The recently agreed Congressional budget compromise includes plans to sell 58 million barrels of oil from the US Strategic Petroleum Reserve, beginning in 2018. This decision raises serious questions. The world has changed enormously since the SPR was established in the 1970s, but the realignment of such an asset for the 21st century deserves a full strategic review and debate. Leaping ahead to treat the SPR like an ATM seems unwise on multiple grounds.
My initial reaction was that the sale would result in the US government effectively buying high and selling low. However, on a last-in, first-out (LIFO) basis the 2011 SPR release (Libyan revolution) should have removed any barrels purchased as prices surged past $100 per barrel (bbl) to over $140, prior to the financial crisis. The oil slated to be sold in 2018-25 was likely injected between December 2003 and June 2005, when West Texas Intermediate crude oil averaged around $44/bbl. The Treasury should at least break even on these sales, allowing us to dispense with judging the trading acumen of the Congress and focus on the strategic aspects of this decision.
The good news is that the combination of revived US oil production and lower domestic petroleum demand effectively doubled the notional import protection that the SPR provides. Yet as Energy Secretary Moniz and a growing body of experts have concluded, the SPR's present configuration is inadequate to deal with whole categories of plausible oil-supply disruptions.
Today's SPR consists entirely of crude oil stored in caverns near the major refining centers of the Gulf Coast, to which it is connected via pipelines. However, while crude oil imports into the Gulf Coast have fallen dramatically, the long-tem decline of oil production in Alaska and California has forced West Coast refiners to import 1-1.5 million bbl/day of oil, including more than half of California's crude supply, much of it from OPEC producers. In the event of an interruption of those deliveries, and under current oil-export restrictions, getting SPR oil from Texas and Louisiana to L.A. and San Francisco would pose enormous logistical challenges.
We have also learned that natural disasters such as hurricanes Katrina and Rita in 2005 and Superstorm Sandy in 2012 affect refinery operations, as well as oil deliveries. A crude oil SPR is of little value if its contents can't be processed into the fuels that consumers and industry actually use. The newer Northeast heating oil and gasoline reserves were intended to address that limitation, though on a much smaller scale.
It is thus fair to say that the SPR established in the Ford Administration and filled by the next five US presidents to a level now equivalent to 137 days of US crude oil imports is not diverse enough in its composition or locations, and too big for our current needs. If we could count on a continuation of cheap, abundant oil for the next two decades, selling off some of the SPR's inventory wouldn't create much cause for concern. Yet the purpose of such a reserve is to mitigate the risks of uncertain and inherently unpredictable future conditions and events. That should be factored into any decision to shrink the SPR.
We don't have to look far to find reasons to suspect that oil prices might someday be higher and more volatile than today--perhaps as soon as the 2018-25 legislated SPR sales period--or to worry that oil supplies from the Middle East might become less secure.
Consider the consequences of the oil price collapse that began over a year ago. Low oil prices have indeed put pressure on the highly flexible US shale sector, where production is now expected to drop by around 500,000 bbl/day by next year. The impact on large-scale, long-lead-time capital investments in places like Canada, the North Sea and Gulf of Mexico has been even more profound. Over $200 billion of new projects and exploration activity have been deferred or canceled. Unlike shale, most of these projects could not be revived quickly if prices rebounded.
As production from existing fields declines without replacement, the current global oil surplus will gradually dissipate, bringing the market back into balance. However, that balance is likely to be more precarious than before, since OPEC's strategic shift to protect market share instead of managing prices entails the shrinkage of its "spare capacity." That means that in a future crisis, Saudi Arabia and other OPEC producers would have less flexibility to increase production to make up for lost output elsewhere.
Barring an unforeseen reduction in global oil demand, the scenario that is starting to take shape, including the prospect of rising US oil imports, increasing reliance on OPEC, and the growth of ISIS in the world's oil "breadbasket", fits the pattern of risks the SPR was originally intended to address. In that light it is hard to justify reducing the size of the SPR without a clear plan for making the remaining volume more effective at shoring up future vulnerabilities in US energy security.
In their haste to reach a deal, Congressional negotiators may also have overlooked some SPR-related alternatives that could generate revenue without draining inventories. These might include allowing other countries to buy into the reserve by means of "special drawing rights," or simply selling long-dated call options backed by the SPR, to be settled in the future by delivery or cash, at the government's discretion.
Together, these strategic and geopolitical concerns should provide ample motivation for the next Congress and administration to revisit the SPR sales provisions of the 2016 budget deal, before they go into effect.