, and is now really the best time to add oil to the SPR?
The president’s critics appear to have good cause for argument. Consider the deficit: If the government acquires oil by accepting Royalties-In-Kind (a typical way to fill the SPR), it foregoes revenues it would have received from later selling the oil, contributing to the budget deficit. If the government purchases another 727 million barrels of oil at $85 apiece, the expense will increase the deficit by a whopping $62 billion.
So, at first blush, the SPR expansion appears to drive prices higher and cause budget deficits to grow. However, appearances can be deceiving.
Despite the pledge to increase the SPR’s capacity by 727 million barrels, the expense and time required to execute the purchasing contracts from August 2007 to March 2008 led to the addition of only 10.8 million barrels, with another 8.8 million barrels to be received between April and July. That does not even bring the storage facilities up to their existing capacity, much less fill the newer, expanded capacity. Purchasing 19.6 million barrels over a year is miniscule compared to the 85 million barrels consumed worldwide every day. These purchases, representing 0.06 percent of total oil consumption over the year, are not enough to have any long-term effects on world oil market prices.
By design, the SPR is a tool to mitigate against short-term energy crises, such as when pipelines were shut down following Hurricane Katrina. Any crisis today would cause a massive increase in the price of oil, probably far exceeding $100 per barrel. Since emergency sales of oil from the SPR are done by competitive bid, we can expect that the SPR oil will be sold at a much higher price than it was purchased. If this is the case, it’s possible that the government could make a tidy profit off the SPR (thereby reducing the deficit), even for oil purchased at $100 per barrel.
In this context, it seems that expanding the SPR can hardly be considered a direct driver of rising prices or budget deficits.
What is important, however, is the fact that the U.S. government decided to invest in massive and expensive increases to the SPR. This decision reveals two deep-rooted views: First, it means that the government is committed to using fossil fuels for the foreseeable future. If a large-scale switch to an alternative form of energy were planned anytime soon, the SPR operations would more likely be scaled down, not geared up. Second, it shows that decision-makers expect more oil supply disruptions down the road, or the SPR would not be needed.
The takeaway message is not that President Bush wants to drive prices and deficits higher, but rather that he and his administration are betting both on a petroleum-dominated future and continued market volatility. So, the real question to ask is, “Is now the time to bet on oil?”
Eisterhold and Webber are at the Center for International Energy & Environmental Policy at the University of Texas at Austin. Visit www.webberenergygroup.com for more information.