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The US and its strategic petroleum reserve dilemma

For almost 40 years the US’s strategic petroleum reserve (SPR) has been the front line of defence against global oil-price shocks

Formed in 1973, the 727 million barrel stash is the legacy of the Middle East oil embargo and an era of gasoline rationing and queues.

The idea for the SPR, however, originated in the Second World War and came up again following the Suez crisis in 1956. The Cabinet Task Force on Oil Import Control recommended a similar reserve in 1970, but it wasn’t until the oil crisis of the early 1970s that the government was tipped to act.

Today it is the largest source of government-owned petroleum reserves in the world, and a potent tool for the US government to protect vital economic and security interests.

The reserve itself is no single entity. The barrels are held in 62 salt caverns located at four separate storage sites along the Gulf Coast. Each pool ranges in size from six to 35m barrels, and each storage facility is chosen for geological properties and proximity to refineries and pipeline networks in Texas and Louisiana.

The main purpose of the SPR is to insulate US consumers from supply disruptions and shortages of refined products like gasoline. It also provides a national defence fuel reserve in the event of war or natural disasters like hurricanes.

It isn’t a rainy-day oil fund. Yet exchanges and swaps of SPR oil have routinely been used to top off heating-oil inventories and smooth out smaller periodic disruptions in regional distribution networks caused by accidents and blockages in the Gulf’s inter-coastal waterways.

The most recent release came in response to Hurricane Isaac in September, and took the form of a 1m barrel loan to Marathon Oil Corporation.

Decisions for SPR withdrawal belong to the president under the authority of the Energy Policy and Conservation Act. In the event of an emergency, SPR oil would be distributed by competitive sale following an executive order from the White House. Presidential decrees were used to release stocks in 1991, before operation Desert Storm to push Saddam Hussein’s forces out of Kuwait, and again in 2005 following Hurricane Katrina.

There are also financial considerations at play. In 1996-97, several co-ordinated sales raised about $894.6bn to reduce the federal budget deficit.

Ongoing smaller sales are used to test the operational capability of the system and to support maintenance activities. Earlier this year such a sale was used to remove scaling in the caverns and prevent “salt creep” that can reduce the capacity of the system by 1m to 2m barrels a year.

But the SPR has also become an instrument of policy, to blunt the impact of high oil prices on the global economy from geopolitical events abroad.

In June 2011, President Barack Obama directed a sale of 30m barrels of crude oil to offset disruptions caused by Libya’s civil war. The US acted in coordination with the International Energy Agency (IEA) to release a total of 60m barrels globally (half from the US).

The US sales were coordinated through a tender process handled by the Department of Energy (DOE). In response to the Libyan crisis, the SPR issued a notice of sale on 24 June 2011, soliciting offers for the purchase of 30m barrels to be delivered by the end of August of that year. The DOE received 90 offers that resulted in 28 contracts with 15 companies for deliveries of 30.64m barrels.

But the view of the SPR is changing as Nor th America’s supply and demand picture shifts, too.

Although IEA rules require member states to hold strategic reserves, some US experts wonder whether the SPR is necessary or even desirable The US and its SPR dilemma in an era of falling domestic demand and rising production. According to Philip Verleger, an industry consultant, the SPR has outlived its original purpose: far from providing a bulwark against supply disruption, the SPR has become a tool for electioneering and low-brow politicking.

Verleger has advised US presidents including Jimmy Carter on energy policy, and was instrumental in the formation of oil-futures markets that led to the creation of the New York Mercantile Exchange.

Even the rumour of a stock release is enough to temper prices and shift broader trading patterns – sometimes to the detriment of consumers. Verleger reckons threats to release oil in recent months have done little to lower crude prices and prompted instead a surge of speculation in the products market.

Because the SPR is made up of raw crude that must be refined before it can be marketed, traders go short on refined products like gasoline and diesel when a release is announced. This has the effect of reducing inventories and raising prices for those commodities.

Sell the SPR!

“Every time we see these rumours (of an SPR release), gasoline and diesel inventories go down, heating oil inventories go down and it’s a big disaster to replace them,” Verleger said in an interview. “An SPR release does nothing for low inventories of product.”

So SPR-release chatter, which has been floating around since March, may have cost cost US consumers about $50bn and opened downstream markets to speculators, reckons Verleger.

His solution is radical: liquidate the reserve. “We don’t need it. It’s served its purpose. We should sell it and pay down the deficit.” An outright sale of the SPR would generate some $75bn for government coffers.

But would it leave the US at risk of a supply interruption – perhaps one stemming from another crisis in the Middle East?

Verleger doesn’t think so – for the same reasons the US and other IEA members are unlikely to open the taps now. The global market is well supplied and demand is weak. “There’s enough oil in the world market. The Saudis have said they will make up any shortfall.”

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