[Senate Hearing 110-358]
[From the U.S. Government Publishing Office]
S. Hrg. 110-358
OIL INVENTORY POLICIES
=======================================================================
HEARING
before the
COMMITTEE ON
ENERGY AND NATURAL RESOURCES
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
TO
RECEIVE TESTIMONY ON U.S. OIL INVENTORY POLICIES, INCLUDING THE
STRATEGIC PETROLEUM RESERVE POLICIES
__________
FEBRUARY 26, 2008
Printed for the use of the
Committee on Energy and Natural Resources
______
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41-997 PDF WASHINGTON DC: 2008
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COMMITTEE ON ENERGY AND NATURAL RESOURCES
JEFF BINGAMAN, New Mexico, Chairman
DANIEL K. AKAKA, Hawaii PETE V. DOMENICI, New Mexico
BYRON L. DORGAN, North Dakota LARRY E. CRAIG, Idaho
RON WYDEN, Oregon LISA MURKOWSKI, Alaska
TIM JOHNSON, South Dakota RICHARD BURR, North Carolina
MARY L. LANDRIEU, Louisiana JIM DeMINT, South Carolina
MARIA CANTWELL, Washington BOB CORKER, Tennessee
KEN SALAZAR, Colorado JOHN BARRASSO, Wyoming
ROBERT MENENDEZ, New Jersey JEFF SESSIONS, Alabama
BLANCHE L. LINCOLN, Arkansas GORDON H. SMITH, Oregon
BERNARD SANDERS, Vermont JIM BUNNING, Kentucky
JON TESTER, Montana MEL MARTINEZ, Florida
Robert M. Simon, Staff Director
Sam E. Fowler, Chief Counsel
Frank Macchiarola, Republican Staff Director
Judith K. Pensabene, Republican Chief Counsel
C O N T E N T S
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STATEMENTS
Page
Bingaman, Hon. Jeff, U.S. Senator From New Mexico................ 1
Craig, Hon. Larry, U.S. Senator From Idaho....................... 5
Domenici, Hon. Pete V., U.S. Senator From New Mexico............. 6
Dorgan, Hon. Byron L., U.S. Senator From North Dakota............ 3
Fredriksen, Katharine, Principal Deputy Assistant Secretary,
Office of Policy and International Affairs, Department of
Energy......................................................... 8
Kenderdine, Melanie A., Associate Director, Strategic Planning,
MIT Energy Initiative, Cambridge, MA........................... 29
Murkowski, Hon. Lisa, U.S. Senator From Alaska................... 4
Rusco, Frank, Acting Director, Natural Resources and Environment,
Government Accountability Office............................... 14
Verrastro, Frank A., Director and Senior Fellow, Energy and
National Security Program, Center for Strategic and
International Studies.......................................... 22
APPENDIX
Responses to additional questions................................ 65
OIL INVENTORY POLICIES
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TUESDAY, FEBRUARY 26, 2008
U.S. Senate,
Committee on Energy and Natural Resources,
Washington, DC.
The committee met, pursuant to notice, at 10:02 a.m. in
room SD-366, Dirksen Senate Office Building, Hon. Jeff
Bingaman, chairman, presiding.
OPENING STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR FROM NEW
MEXICO
The Chairman. Why don't we go ahead and get started.
Senator Domenici is on his way. I need to advise all witnesses
which, unfortunately, we have, I believe it's going to be three
votes that start at 10:10. We're not going to have to break
right at 10:10, but about 10:20 we will have to break.
So, maybe we can get as many statements in as possible
before then. Let me just make a very short statement here.
Thank you for being here. Thanks to all the witnesses.
The purpose of this hearing is to discuss a critical aspect
of our Nation's energy security, oil inventories and in
particular, the strategic petroleum reserve. I'm concerned
about the current policy to fill the SPR with royalty in kind
oil from the Department of Interior regardless of market
conditions. For that reason I have co-sponsored Senator
Dorgan's bill to essentially take a time out on filling SPR as
we face the threat that Venezuela might suspend oil shipments
to the U.S. It's more appropriate, in my view, for us to
consider releasing oil from the SPR rather than filling it.
I'd also like to discuss the broader policy issues related
to the Strategic Petroleum Reserve. The Administration has
asked Congress for legal authority to double the size of the
reserve to 1.5 billion barrels. Before we can consider such a
request, I believe it would make sense to think first about our
policy related to the SPR fill and drawdown. Second, think
about whether simply increasing crude storage will truly
enhance our ability to respond to oil supply disruptions.
Our Strategic Petroleum Reserve fill and drawdown policies
are inconsistent across different Administrations. Sometimes
they're inconsistent within Administrations. Perhaps it's time
to consider adding more clarity to SPR policies so that the
market can know what to expect during oil supply disruptions.
I'm concerned that the current Administration seems to have
changed the long standing policy that originated in the Reagan
Administration which stated that in the case of a world oil
supply disruption, the SPR would be drawn down early and in
large volumes. The SPR policy enacted during the 1990 and 1991
Desert Storm Operation offered an example of this ``early and
large volumes'' policy and action. The DOE observed that world
oil markets remained remarkably calm throughout most of the war
due largely to the swift release of the Strategic Petroleum
Reserve oil.
Then Secretary of Energy Watkins noted, ``We have sent an
important message to the American people that their 20 billion
dollar investment in an emergency supply of crude oil has
produced a system that can respond rapidly and effectively to
the threat of an energy disruption.'' In contrast, the current
Administration has gone in a different direction deciding not
to release SPR oil despite three nearly simultaneous oil supply
disruptions in Venezuela, Iraq and Nigeria in 2003. In order to
ensure that this large investment, it was worth 20 billion when
Secretary Watkins was in office, but today it's worth more like
70 trillion, still responds effectively in the case of a
disruption, we need to clarify the conditions under which SPR
should be used. For a more technical level we need to discuss
whether we should be adding more crude oil inventories or
instead storing refined products; whether we should have the
government own all of the oil or whether there are other more
market friendly approaches to increasing our supply cushion.
The IEA has pointed out that the United States demand for
refined petroleum products exceeds our refinery capacity. The
agency therefore has recommended that we consider other policy
options to enhance our response capability. Our Nation's energy
security is too important to set on auto pilot, and the purpose
of today's hearing is to determine what other course we might
follow.
I know Senator Domenici is going to have an opening
statement when he arrives. Let me just ask if either of my
colleagues felt they'd want to make a statement right now. Do
you want to start?
Senator Barrasso. Just in the interest of time, Mr. Chair,
I know you----
The Chairman. Yes.
Senator Barrasso [continuing]. Have the committee voting in
about 10 minutes. Senator Domenici is coming in.
The Chairman. Oh, good. Ok.
[The prepared statements of Senators Bingaman, Dorgan, and
Murkowski follow:]
Prepared Statement of Hon. Jeff Bingaman, U.S. Senator From New Mexico
Thank you all for coming today to discuss a critical aspect of our
nation's energy security: oil inventories and the Strategic Petroleum
Reserve in particular. I am concerned about the current policy to fill
the SPR with Royalty-in-Kind oil from the Department of the Interior,
regardless of market conditions, which is why I am co-sponsoring
Senator Dorgan's bill to take a time out on filling the SPR. As we face
the threat that Venezuela might suspend oil shipments to the United
States, it is more appropriate for us to be considering releasing the
SPR rather than filling it.
But I would also like to discuss broader policy issues related to
the Reserve. The Administration has asked Congress for the legal
authority to double the size of the Reserve to 1.5 billion barrels.
Before we can even consider such a request, it seems to me that we need
to think first about our policy related to SPR fill and drawdown, and
second, think about whether simply increasing crude storage will truly
enhance our ability to respond to oil supply disruptions.
Our SPR fill and drawdown policies are inconsistent across
different Administrations, and sometimes within Administrations.
Perhaps it is time for us to consider adding more clarity to SPR
policies, so that the market can know what to expect during oil supply
disruptions. I am concerned that the current Administration seems to
have changed the long-standing policy that originated in the Reagan
Administration, which stated that in the case of a world oil supply
disruption, the SPR would be drawn down early and in large volumes. The
SPR policy enacted during the 1990-1991 Desert Storm operation offered
an example of this ``early and in large volumes'' policy in action. DOE
observed that ``world oil markets remained remarkably calm throughout
most of the war, due largely to the swift release of the Strategic
Petroleum Reserve oil.'' Then-Secretary of Energy Watkins noted, ``We
have sent an important message to the American people that their $20
billion investment in an emergency supply of crude oil has produced a
system that can respond rapidly and effectively to the threat of an
energy disruption.''
However, the current Administration gone in a different direction,
deciding not to release SPR oil, despite three nearly simultaneous oil
supply disruptions in Venezuela, Iraq, and Nigeria in 2003. In order to
ensure that this large investment--worth $20 billion in Secretary
Watkin's day, but more like $70 billion today--still responds
effectively in the case of a disruption, we need to clarify the
conditions under which the SPR should be used.
On a more technical level, we need to discuss whether we should be
adding more crude oil inventories, or storing refined products; whether
we should have the government own all of the oil, or whether there are
other, more market-friendly approaches to increasing our supply
cushion. The International Energy Agency has pointed out that U.S.
demand for refined petroleum products exceeds our refinery capacity.
The Agency therefore has recommended that we consider other policy
options to enhance our emergency response capability.
Our nations' energy security is too important to set on auto-pilot.
I hope that this hearing will help us to be more thoughtful about our
emergency response capability.
______
Prepared Statement of Hon. Byron L. Dorgan, U.S. Senator From
North Dakota
When it comes to the Strategic Petroleum Reserve (SPR), the
Administration's policy has been to say let's ``top it off'' I want to
be clear that we have a major difference of opinion. My view, and that
of many of my colleagues, is that we need to take a timeout from
filling the SPR.
With oil trading at record highs and supplies tightening, it makes
no sense to me why this Administration wants to continue removing oil
from the market and sticking it underground. The SPR is more than 96
percent full. We are meeting our international treaty obligations for
oil inventories from public and private oil stocks. DOE's own figures
show that we have about 118 days of import protection, which is more
than our 90-day requirement.
Oil has been trading at over $100 per barrel for a number of days
in 2008. OPEC is expected to cut production again. Excess speculation
is distorting market fundamentals and driving up the price of a barrel.
We heard testimony before the Energy Subcommittee from an oil industry
expert at Oppenheimer that excess speculation may be adding as much as
$30 to the price of a barrel of oil.
Keeping oil on the market, instead of putting it underground, will
put some downward pressure on oil prices and help ease the pain
consumers are feeling at the pump.
However, the Administration continues to maintain that removing oil
from the market and storing it underground does not impact on the oil
prices. The Department of Energy has supposedly done an internal
analysis that says that there is little to no major market impact
because this is such a small portion of global daily use. I have not
seen this analysis. I am not certain whether it has been peer-reviewed
or even if it is available to the public.
I would like to know whether the Administration has a determined
price threshold that would reverse its SPR fill policy. Is it oil
trading at $120/barrel per barrel? Is it $3.50/gallon gasoline? When
will they say filling the reserve becomes cost prohibitive?
Along with a price threshold, I would also like the Administration
to provide to the Congress the total costs for filling the SPR today or
the potential costs of their long-term plan to fill the SPR to the 1.5
billion barrel level.
We must further examine the near- and long-term use of precious
federal resources to make our nation more energy secure. I am convinced
that filling the SPR at this time is not the best way to direct
resources toward our national energy priorities.
Congress recently passed major energy bills to address our
challenges including the Energy Policy Act of 2005, the Gulf of Mexico
Energy Security Act of 2006 and the Energy Independence and Security
Act of 2007. These are important steps, but much more needs to be done.
This Administration continues to short-change funding for critical
energy programs, but they have no problem filling the SPR with $100/
barrel oil. This makes no sense to me.
I want to be clear that I do believe the SPR is an important asset
for our nation's economic and national security interests. But I also
believe that we need to look at other alternatives rather than just
``topping it off' at any price.
For these reasons, I introduced S. 2598, the Strategic Petroleum
Reserve Fill Suspension and Consumer Protection Act of 2008. I very
much appreciate the support of Senators Bingaman, Collins, Kerry,
Wyden, Levin, and Lieberman who have joined me as original cosponsors,
and I certainly welcome others as cosponsors.
This legislation is very simple: It would suspend filling the
Strategic Petroleum Reserve for one year unless the price of oil drops
below $50 per barrel during the remainder of 2008. This includes both
purchasing oil for the reserve and filling the reserve with oil from
royalty-in-kind contracts or any other means of acquisition.
As I said earlier, the reserve is at least 96 percent full. The
current capacity is 727 million barrels of oil. The current inventory
is about 700 million barrels. The Administration has gone forward and
recently awarded three contracts to Shell Trading Co., Sunoco
Logistics, and BP North America to fill an additional 12.3 million
barrels of oil over the next six months. My understanding is that they
may offer contracts later this year to fill 125,000 barrels per day for
an amount of time.
I am particularly concerned that the DOE is removing highly sought
after light sweet crude from the market. We heard testimony on November
12, 2007 from Dr. Philip Verleger before a joint hearing between the
Energy Subcommittee and Homeland, Government Affairs Permanent
Subcommittee on Investigations that indicated the Administration's
policy could be adding as much as $10 to the price of a barrel of oil.
Dr. Verleger went onto make the point that this volume of light
sweet crude that they want to put into the SPR may have only been 0.3
percent of the total global supply available, but it was adding at much
as 10 percent to the price of light sweet crude. Yet, DOE still claims
that their policy has no economic impact on the price of oil.
I believe it does and we need to take a timeout from filling the
SPR to help stabilize energy prices.
Mr. Chairman, I think that this hearing is very timely, and I hope
to work with you and other colleagues in the Senate to reverse this
wrongheaded, senseless approach.
______
Prepared Statement of Hon. Lisa Murkowski, U.S. Senator From Alaska
Mr. Chairman, thank you for holding this oversight hearing on the
workings of the nation's Strategic Petroleum Reserve (SPR). I would
like to express my clear support for expanding the size of the nation's
hydrocarbon reserves, while also expressing some willingness to see the
government show more flexibility on when it deposits oil into the SPR.
Following the 1973 Arab oil embargo, the United States wisely chose
to utilize salt caverns in Louisiana and Texas and fill them with oil
to provide the nation with strategic energy stockpiles in the event of
import supply disruptions, whether caused by politically induced
boycotts or naturally induced hurricanes or earthquakes.
Currently the Strategic Petroleum Reserve contains about 699
million barrels of oil stored in four salt caverns: the Bryan Mound and
Big Hill reserves in Texas and the West Hackberry and Bayou Choctaw
reserves in Louisiana. Congress in 2005 already authorized the
expansion of the four existing sites, plus the development of a new 160
million barrel reserve, likely to be located at Richton in Mississippi,
in order to increase the reserve to hold up to 1 billion barrels from
the 727 it currently can hold. The President last year proposed that
the size of the reserve be increased still further to 1.5 billion
barrels by 2026.
Under U.S. commitments to the International Energy Agency that were
the outgrowth of G-8 discussions after the 1973-74 embargo, America and
all G-8 nations are required to hold petroleum inventories equal to 90
days of (net) oil imports. Since the commercial reserves held by
private firms continue to decrease relative to U.S. needs, the size of
the nation's strategic reserves needs to increase. According to the EIA
by 2010 we will have only 61 days of oil import protection from the 727
million barrels in the four existing caverns. Even proceeding with the
expansion to 1 billion barrels will only provide the nation a 62-day
supply given the nation's likely increased consumption of petroleum by
2030. We will continue to have to encourage private companies to
maintain a 30-to 60-day commercial inventory supply just to meet our
international commitments.
But maintaining and expanding the Strategic Petroleum Reserve is
required not just to maintain our commitment to the International
Energy Agency. It is important if we are to protect the nation's
military and economic security. Currently this nation produces about
5.2 million barrels of oil a day. While EIA predicts that today's high
prices may edge production back to a peak of 6.4 million barrels a day
by 2020, our consumption is nearly 21 million barrels a day and is
expected to hit nearly 25 million barrels a day by 2030.
Thus it is clear that we need to improve and expand SPR, not
curtail its operations. Our existing SPR can pump only about 4.4
million barrels of oil a day out of the salt caverns and into pipelines
to head to refineries. That ability needs to continually expand in
order for our stored oil to be readily available to help maintain our
economy in the event of energy import disruptions. We also need to
consider funding expansions of refined product reserves, not just for
the Northeast, but for the West Coast and Southwest. Given the nation's
pipeline network limitations, it takes only 5 or 6 days to move SPR oil
to Midwestern refineries and 6 to 8 days to move SPR oil by tanker to
East Coast refineries, but 16 to 18 days to move oil to the West Coast
via the Panama Canal. It is important that we plan and install new ways
to store reserves of both crude oil and refined products on the West
Coast and add to the Northeast heating oil reserve so that we can store
more refined products for East Coast use. The effects of 2005's
Hurricanes Katrina, Rita and Wilma all show that speading our reserves
around geographically would make excellent sense from a strategic
standpoint.
The need for West Coast oil was one of the reasons that last year I
and my Alaska colleague Senator Ted Stevens proposed opening the Arctic
coastal plain to oil development, but moving the federal share of the
oil that would be produced into a new Strategic Petroleum Reserve. That
would allow us to expand our oil stockpiles without hurting current
market supplies or prompting price hikes for oil. I still hope to
convince Congress of the economic and supply benefits of classifying
part of the Alaska's reserves in the Arctic National Wildlife Refuge
for deposit in a SPR.
So I support continued funding to expand the physical size of the
SPR. But I am willing to listen to arguments for permitting oil to be
deposited into the SPR only when prices are below last week's $100 per
barrel price. While we don't actually pay money for oil--we simply
divert the U.S. royalty share of Gulf of Mexico oil production into
SPR--putting that oil into the reserve takes oil that could go onto
world markets to help drive down prices out of general circulation.
Even though the amount of oil, 70,000 barrels a day is so small that it
likely has little effect on prices, depositing that oil in SPR
certainly does little to reduce high prices.
So it does make sense to fill the SPR more slowly when prices are
high so that more of the U.S. royalty share of oil goes to markets to
help put some slight pressure to drive down prices. While I do not
support passing a statute that prohibits deposits unless oil prices are
less than some set threshold, it does make sense to suspend oil
deposits and to sell government oil on the open market to help
psychologically reduce prices at times of extremely high prices and
significant price volatility.
I expect this hearing to give us better guidance on how to suggest
to the Department of Energy on when to acquire oil for SPR and when to
stop pumping new oil into the reserve. While oil prices aren't likely
to return to the $10 per barrel prices of two decades ago, they
certainly are likely to fall from the current $90 to $100 per barrel
price. And as we all know it is better to buy low, than to buy high.
I look forward to the expert testimony and advice we are to receive
today to help us craft a better oversight policy for SPR acquisitions
and storage efforts. Thank you Mr. Chairman.
STATEMENT OF HON. LARRY CRAIG, U.S. SENATOR
FROM IDAHO
Senator Craig. Mr. Chairman, while the Senators are being
seated, can I make just a few comments?
The Chairman. Sure.
Senator Craig. I'm not in disagreement with you as it
relates to a consistent policy. Last week with the explosion of
the refinery in Texas, oil hit $100 a barrel. Who says $70 and
$80 and $90 barrel oil may not be a bargain today based on what
it could be out there in the future.
What we did in, you know, EPACT with bumping it up to a
billion barrels instead of the 699 million we have now probably
is the right and reasonable cushion. We may never reach that
goal if we set the target at $50 a barrel. But having said that
let me suggest that there's another way of looking at this.
If we took 10 million out of the SPR money and did the kind
of responsible inventory of offshore reserves today. That we
know are out there, but we don't have a contemporaneous, modern
inventory and analysis of where they all are. That might be the
greatest SPR for our country that we could possibly have. We
know the fights involved in all of that and so the easy way out
is to buy expensive oil and stick it back in the ground. What
about the less expensive oil that's already out there in the
ground that we ought to inventory and modernize to know what
our country has available to it.
There are a lot of ways of looking at this. I suggest the
greatest pro is in the Gulf. It's in ANWR. It's in off our East
and West Coast. But none of us want to go there. We want to
fight over a reasonable cushion of security of a billion
barrels and a refinery capacity that in a short run or at least
in the case of the explosion, in Texas, that takes a refinery
off line for a time, causes a spike in the market.
I guess that's my concern. I can see the need of
consistency. I can also see the need of security and the
greater security is not in SPR, it's in tapping our own
reserves. Thank you.
The Chairman. Senator Domenici, did you want to make a
statement at this point or do you want me to go right to the
witnesses? What's your preference?
STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR FROM NEW
MEXICO
Senator Domenici. I prefer that you go on. I just wanted to
comment on your statement that we don't want to proceed with
the offshore resources and the like. I want the record to show
that that plural ``we'' didn't apply to me, cause I do.
The Chairman. I'm talking about a collective ``we'll'' in
this context. That's right.
Senator Domenici. I've already tried and we've succeeded a
little bit.
The Chairman. That's right.
Senator Domenici. We've got to try some more. Instead of
doing this we ought to have another bill. I'll put my prepared
statement in the record and might use it in the questions.
Senator Domenici. But for the purposes of where we are, I
don't agree with the bill that suggests that we ought to stop
putting oil in SPR because of the current price. Thank you, Mr.
Chairman.
[The prepared statement of Senator Domenici follows:]
Prepared Statement of Hon. Pete V. Domenici, U.S. Senator From
New Mexico
Welcome. I want to thank our panel of witnesses for taking time out
of their busy schedules to join us today. Your testimony will be
invaluable as we look into the United States' oil inventory policy,
specifically the policy related to the Strategic Petroleum Reserve
(SPR).
In the last year, oil prices have increased nearly 60% because of
geopolitical instability, a lack of additional refining capacity, and
the tightness of the global market. Despite the increase in oil and
petroleum costs, the Energy Information Administration (EIA) in its
2008 Energy Out look expects world oil consumption to rise 0.6% and the
total U.S. petroleum consumption to increase 1.0% in 2008.
Recently, there has been concern surrounding SPR fill activity
because of high oil prices. However, the fill rate of the SPR is 70,000
barrels a day, which is less than one tenth of one percent of U.S.
daily consumption and between one sixteenth and one ninth of one
percent of world oil consumption, which is reaching approximately 90
million barrels per day. Therefore, the fill activity is having a
minimal impact on the market and has done little to increase world oil
prices.
Almost everyone agrees that we should have a SPR, but there has
been controversy since the 1980's surrounding the purpose of the SPR
and how the reserve should be used and managed.
The U.S. established the SPR as a result of the Arab Oil Embargo by
the Organization of Petroleum Exporting Countries (OPEC), which reduced
crude oil production and caused economic disruption to the U.S. The
original intent of the SPR was to discourage the use of oil as a
political weapon and to be used during temporary oil supply
disruptions.
Our nation's future energy security is tenuous because the U.S.
continues to increase petroleum consumption while our domestic
production is leveling off. The result is a greater dependence on
foreign oil year after year. Additionally, there is an increase in
political instabilities within oil producing countries like Nigeria and
Venezuela, and the presence of terrorist activities in the Middle East
increases the potential risk to OPEC production. Not to mention acts of
nature such as hurricanes.
The SPR's current capacity is 727 million barrels, it has an
inventory of 698 million barrels and a drawdown ability of 4.4 million
barrels a day for the first 90 days; and thereafter the rate would
begin to decline. Therefore, filling and expanding the reserve is
necessary to strengthen the long-term energy security of the United
States. The SPR is not intended to affect oil prices. It is a national
security asset.
Mr. Chairman, I appreciate your willingness to hold this hearing
and examine the SPR inventory policies. But this is also an opportunity
to recognize the fact that we should focus on expanding access to new
domestic sources of oil. As you know I would like to see development
increase on the outer continental shelf. And I am hopeful that we will
not revise the wise policies of advancing research and development and
commercial production of oil shale.
As Recent studies by the Department of Interior estimate that
federal lands have more than 20 billion barrels of untapped oil and
another 20 billion in federally restricted offshore areas. This amount
of federally restricted domestic resources is 100 times more than the
amount in the SPR. As prices continue to rise and we ship nearly $400
billion annually overseas to import oil-it is essential that we re-exam
our domestic production policies.
I look forward to hearing from today's witnesses, and, going
forward, to working with the members of this Committee on this serious
matter. Thank you.
The Chairman. Alright. Why don't we get started on the
statements? As I indicated about 10 minutes into the first vote
we'll just stop wherever we are and return after what I think
will be three votes.
Our witnesses--let me introduce them all here. Katharine
Fredriksen, who is the Principal Deputy Assistant Secretary in
the Office of Policy and International Affairs in the
Department of Energy, thank you for being here. Frank Rusco,
who is the Acting Director for the Natural Resources and
Environment area in the GAO. Frank Verrastro, thank you for
being here. He's the Director and Senior Fellow with Energy and
National Security Program for the CSIS, the Center for
Strategic and International Studies here in Washington. Melanie
Kenderdine, who is the Associate Director for Strategic
Planning at the MIT Energy Initiative in Cambridge, thank you
for being here.
Ms. Fredriksen, why don't you go right ahead?
STATEMENT OF KATHARINE FREDRIKSEN, PRINCIPAL DEPUTY ASSISTANT
SECRETARY, OFFICE OF POLICY AND INTERNATIONAL AFFAIRS,
DEPARTMENT OF ENERGY
Ms. Fredriksen. Thank you, Mr. Chairman, members of the
committee. It's my pleasure to appear before you today to
discuss the importance of the Strategic Petroleum Reserve and
its role in providing energy security to our Nation.
Our energy security is directly intertwined with our
national security. In fact we are in a time of great risk when
it comes to both realities. Global energy consumption will
continue to increase by roughly 50 percent by 2030 with oil
projected to remain the single largest source of that energy.
Oil resources are often located in places that are
geographically hard to reach, difficult to develop and
politically unstable or unfriendly to new, foreign investment.
Record high oil prices reflect that growing global demand, the
limited spare to production capacity due to insufficient
investment, a similar lack of investment in exploration and
rising development costs. In 2006 the United States imported
over 12 million barrels of petroleum a day accounting for
roughly 60 percent of our daily consumption.
Although you must answer today's question on reserve
capacity, we must also confront the question of tomorrow. That
is how to reduce our dependence on fossil fuels. We must as a
global leader in the world and the world's largest energy
consumer, fundamentally transform the way the world produces
and consumes energy.
We must expand and diversify our supplies and our
suppliers, increase our efficiency, modernize and expand our
infrastructure and improve our environmental stewardship. We
must confront the reasons why we are dependent on foreign oil.
How we can mitigate these circumstances including increasing
our own domestic exploration and production.
Despite the concern about reliance on foreign oil this
Nation continues to forgo available self help, the tremendous
resources available in ANWR and the vast majority of the outer
continental shelf. The Department is continually working to
develop alternative energy sources and to improve our existing
energy infrastructure. Only by confronting our energy security,
in its entire context, can we properly make decisions on our
national reserves and their critical importance to our Nation
in times of natural or unnatural emergencies.
In looking at the two emergency drawdowns in the SPR's
history, it is clear that this tool was vital during both
events, whether as a result of a global conflict like Operation
Desert Storm or a natural disaster such as Hurricanes Katrina
and Rita where approximately 25 percent of our Nation's
refining capacity was impacted. Our reserves were critical in
these periods. They were immediately put into action.
The conversation should not focus on whether the Strategic
Petroleum Reserves serve a significant role in our energy
security because it unquestionably does, as our Nation's one
and only insurance policy against global supply disruption. The
conversation should also not focus on whether the Reserve
serves its purpose as America's fulfillment to our
international treaty commitments as agreed to under the
agreement for International Energy Program under the IEA
charter because we do. The conversations should instead focus
on a shared philosophy to increase the capacity of the Reserve
and answer the President's call in his 2007 State of the Union
Address to double that Reserve to 1.5 billion barrels.
This conversation is imperative. It needs to be addressed
so that the United States has the appropriate and vital layer
of protection it needs to ensure that adequate energy supplies
are available to the American people in the case of a severe
supply disruption. Our energy and national security concerns
must be paramount. One might argue that the macro economic
shock from a severe supply disruption is greater when oil is at
$100 per barrel then when it is at $50 or even $20 per barrel.
Thus the protection provided by the SPR is even more
imperative.
As of today the SPR has an inventory of approximately 699
million barrels of its current capacity of 727 million barrels.
In the case of a severe supply disruption that accounts for
approximately 58 days of U.S. petroleum imports based on the
EIA's import information. By law the SPR may be used if the
President has determined that a severe supply disruption has
occurred that threatens the economic security of the United
States or it can use it in fulfillment of international treaty
obligations.
By the end of March 2008, we expect the SPR inventory to
reach 700.7 million barrels, the highest volume to date. That
was the level reached just before Hurricane Katrina. As a
result of the damage to production and refining from those
hurricanes, President Bush issued a finding of severe energy
supply emergency.
Short term loans totaling 9.8 million barrels were
executed. The IEA then authorized a 60 million barrel drawdown
to counter the effects on the global market of which the U.S.
was obligated to offer 30 million barrels to the market. This
resulted in the competitive sale of 11 million barrels.
The loaned oil has been replaced. It was done in May 2007.
The sold oil has not yet been repurchased.
According to the IEA in September of last year, our total
oil stocks in the U.S. including the SPR roughly equate to 120
days of net imports or about 80 days of our consumption. There
are no compulsory stock requirements for oil companies in the
United States. The number of days of net import protection the
SPR inventory provides has significantly declined since the end
of 1985. Import dependency has steadily risen from 30 percent
of demand in 1985 to approximately 60 percent in 2004.
The SPR's net import coverage has fallen from a high of 118
days at the end of 1985 to a range of approximately 55 days in
recent years. Increases in the SPR volume since 2001 have
interrupted that downward trend as can be shown from the
graphic. Oil initially purchased for the SPR was chosen to
represent the crude that are processed by our refineries.
Seven categories of crude were used to define the crude
quality for acquisition. But in order to achieve the required
site drawdown rates it was necessary to co-mingle similar sweet
crudes in storage. Today the SPR maintains only two
segregations of oil types: one sweet and one crude, or one
sour.
Light crudes were selected because they offer several
significant advantages in the event of a crude import
disruption. First they can be refined or processed by all
refineries from the simplest to the most complex. They are the
easiest crudes to refine requiring only the basic refinery
processing units. They don't require any of the desulfurization
equipment, vacuum distillation, cat cracking or cooking units
to handle the heavy bottoms.
Second, most refiners can use light crudes to increase or
maximize their refinery output of light distillate. This is
especially important when refined product exports have been
disrupted. Light crudes will produce the maximum volume of
gasoline and naphtha. A barrel of light crude will yield more
gasoline and naphtha in the refining than a barrel of medium or
heavy crude will.
In 2005 we conducted a comprehensive crude compatibility
study of the current SPR crude oil streams. In general the
crudes currently stored are compatible and desirable for the
majority of the U.S. refineries and are well suited to mitigate
supply disruptions. There are however, 11 of the 150 refineries
in the U.S. which are specifically configured to process heavy
crude oil that will be impacted in the event of a disruption of
foreign crude supplies. They would still be able to process a
limited supply or quantity of crude oil from the SPR and still
maintain----
The Chairman. Could you go ahead and sort of summarize your
comments? They're running longer than we had expected.
Ms. Fredriksen. No problem, sir. It's a very difficult
topic. I appreciate your patience.
I will close by saying that the expansion of the SPR is
essential to meeting our future energy security needs. It is
our intent to increase the level of import protection stored in
the SPR as expeditiously as practicable. It is important to
remember that the SPR is a government asset.
A total of $19.4 billion in Federal funding has been
provided for acquisition of SPR. Based on current market prices
that inventory is valued at $62.8 billion based on a $90 per
barrel assumption. The amount currently being placed in the SPR
of 70,000 barrels per day of royalty in kind oil is less than
one-tenth of 1 percent of the daily global demand of 85 billion
barrels per day and is well within producers existing excess
production capacity.
This modest fill rate does not put undue pressure on
markets. The EIA, the IEA and the Cambridge Energy Research
Associates have repeatedly stated that global oil demand grows
and reduce commercial inventories have created the tightness on
the markets, not the modest SPR fill rate. Democrat and
Republican Presidents, Democrat and Republican led Congresses,
the 27 member nations of the IEA, as well as China and India,
all recognize the need for a strong Strategic Petroleum
Reserve.
In 2005 Congress passed and the President signed into law
the expansion of the SPR to one billion barrels. We must remain
on course to protect our energy and national security. I will
be happy to answer any questions. I thank you for this
completes my oral testimony.
[The prepared statement of Ms. Fredriksen follows:]
Prepared Statement of Katharine Fredriksen, Principal Deputy Assistant
Secretary, Office of Policy and International Affairs, Department of
Energy
Mr. Chairman, members of the Committee, it is my pleasure to appear
before you today to discuss the Strategic Petroleum Reserve (SPR) and
its important role in providing energy security to the United States.
energy security
Our Nation's energy security is directly intertwined with our
national security. In fact, we are in a time of great risk when it
comes to both realities. Global energy consumption will increase by
roughly 50 percent by 2030, with 70 percent of that growth coming from
the world's emerging economies. While oil's share of total energy use
is projected to decline, it is projected to remain the single largest
source of energy through 2030, with oil increasing in absolute terms.
Oil resources are often located in places geographically hard to reach,
difficult to develop and politically unstable, or unfriendly to new
foreign investment, superior technology, and modern business practices
of international energy companies.
Record high oil prices reflect growing global demand, limited spare
oil production capacity due to insufficient investment in producing new
supply, lack of investment in exploration and rising development costs.
In 2006, the United States imported over 12 million barrels of
petroleum a day, accounting for roughly 60% of our daily consumption.
Although we must answer today's question on reserve capacity, we
must also confront the question of tomorrow, which is how to reduce
America's dependence on fossil fuels to begin with? We must, as a
global leader, fundamentally transform the way the world produces and
consumes energy. We must expand and diversify our energy supply and our
suppliers, increase our energy efficiency, modernize and expand our
infrastructure and improve our environmental stewardship.
We must confront the reasons we are dependent on foreign oil, and
how we can mitigate these circumstances, including increased domestic
exploration and production. Our domestic exploration has nearly
bottomed out. Despite all the concern about reliance on foreign oil
this Nation continues to forego available self help: the tremendous
resource available in ANWR and the vast majority of the Outer
Continental Shelf. The Department is continually working to develop
alternative energy sources and improve our existing energy
infrastructure and eliminate the road blocks to that progress.
Only by confronting our energy security in its entire context, can
we properly make decisions on our national reserves and their critical
importance to our Nation in time of natural or unnatural emergencies.
In looking at the two emergency drawdowns in the SPR's history, it is
clear this vital tool was essential during both events, whether as the
result of a global conflict like Operation Desert Storm, or a natural
disaster, such as Hurricanes Katrina and Rita where approximately 25
percent of our Nation's refining capacity was impacted. Our reserves
were critical in these time periods and were immediately put into
action.
The conversation should not focus on whether the Strategic
Petroleum Reserve serves a significant role in our energy security,
because it unquestionably does as our Nation's one and only insurance
policy against global supply disruption. The conversation should also
not focus on whether the Reserve serves its purpose as America's
fulfillment of its international treaty commitments, as agreed to in
the Agreement for an International Energy Program, because we do. The
conversation should instead focus on a shared philosophy to increase
the capacity of the Reserve, and answer the President's call in his
2007 State of the Union address to double it. This conversation is
imperative and needs to be addressed so that the United States has the
appropriate and necessary layer of protection it needs to ensure that
adequate energy supplies are available to the American people in the
case of a severe supply disruption. Our energy and national security
concerns must be paramount.
BACKGROUND
In response to the 1973 Arab oil embargo, Congress enacted the
Energy Policy and Conservation Act (Public Law 94-163) to establish the
SPR. It was authorized in recognition of the long-term dependence of
the United States on imported crude oil and petroleum products and the
protection that a national petroleum stockpile would provide in the
event of future severe supply interruptions.
As of today, the SPR has an inventory of 698.6 million barrels of
its current capacity of 727 million barrels. In case of a severe supply
disruption, that accounts for roughly 58 days of U.S. petroleum imports
based on Energy Information Administration (EIA) historical import
information. By law, the SPR may be used if the President determines
that a severe oil supply interruption has occurred that threatens the
economic security of the United States or in fulfillment of
international treaty obligations.
CURRENT STATUS
By the end of March 2008, we expect the SPR inventory to reach
700.7 million barrels, the highest volume to date. That was the level
reached just before Hurricane Katrina devastated the Gulf Coast area in
2005, triggering a complete shutdown of production and extensive damage
to the refining and distribution facilities in the region. As a result,
President Bush issued a finding of a severe energy supply emergency.
Short-term loans (or time exchanges) totaling 9.8 million barrels were
also executed. The International Energy Agency (IEA), then authorized a
60 million barrel drawdown to counter the effects on the global market,
of which the U.S. offered to obligate approximately 30 million barrels
to the market. This resulted in the competitive sale of 11 million
barrels. The loaned oil and accompanying premium barrels were replaced
by May 2007.
According to an IEA Report published in September 2007, total oil
stocks in the U.S. currently, including the SPR, roughly equal to 120
days of net oil imports, or about 80 days of total consumption. There
are no compulsory stock requirements for oil companies in the United
States. The number of days of net import protection that the SPR
inventory provides has significantly declined since the end of 1985.
Import dependency has steadily risen, from 30% of demand in 1985 to
approximately 60% in 2004. The SPR's net import coverage has fallen
from a high of 118 days at the end of 1985 to a range of approximately
55 days in recent years. Increases in the SPR volume since 2001 have
interrupted the downward trend.
IEA COMPLIANCE
The United States is a founding member of the International Energy
Agency (IEA). The IEA was formed with the understanding that the energy
security of the oil consuming and producing nations is interdependent.
Member countries must maintain the equivalent of 90 days of net oil
imports as emergency reserves and take cooperative action in the event
of a severe oil supply interruption. The IEA currently has 27 member
countries and we are working to encourage other countries such as China
and India to establish strategic reserves and manage them in accordance
with IEA principles. Expanding IEA membership and promoting the
establishment and implementation of IEA best practices support the
ongoing mission of the SPR.
The United States' obligation as a signatory to the International
Energy Program requires that we: (1) hold emergency stocks equivalent
to at least 90 days of net oil imports (which can be met through
reliance on government owned, commercial or both), and (2) release
stocks and share available oil in the event of a major supply
disruption. The Agreement on an International Energy Program (the
Charter of the IEA) carries the commitment and status of a treaty. The
U.S. SPR alone represents roughly 46 percent of total IEA strategic
reserves.
While committed to the principles of the free market, we believe
that it is the responsibility of the U.S. Government to ensure energy
supply for the Nation and fulfill its commitment to the IEA. The most
effective deployment of a strategic petroleum reserve is guaranteed by
maintaining Government-owned and operated stocks. It is the policy of
the Administration that the SPR be used only for severe supply
emergencies and not for price or market manipulation.
Oil initially purchased for the SPR was chosen to represent the
crudes being processed by U.S. refineries. Seven categories of crude
were used to define the crude quality for acquisition. However, in
order to achieve the required site drawdown rates, it was necessary to
commingle similar sweet crude types in storage. Today, the SPR
maintains only two oil segregations in storage at its sites. One is
sweet crude, which has a sulfur content of no greater than 0.5 percent.
The second is sour crude with a higher sulfur content of approximately
1.4 percent. Both crude types are classified as light oil having an
American Petroleum Institute (API) gravity that ranges from 30 to 37
degrees.
Light crudes were selected because they offer several significant
advantages in the event of a crude import disruption. First, light
sweet crudes can be refined or processed by all refineries, from the
simplest to the most complex. Light crudes are the easiest crudes to
refine, requiring only the basic refinery processing units. They do not
require all the desulphurization equipment and vacuum distillation, cat
cracking, or coking units to handle the heavy bottoms. Second, most
refiners can use light sweet crudes to increase or maximize their
refinery output of light distillates. Sweet crudes can be used by many
refineries to increase refinery utilizations beyond normal levels. This
is especially important when refined product exports have been
disrupted--light crudes will produce the maximum volumes of gasoline
and naphtha. A barrel of light crude will yield more gasoline and
naphtha in refining than a barrel of medium or heavy crude would. This
is important to the U.S. whose transportation system and economy is so
highly dependent on gasoline.
In 2005, the SPR conducted a comprehensive Crude Compatibility
Study of the current SPR crude oil streams. In general, the crudes
currently stored in the SPR are compatible and desirable for the
majority of the U.S. refineries and are well suited to mitigate most
supply disruptions. There are, however, eleven refineries of the 150 in
the U.S. which have been specifically configured for processing heavy
crude largely from Latin America that would be impacted in the event of
a disruption of foreign crude supplies. However, they would still be
able to process a limited quantity of SPR crude and maintain their full
production of gasoline.
To address the potential compatibility issues of the eleven heavy
crude refiners and provide full protection for the Nation for all
disruption scenarios, DOE has stated in the SPR Crude Compatibility
Study, it will consider the storage of some volumes of lower gravity
crude in the planned expansion of the SPR to 1.0 billion barrels.
SPR FILL POLICIES AND GOALS
The SPR achieved its congressionally mandated goal of 90 days of
import protection in 1983. In 1985, the SPR's import protection level
was 118 days. In the early 1990s, Congress discontinued funding for SPR
oil acquisition and SPR fill activities were suspended in 1994. As a
result of increasing U.S. petroleum consumption and increasing import
dependence, the SPR's import protection level currently stands at
roughly 58 days.
In 1999, the Clinton Administration took steps to reverse this
erosion in the Nation's import protection by taking Federal royalty oil
in-kind from offshore production leases and transferring it to the
Department of Energy to fill the SPR. After the attack on September 11,
2001, the President directed the SPR to be filled to its then full
capacity of 700 million barrels using Federal royalty oil in the
interest of national security. This took four years and was achieved in
August 2005.
In the Energy Policy Act of 2005 (EPACT 2005), Congress directed
the Secretary of Energy to acquire petroleum in sufficient quantities
to fill the SPR to the 1,000,000,000-barrel capacity ``as expeditiously
as practicable'', without incurring excessive costs or appreciably
affecting the price of petroleum products to consumers. It also directs
the Secretary of Energy to promulgate procedures for the acquisition of
petroleum for the Reserve. In addition, the law requires that the
procedures include criteria for reviewing requests for the deferral of
scheduled deliveries. The Administration has endorsed this SPR fill
policy, finalized the necessary procedures, and resumed SPR fill
activities in 2007.
In 2007, President Bush called on Congress in his State of the
Union address, `` . . . to further protect America against severe
disruptions to our oil supply, I ask Congress to double the current
capacity of the Strategic Petroleum Reserve.'' This increase to 1.5
billion barrels will provide vital petroleum stocks to protect America
against potential disruptions to our oil supplies and disastrous
impacts to our economy.
Under the SPR's EPACT 2005 oil acquisition procedures, DOE assesses
current market conditions and the impact of acquiring additional oil
for the Reserve--a market analysis which includes a review of current
and future prices in official outlooks published by the EIA and IEA as
well as other industry assessments and expert studies.
Royalty-in-kind (RIK) exchanges are conducted on a value basis and
the quantity of oil received by the Government is independent of
contracted crude oil prices. Separate market analyses conducted to
address the restart of the SPR oil fill program using RIK exchange in
the last half of 2007 and its continuation during the first half of
2008 concluded that the quantities involved would not exacerbate market
conditions and the potential benefits derived from incrementally
increasing the size of the SPR outweigh any potential risk to the
market.
The SPR has approximately $584 million in available balance from
the Hurricane Katrina Oil Sale in 2005 which is to be used for the
repurchase of oil for the Reserve. Following a market assessment in
January 2007, the SPR offered bids twice in the Spring of 2007 to
acquire oil using these funds, but did not exercise the option to
purchase due to unreasonable offers.
DOE plans to utilize the $584 million balance to purchase
replenishment oil on the market in Fiscal Year 2008. Before buying
additional reserves, DOE will conclude a market assessment and make a
determination whether it is a reasonable time to issue a solicitation.
The Department will continue to monitor market conditions and
thoroughly review responses to solicitations to determine if bids
reflect fair market value to the government.
SPR EXPANSION AND ENERGY SECURITY OBJECTIVES
Expansion of the SPR is essential to meeting the Nation's future
energy security needs.. It is our intent to increase the level of
import protection stored in the SPR as expeditiously as practicable.
The Administration's objectives for the SPR oil fill and energy
security are:
Achieve 727 million barrels in 2009
Achieve 1.0 billion barrels in 2019
Achieve 1.5 billion barrels in 2029
It is important to remember that SPR oil is a Government asset. A
total of $19.2 billion in federal funding has been provided for
acquisition of SPR (or $27.51/bbl). Based on current market prices, the
SPR inventory is valued at $62.8 billion (assuming $90.00/bbl).
The amount currently being placed in the SPR of 70,000 barrels per
day (as delivered by DOI to DOE, not as placed into the SPR) is less
than one-tenth of one percent of the daily global demand of 85 billion
barrels per day and is well within producers' existing excess
production capacity. The modest fill rate does not put undue pressure
on markets. The EIA, Cambridge Energy Research Associates (CERA) and
the IEA have repeatedly stated that global oil demand growth and
reduced commercial inventories have created tightness in the markets,
not the modest SPR fill rate. No empirical evidence exists that would
support the suggestion that markets are sensitive to supply changes
that the SPR fill rate, 0.05% of world supply, is, or would drive
market prices up at any significant level.
Mr. Chairman, and members of the Committee, this completes my
prepared statement. I would be happy to answer any questions you may
have at this time.
The Chairman. Thank you very much. We have this vote that
started about 10 minutes ago. I think probably the best course
is to just go into recess at this point and come back after
these votes and commence again. Thank you.
Senator Domenici. How many do we have?
The Chairman. I believe there are three. Although the email
said five, so I think the email was wrong. We'll find out.
Thank you.
[Recessed.]
The Chairman. We are back from the votes. Our final vote is
occurring now. Mr. Rusco, why don't you go ahead and give us
the perspective of the General Accountability Office, please?
STATEMENT OF FRANK RUSCO, ACTING DIRECTOR, NATURAL RESOURCES
AND ENVIRONMENT, GOVERNMENT ACCOUNTABILITY OFFICE
Mr. Rusco. Thank you. Mr. Chairman and members of the
Committee, I'm pleased to be here today to discuss issues
surrounding the cost and use of the Strategic Petroleum
Reserve.
DOE has been directed to add about 300 million barrels of
oil to the current reserve of almost 700 million barrels. With
the price of oil recently hitting $100 per barrel, this
expansion could easily run into the tens of billions of
dollars. In my testimony today I will discuss three things DOE
can do to reduce the cost of expanding the Reserve and to
improve its effectiveness.
First, DOE has not, but should put heavier grades of crude
oil in the Reserve because A: many U.S. refineries run most
efficiently using heavier oil than what is currently in the
Reserve, and B: heavier oils are cheaper than light oils.
Second, DOE should put fewer barrels of oil into the
Reserve when oil prices are high and more when prices are low.
Our work has shown that such an approach would save a great
deal of money.
Third, DOE's current practice of trading royalty oil for
different oil to put in the Reserve is more complicated and
less efficient then buying oil directly in the market.
I would like to elaborate on these three points. Our work
indicates that about 40 percent of all crude oil used by U.S.
refineries is heavier than what is currently in the Reserve.
Many U.S. refineries run most efficiently using heavier oils.
In practice this means that during an oil supply disruption,
many U.S. refineries would have to operate below capacity if
they used oil from the Reserve.
This loss in capacity would reduce supplies of gasoline and
diesel and exacerbate the economic effects of the supply
disruption. DOE itself has determined that it should have 10
percent heavy oil in the Reserve, however to date, it currently
has none. We believe more than 10 percent is likely warranted.
Including heavy oils in the Reserve would also save lots of
money. In recent years the difference in price between light
and heavy oil has averaged about $12 per barrel. If these price
differences continue while DOE increases the size of the
Reserve, DOE could potentially save over $3 billion by simply
buying heavy oil.
DOE should put fewer barrels into the Reserve when prices
are higher and more when prices are lower. One way to do this
is to buy a constant dollar amount of oil each month as opposed
to buying a constant number of barrels. This approach commonly
referred to as dollar-cost averaging is very similar to what
many of us do when we put steady monthly contributions into our
401k plans.
Our work indicates that DOE could have saved over a half a
billion dollars during fiscal years 2001 through 2005 had it
used such an approach. These foregone savings amount to almost
15 percent of the total cost of the oil added to the Reserve
during these years. Going forward our simulations show that
because oil prices are typically volatile using a constant
dollar approach would save money as DOE adds to the Reserve
whether oil prices are generally rising or falling.
Finally, trading royalty oil for other oil to fill the
Reserve is inherently more complicated and less efficient than
buying oil in the market. The Department of Interior gives
royalty oil to DOE which turns around and trades it for
different oil to put into the Reserve. This requires
coordination between DOE and DOI. This coordination is not
happening to an appropriate degree.
For example, the DOE Inspector General recently issued a
report that among other things found that neither DOE nor DOI
can be sure that DOE is even receiving the agreed upon number
of barrels from DOI because neither agency follows the entire
process from beginning to end. There's a blind spot in the
oversight process.
To conclude, the United States has a Strategic Petroleum
Reserve to protect our economy from oil supply shocks. It has
proven useful in the past such as in the aftermath of
Hurricanes Katrina and Rita. Currently the Reserve holds about
56 days of net oil imports. But it will have to grow to
maintain the same level of protection if demand for oil
continues to rise.
However, we have a large Reserve now that can protect the
economy from any, but the most extreme supply disruptions. This
allows us some flexibility to be smarter about how we add oil
to the Reserve. Our work shows that several billion dollars
could be saved and the Reserve made more efficient by: one,
putting heavier oils into the Reserve, two, buying less when
prices are higher and more when prices are lower and three,
using cash instead of a trading system for purchasing oil.
Achieving these dollar savings is important in these times of
slower economic growth and budget deficits.
Thank you. This completes my oral statement. I would be
happy to answer any questions.
[The prepared statement of Mr. Rusco follows:]
Prepared Statement of Frank Rusco, Acting Director, Natural Resources
and Environment, Government Accountability Office
Strategic Petroleum Reserve
OPTIONS FOR IMPROVING THE COST-EFFECTIVENESS OF FILLING THE RESERVE
WHY GAO DID THIS STUDY
The Strategic Petroleum Reserve (SPR) was created in 1975 to help
insulate the U.S. economy from oil supply disruptions and currently
holds about 700 million barrels of crude oil. The Energy Policy Act of
2005 directed the Department of Energy (DOE) to increase the SPR
storage capacity from 727 million barrels to 1 billion barrels, which
it plans to accomplish by 2018. Since 1999, oil for the SPR has
generally been obtained through the-royaltyin-kind program, whereby the
government receives oil instead of cash for payment of royalties on
leases of federal property. The Department of Interior's Minerals
Management Service (MMS) collects the royalty oil and transfers it to
DOE, which then trades it for oil suitable for the SPR.
As DOE begins to expand the SPR, past experiences can help inform
future efforts to fill the reserve in the most cost-effective manner.
In that context, GAO's testimony today will focus on: (1) factors GAO
recommends DOE consider when filling the SPR, and (2) the cost-
effectiveness of using oil received through the royalty-inkind program
to fill the SPR.
To address these issues, GAO relied on its 2006 report on the SPR,
as well as its ongoing review of the royalty-in-kind program, where GAO
interviewed officials at both DOE and MMS, and reviewed DOE's SPR
policies and procedures. DOE provided comments on a draft of this
testimony, which were incorporated where appropriate.
WHAT GAO FOUND
To decrease the cost of filling the SPR and improve its efficiency,
GAO recommended in previous work that DOE should include at least 10
percent heavy crude oils in the SPR. If DOE bought 100 million barrels
of heavy crude oil during its expansion of the SPR it could save over
$1 billion in nominal terms, assuming a price differential of $12
between the price of light crude oil and the lower price of heavy crude
oil, the average differential over the last five years. Having heavy
crude oil in the SPR would also make the SPR more compatible with many
U.S. refineries, helping these refineries run more efficiently in the
event that a supply disruption triggers use of the SPR. DOE indicated
that, due to the planned SPR expansion, determinations of the amount of
heavy oil to include in the SPR should wait until it prepares a new
study of U.S. Gulf Coast refining requirements. In addition, we
recommended that DOE consider acquiring a steady dollar value--rather
than a steady volumeof oil over time when filling the SPR. This
``dollar-cost-averaging'' approach would allow DOE to acquire more oil
when prices are low and less when prices are high. GAO found that if
DOE had used this purchasing approach from October 2001 through August
2005, it would have saved approximately $590 million, or over 10
percent, in fill costs. GAO's simulations indicate that DOE could save
money using this approach for future SPR fills, regardless of whether
oil prices are trending up or down as long as there is price
volatility. GAO also recommended that DOE consider giving companies
participating in the royalty-in-kind program additional flexibility to
defer oil deliveries in exchange for providing additional barrels of
oil. DOE has granted limited deferrals in the past, and expanding their
use could further decrease SPR fill costs. While DOE indicated that its
November 2006 rule on SPR acquisition procedures addressed our
recommendations, this rule does not specifically address how to
implement a dollar-cost-averaging strategy.
Purchasing oil to fill the SPR--as DOE did until 1994--is likely to
be more cost-effective than exchanging oil from the royalty-in-kind
program for other oil to fill the SPR. The latter method adds
administrative complexity to the task of filling the SPR, increasing
the potential for waste and inefficiency. A January 2008 DOE Inspector
General report found that DOE is unable to ensure that it receives all
of the royalty oil that MMS provides. In addition, we found that DOE's
method for evaluating bids has been more robust for cash purchases than
royalty-in-kind exchanges, increasing the likelihood that cash
purchases are more cost-effective. For example, in April 2007, DOE
solicited two different types of bids--one to purchase oil for the SPR
in cash and one to exchange royalty oil for other oil to fill the SPR.
DOE rejected offers to purchase oil when the spot price was about $69
per barrel, yet in the same month, DOE exchanged royalty-in-kind oil
for other oil to put in the SPR at about the same price. Because the
government would have otherwise sold this royalty-in-kind oil, DOE
committed the government to pay, through foregone revenues to the U.S.
Treasury, roughly the same price per barrel that DOE concluded was too
high to purchase directly.
Mr. Chairman and Members of the Committee: We are pleased to be
here today to participate in the Committee's hearing on the Strategic
Petroleum Reserve (SPR). Congress authorized the SPR in 1975 to protect
the nation from oil supply disruptions following the Arab oil embargo
of 1973 and 1974 that led to sharp increases in oil prices. The federal
government owns the SPR, and the Department of Energy (DOE) operates
it. The SPR currently has the capacity to store up to 727 million
barrels of crude oil in salt caverns in Texas and Louisiana. As of
February 19, 2008, current inventory of the SPR stood at 698.6 million
barrels of oil, which is roughly equivalent to 56 days of net oil
imports. DOE made direct purchases of crude oil until 1994, when
purchases were suspended due to the federal budget deficit, and in
fiscal years 1996 and 1997 approximately 28 million barrels of oil were
sold to reduce the deficit. Since DOE resumed filling the SPR in 1999,
it has obtained oil from the Department of the Interior's Minerals
Management Service (MMS) ``royalty-in-kind'' program. Through this
program, the MMS receives oil instead of cash for payments of royalties
from companies that lease federal property for oil and gas development.
MMS contracts for some of this royalty oil to be delivered to
designated oil terminal locations or ``market centers'' where DOE takes
possession. Because the royalty oil often does not meet SPR quality
specifications, and because the market centers can be distant from SPR
storage sites, DOE generally awards contracts to exchange royalty oil
at the market center for SPR-quality oil delivered to SPR facilities.
Obtaining oil for the SPR through the royalty-in-kind program avoids
the need for Congress to make outlays to finance oil purchases, but the
foregone revenues associated with using royalty-in-kind oil to trade
for SPR oil imply an equivalent loss of revenue because MMS would
otherwise sell the oil and deposit the revenues with the U.S. Treasury.
Interior estimates that the forgone revenue attributable to using the
royalty-in-kind program to fill the SPR was $4.6 billion from fiscal
year 2000 through fiscal year 2007.
The Energy Policy Act of 2005 directed DOE to increase the SPR
storage capacity to 1 billion barrels and to fill it ``as expeditiously
as practicable without incurring excessive cost or appreciably
affecting the price of petroleum products to consumers.''\1\ It
required DOE to select sites to expand the SPR's storage capacity
within 1 year of enactment, by August 2006. On February 14, 2007,
Secretary of Energy Samuel Bodman designated three sites for the
expansion, including a 160 million barrel facility in Richton,
Mississippi, an 80 million barrel expansion of a facility in Big Hill,
Texas, and a 33 million barrel expansion of a facility in Bayou
Choctaw, Louisiana. In its June 2007 SPR plan, DOE anticipated these
expansions would begin in fiscal year 2008 and be complete in 2018.\2\
\3\ DOE also indicated that it would prefer to continue using the
royalty-inkind program to fill the additional storage capacity. DOE
estimates the capital cost for the SPR expansion at approximately $3.67
billion, and estimates the cost of operating and maintaining the
expanded portion of the SPR at $35 to $40 million per year.
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\1\ Pub. L No. 109-58 (2005). The Energy Policy and Conservation
Act, Pub. L. No. 94-163 (1975), created the SPR and authorized storage
of up to 1 billion barrels of petroleum products.
\2\ DOE, Office of Petroleum Reserves, Strategic Petroleum Reserve
Plan: Expansion to One Billion Barrels (Washington, D.C.: June 2007).
\3\ In his State of the Union speech on January 23, 2007, President
Bush proposed expanding the SPR further to 1.5 billion barrels.
Secretary of Energy Samuel Bodman indicated that DOE's goal was to have
this expansion completed by 2027.
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As DOE begins to expand the SPR, past experiences may help inform
future efforts to fill the SPR in the most cost-effective manner. In
that context, our testimony today will focus on: (1) factors we
recommend DOE consider when filling the SPR, and (2) the cost-
effectiveness of using oil received through the royalty-in-kind program
to fill the SPR.
To address these issues, we are summarizing work from our August
2006 report on the SPR and our ongoing review of the royalty-in-kind
program.\4\ For our August 2006 report, we contracted with the National
Academy of Sciences to convene a group of 13 industry, academic,
governmental, and nongovernmental experts to collect opinions on the
impacts of past SPR fill and use and on recommendations for the future.
We also reviewed records and reports from DOE and the International
Energy Agency. In addition, for our ongoing review of the royalty-in-
kind program for this committee and others, we identified and reviewed
applicable laws and documentation on DOE policies and procedures for
evaluating SPR purchase and exchange bids, and interviewed officials at
both Interior and DOE. We have also drawn upon previous GAO reports on
the royalty-in-kind program.\5\ We conducted our work on this testimony
in January and February 2008 in accordance with generally accepted
government auditing standards. Those standards require that we plan and
perform the audit to obtain sufficient, appropriate evidence to provide
a reasonable basis for our findings and conclusions based on our audit
objectives. We believe that the evidence obtained provides a reasonable
basis for our findings and conclusions based on our audit objectives.
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\4\ GAO, Strategic Petroleum Reserve: Available Oil Can Provide
Significant Benefits, but Many Factors Should Influence Future
Decisions about Fill, Use, and Expansion, GAO-06-872 (Washington, D.C.:
Aug. 24, 2006).
\5\ GAO, Royalties Collection: Ongoing Problems with Interior's
Efforts to Ensure a Fair Return for Taxpayers Require Attention, GAO-
07-682T (Washington, D.C.: Mar. 28, 2007).
GAO, Mineral Revenues: Cost and Revenue Information Needed to
Compare Different Approaches for Collecting Federal Oil and Gas
Royalties, GAO-04-448 (Washington, D.C.: Apr. 16, 2004).
GAO, Mineral Revenues: A More Systematic Evaluation of the
Royalty-in-Kind Pilots is Needed, GAO-03-296 (Washington, D.C.: Jan. 9,
2003).
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In summary:
To fill the SPR in a more cost-effective manner, we
recommended in previous work that DOE include in the SPR at
least 10 percent heavy crude oils, which are more compatible
with many U.S. refiners and generally cheaper to acquire than
the lighter oils that comprise the SPR's volume. DOE indicated
that, due to the planned SPR expansion, such determinations
should wait until it prepares a new study of U.S. Gulf Coast
heavy sour crude refining requirements. In addition, we
recommended that DOE consider acquiring a steady dollar value
of oil over time and allowing oil companies more flexibility to
defer delivery of royalty-in-kind exchanges to the SPR when
prices are likely to decline in return for additional
deliveries in the future. In updating us on the status of this
recommendation, DOE indicated that its November 8, 2006, rule
on SPR acquisition procedures addressed our recommendations;
however, this rule does not specifically address both how to
implement a dollar-cost-averaging strategy and how to provide
industry with more deferral flexibility. In subsequent comment,
DOE noted that the November 8, 2006, acquisition procedures do
not address dollar-cost-averaging, but they do address
flexibility of purchasing and scheduling in volatile markets.
Filling the SPR with oil purchased in cash is likely to be
more cost-effective than filling the SPR through the royalty-
in-kind program for several reasons. For example, the royalty-
in-kind program adds a layer of administrative complexity to
the task of filling the SPR, increasing the potential for waste
or inefficiency. Moreover, DOE has evaluated the cost of cash
purchases more thoroughly than exchanges, increasing the
likelihood that cash purchases are more cost-effective. For
example, in May 2007, DOE rejected cash purchases for the SPR,
concluding that the current price of about $69 per barrel was
unusually high. However, in the same month, DOE entered into
contracts to exchange royalty oil, effectively committing the
government to pay--through foregone revenues to the U.S.
Treasury--about the same price for oil that it concluded was
too high to purchase directly. In November, DOE entered into
another exchange contract when oil was about $96 per barrel.
doe could improve the cost-effectiveness of filling the spr
To decrease the cost of filling the SPR and improve its efficiency,
we have recommended in our previous work that DOE: (1) include at least
10 percent heavy crude oil in the SPR, (2) consider acquiring a steady
dollar value of oil, and (3) consider allowing oil companies additional
flexibility to defer deliveries in exchange for delivering additional
barrels of oil at a later date. The current composition of the SPR is
entirely of medium to light grades of oil.\6\ \7\ Including heavier oil
in the SPR could significantly reduce fill costs because heavier oil is
generally less expensive than lighter grades. We recommended in our
August 2006 report that DOE, at a minimum, implement its own
recommendation made in a 2005 study to have at least 10 percent heavy
oil in the SPR.\8\ In addition, we found that DOE may have
underestimated how much heavy oil should be in the SPR to minimize oil
acquisition costs. Therefore, we further recommended that DOE examine
the maximum amount of heavy oil that should be held in the SPR. To
illustrate the potential magnitude of savings from including heavy
crude oil in the SPR, we have done some simple calculations. If DOE
included 10 percent heavy oil in the SPR as it expands to 1 billion
barrels, that would require DOE to add 100 million barrels of heavy
oil, or about one-third of the total new fill. From 2003 through 2007,
Maya--a common heavy crude oil--has traded for about $12 less per
barrel on average than West Texas Intermediate--a common light crude
oil. If this price difference were to persist over the duration of the
new fill period, DOE would save about $1.2 billion in nominal terms by
filling the SPR with 100 million barrels of heavy oil.\9\ The savings
could be even larger if DOE included more than 10 percent heavy oils in
the SPR.
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\6\ For information on the composition of the SPR, see DOE, Office
of the Assistant Secretary for Fossil Energy, Strategic Petroleum
Reserve: Annual Report for Calendar Year 2006.
\7\ The weight of oil is measured by its gravity index. According
to DOE's Energy Information Administration (EIA), light oil is greater
than 38 degrees gravity, while intermediate oils, such as those in the
SPR, are 22 to 38 degrees gravity.
\8\ See DOE, Office of the Deputy Assistant Secretary for Petroleum
Reserves, Strategic Petroleum Reserve Crude Compatibility Study
(December 2005).
\9\ This calculation is intended to illustrate the magnitude of
potential savings, and is not meant to be a projection of actual
savings. The actual price difference between light and heavy oil over
the course of the new fill could be smaller or larger than over the
past 5 years, which would either reduce or increase the savings,
respectively.
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Including heavier oil would have the additional benefit of making
the composition of SPR oil more compatible with U.S. refineries. In
recent years, many refiners in the United States have upgraded their
facilities so they can process heavy oil. Our analysis of DOE's Energy
Information Administration (EIA) data shows that, of the approximately
5.6 billion barrels of oil that U.S. refiners accepted in 2006,
approximately 40 percent was heavier than that stored in the SPR.\10\
Refineries that process heavy oil cannot operate at normal capacity if
they run lighter oils. For instance, DOE's December 2005 study found
that the types of oil currently stored in the SPR would not be fully
compatible with 36 of the 74 refineries considered vulnerable to supply
disruptions. DOE estimated that if these 36 refineries had to use SPR
oil, U.S. refining throughput would decrease by 735,000 barrels per
day, or 5 percent, substantially reducing the effectiveness of the SPR
during an oil disruption, especially if the disruption involved heavy
oil. To improve the compatibility of SPR oil with refineries in the
United States, the DOE study concluded that the SPR should contain
about 10 percent heavy oil. However, our August 2006 report found that
DOE may have underestimated how much heavy oil should be in the SPR to
maximize compatibility with refiners. We also found DOE may have
underestimated the potential impact of heavy oil disruptions on
gasoline production. Several refiners who process heavy oil told us
that they would be unable to maintain normal levels of gasoline
production if forced to rely on SPR oil as currently constituted. For
example, an official from one refinery stated that if it exclusively
used SPR oil in its heavy crude unit, it would produce 11 percent less
gasoline and 35 percent less diesel. Representatives from other
refineries told us they might need to shut down portions of their
facilities if they could not obtain heavy oil. For these reasons, we
recommended that DOE conduct a new review of the optimal oil mix in the
SPR and determine the maximum volume of heavy oil that could be
effectively put in the reserve.
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\10\ According to DOE's EIA, heavy oil has a gravity index of 22
degrees or below. According to EIA 2006 data, about 10 percent of the
oil accepted by U.S. refiners has this gravity index. An additional 30
percent of oil accepted by U.S. refiners was 22 to 30 degrees gravity,
however, according to DOE, all oils stored in the SPR range from
approximately 30 to 37 degrees gravity.
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In addition, we recommended that DOE consider filling the SPR by
acquiring a steady dollar value of oil over time, rather than a steady
volume of oil over time as has occurred in recent years. This ``dollar-
cost averaging'' approach would allow DOE to take advantage of
fluctuations in oil prices and ensure that more oil would be acquired
when prices are low and less when prices are high. In our 2006 report,
we found that if DOE had used this approach from October 2001 through
August 2005, it could have saved approximately $590 million in fill
costs. We also ran simulations to estimate potential future cost
savings from using a dollarcost-averaging approach over 5 years and
found that DOE could save money regardless of the price of oil as long
as there is price volatility, and that the savings would be generally
greater if oil prices were more volatile.
We also recommended that DOE consider allowing oil companies
participating in the royalty-in-kind program more flexibility to defer
their deliveries to the SPR at times when filling would significantly
tighten the market or when prices are expected to decline.\11\ In
return for these deferrals, companies would provide additional barrels
of oil when they resumed deliveries. DOE has already approved some
delivery deferrals at companies' requests, such as during the winter
2002-2003 oil workers' strike in Venezuela. From October 2001 through
August 2005, DOE received an additional 4.6 million barrels of oil for
the SPR valued at approximately $110 million as payment for these
delivery deferrals. However, DOE has denied some deferral requests and
experts have noted that there is room to expand the use of deferrals.
Experts noted DOE would need to exercise its authority to deny
deferrals at times when it is in the national interest. Nonetheless,
given that the SPR currently holds roughly 56 days of net imports, we
believe there is sufficient inventory for some flexibility in allowing
deferrals.
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\11\ For example, this situation could occur if futures prices are
lower than current prices. Futures prices of oil reflect the cost of
delivery at a specified place, price, and time in the future.
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In updating us on the status of recommendations we made to DOE in
our August 2006 report, DOE indicated that its November 8, 2006, rule
on SPR acquisition procedures addressed our recommendations on dollar-
cost-averaging and deferrals. However, the new acquisition rule does
not specifically address our recommendations to study both how to
implement a dollar-cost-averaging strategy and how to provide industry
with more deferral flexibility. In subsequent comment, DOE noted that
the November 8, 2006, acquisition procedures do not address dollar-
cost-averaging, but they do address flexibility of purchasing and
scheduling in volatile markets. As to our recommendation on the optimal
mix of oil in the SPR, DOE indicated that, due to the planned SPR
expansion, such determinations should wait until it prepares a new
study of U.S. Gulf Coast heavy sour crude refining requirements. We
believe the SPR expansion offers DOE an ideal opportunity to change the
SPR's oil mix to include heavier oils that are less costly to acquire
and better match U.S. refining capacity. We look forward to DOE
completing its new study of U.S. Gulf Coast heavy crude refining
requirements and believe such a study will find that DOE should include
at least 10 percent heavy oils in the SPR.
PURCHASING OIL TO FILL THE SPR MAY BE MORE COST-EFFECTIVE THAN CURRENT
ROYALTY-IN-KIND PROGRAM
There are several reasons that purchasing oil--as DOE did until
1994--may be more cost-effective than filling the SPR using the current
royaltyin-kind program. For instance, there may be fewer bidders for
the royalty oil under the current exchange system than a direct cash
purchase system, which in turn may limit competition and the exchange
deals that DOE can negotiate. In the exchange process, a single company
must be able to and interested in both accepting oil at the designated
market centers and delivering other oil with specific characteristics
to the SPR. This may limit the number of companies interested in
bidding on exchange contracts. In contrast, if DOE purchased oil, many
additional companies may be interested in selling their oil, increasing
competition and lowering prices.\12\ In 2007, the then Deputy Assistant
Secretary for Petroleum Reserves, who directed activities of the SPR,
told us that he agrees with this reasoning. The inherent limits of
exchanging versus direct purchases are compounded by the fact that DOE
and Interior have not systematically analyzed where to send royalty oil
in a way that maximizes the value of the exchanges. The value of
exchanges is a function of both the costs to deliver oil to market
centers and the deals that DOE can negotiate at particular market
centers. The informal process that DOE and Interior currently use to
identify market centers does not systematically analyze the tradeoffs
between these two factors to identify market centers that optimize net
value to the government.
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\12\ We note that including heavier oils in addition to lighter
oils would also increase the number of potential suppliers of oil for
the SPR.
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In addition, royalty-in-kind exchanges add a layer of
administrative complexity to the task of filling the SPR, increasing
the potential for waste or inefficiency. In a January 2008 report, the
DOE Inspector General concluded that DOE does not have an effective
control system over receipts of royalty oil from Interior at the market
centers.\13\ Specifically, the Inspector General found that DOE did not
have adequate controls to ensure that the volumes of oil that
contractors reported to have received from Interior at the market
centers matched scheduled deliveries. As a result, DOE did not have
assurance that it received all of the oil that Interior shipped,
raising concerns that DOE may not have received its full entitled
deliveries to the SPR. If DOE purchased all of its oil, it would no
longer need to exchange oil at designated market centers and would not
need to coordinate with Interior. Moreover, rather than diverting a
fraction of the oil collected through the royalty-in-kind program to
fill the SPR, Interior could sell that fraction in competitive sales,
as it currently does for the other oil it receives through the royalty-
in-kind program. A senior Interior official said that selling the
royalty oil would be simpler for Interior to administer than the
current exchanges.
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\13\ DOE Office of Inspector General, Audit Report: Department of
Energy's Receipt of Royalty Oil, DOE/IG-0786 (Washington, D.C.: Jan.
2008).
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Further, DOE's method for evaluating bids is more robust for cash
purchases than royalty-in-kind exchanges, increasing the likelihood
that cash purchases are more cost-effective. In November 2006, DOE
issued a final rule that describes how DOE will evaluate offers when it
is purchasing oil and when it is exchanging royalty oil for other oil
for the SPR.\14\ This rule provides DOE with considerable flexibility
in the degree of analysis it can conduct when evaluating offers, and,
in practice, DOE's method for evaluating bids for cash purchases has
been more robust than it has for exchanges. For example, in April 2007,
DOE solicited two different types of bids--one to purchase oil for the
SPR in cash and one to exchange royalty oil for other oil to fill the
SPR.\15\ In deciding whether to purchase oil, DOE evaluated the bids it
received in the context of overall market trends. It concluded that the
offers it received from sellers were priced too high, in part because
the price of oil was generally high and because the prices of the
specific type of oil DOE sought to purchase were unusually high
relative to other oil types. As a result, DOE rejected offers to
purchase oil when the spot price for Light Louisiana Sweet (LLS)--a
commonly used benchmark for Gulf Coast oil--was about $69 per barrel
and decided to delay purchasing any oil until at least the end of the
summer driving season.\16\ In contrast, DOE's method for evaluating
bids for exchanging royalty oil focused on whether the oil DOE would
receive would be at least the same value as the oil it would exchange.
It did not include an analysis of whether overall market conditions
indicated that it would be more profitable for the federal government
to stop or delay exchanges and have Interior sell the royalty oil for
cash instead. In this case, in the same month, DOE entered into royalty
oil exchange contracts when the spot price of LLS was about $67 a
barrel, effectively committing the government to pay--through foregone
revenues to the U.S. Treasury--roughly the same price for oil that DOE
concluded was too high to purchase. Moreover, in November, it awarded
additional exchange contracts when the spot price of LLS had reached
$96 a barrel.\17\
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\14\ 1410 C.F.R. Part 626.
\15\ DOE's solicitations to purchase oil were part of a plan to
replace 11 million barrels of SPR oil that DOE sold in the fall of 2005
after Hurricane Katrina disrupted refinery supplies.
\16\ The spot price reflects the price for immediate settlement of
oil purchases.
\17\ By itself, the spot price does not determine how many barrels
of oil the government will receive through royalty exchanges. Rather,
this is determined by the relative value--the price of the grade of oil
that DOE has to exchange (the oil it receives from Interior) versus the
price of the grade of oil that it wishes to receive in an exchange.
This means that the government could receive the same number of barrels
of SPR oil through its exchanges when spot prices are low or high.
However, from a broader federal perspective, it would be more cost-
effective if the federal government deferred royalty exchanges when oil
prices were high and sold the royalty oil for cash. It could then
purchase oil when oil prices were lower, acquiring more of the desired
grade of oil for the same amount of money.
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It should also be noted that the current exchange method is less
transparent than direct purchases because the primarily cash-based
federal budget does not account for noncash transactions. Interior
estimates that the royalty-in-kind program cost the federal government
in total foregone revenue $4.6 billion from fiscal year 2000 through
fiscal year 2007. This foregone revenue was not reflected in the
federal budget since no federal cash flows were involved. Congressional
budget decisionmakers therefore have not had the opportunity to
consider whether the value of the transferred oil could be reallocated
to other competing resource needs.
Importantly, the royalty-in-kind effort to fill the SPR creates,
essentially, a ``blind spot'' where neither DOE nor Interior, the two
agencies responsible for running the joint program, systematically
examines whether exchanges of millions of barrels of royalty oil have
been a cost-effective approach to filling the reserve. DOE does conduct
a prospective analysis to estimate whether the value of the oil it will
receive in the exchanges will be at least as valuable as the royalty
oil it will exchange. However, DOE enters into exchange agreements that
can last 6 months, and DOE's initial estimates of the values of the
different oil types may not hold over the duration of the contracts.
DOE has not analyzed any of the completed exchanges to determine
whether those exchanges performed as well as expected. Similarly, when
evaluating the performance of the royalty-in-kind program overall,
Interior does not analyze whether the royalty oil transfers to DOE are
a cost-effective means to fill the reserve.\18\ The 60.7 million
barrels of oil that Interior transferred to DOE from fiscal year 2004
to 2005 accounted for 58 percent of all the royalty-in-kind oil that
Interior collected during that time. While Interior reports to Congress
each year on the financial performance of its royalty-in-kind program,
these reports have not included a measure of the cost-effectiveness of
using royalty oil to fill the SPR.
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\18\ Interior does, however, have procedures in place to ensure
that it pays a reasonable rate to transport oil from the offshore
federal leases, where the oil is produced, to the market centers where
DOE takes possession of the oil.
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Because the SPR has reached sufficient size to address near-term
supply disruptions, decisions about future fill practices can be made
in a more flexible, cost-effective manner without unduly hurting our
ability to respond to such disruptions. With oil prices recently
exceeding $100 a barrel, there should be greater interest in finding
ways to reduce fill costs. If it is to reach its goal of filling the
expanded SPR by 2018, DOE will have to, in some combination, purchase
or receive through royalty-in-kind transfers roughly 300 million
barrels of oil. Our work shows that substantial cost savings could be
achieved through increased purchasing of heavy oil, a dollar-cost-
averaging purchasing strategy, more flexibility in the timing of oil
purchases and deliveries, and greater attention paid to the opportunity
costs of filling the SPR with royalty oil. Based on our past estimates
of the cost savings potential of dollar cost averaging and the
significantly lower cost of heavier oils, DOE could save well over 10
percent of the costs of filling the SPR to the currently authorized
level--an amount that is likely well in excess of $1 billion. During
this era of dire national long-term fiscal challenges, it is all the
more important that DOE make fill decisions in a cost-effective manner.
Mr. Chairman, this concludes my prepared statement. I would be
pleased to respond to any questions that you or other members of the
Committee may have at this time.
The Chairman. Thank you very much. Mr. Verrastro, why don't
you go right ahead?
STATEMENT OF FRANK A. VERRASTRO, DIRECTOR AND SENIOR FELLOW,
ENERGY AND NATIONAL SECURITY PROGRAM, CENTER FOR STRATEGIC AND
INTERNATIONAL STUDIES
Mr. Verrastro. Thank you, Mr. Chairman. I, too, appreciate
the opportunity to appear before you today to talk about the
SPR and also inventory policies writ large. As you have copies
of my complete written statement, let me focus on just a few
remarks this morning on key points.
The Strategic Petroleum Reserve in the U.S. is the world's
largest stockpile of government owned crude held specifically
for the purpose of mitigating the impacts of oil supply
disruptions. Directives on the use of the Reserve, as well as
definitional guidelines on what constitutes a severe supply
disruption in a national energy emergency are incorporated in
the Energy Policy and Conservation Act that was passed in 1975,
although the concept of a national oil storage system predates
EPCA by about 30 years. The statutory definitions also provide
that a supply interruption is deemed to exist if the President
determines that a severe increase in the price of petroleum
products has resulted from such emergency and such price
increase is likely to cause major adverse impact on the
national economy. So it's more than just volumes.
My written statement goes into greater detail on the
history of the Reserve. So I won't repeat that history here
except to emphasize that the language of EPCA clearly
contemplated a Petroleum Reserve to address crude oil and
refined product shortages but that studies at the time
concluded that a more centralized crude oil reserve was a
decidedly better option and also less expensive than a host of
smaller product stockpiles. But much has changed in the 30
years since that analysis was originally done.
One of my recommendations today is that as we pursue a
national strategy of greater diversification of fuels and
suppliers in the face of new risks and market conditions. We
should not neglect considering the role of strategic stockpiles
and how their composition and use can better ensure reliable
supply. With respect to operating discretion and management of
the Reserve, it should be noted that EPCA affords the President
significant and broad discretion. That not surprisingly, and as
you pointed out in the beginning, Mr. Chairman, the current
Administration has chosen to broadly exercise that latitude,
particularly with respect to conditions under which they would
use the Reserve.
In 2004, Vice President Cheney noted that the
Administration would expect to use the SPR for dealing with
shortfalls arising only from major supply disruptions which he
characterized as involving the loss of some five or six million
barrels a day. In his characterization the Vice President
invoked both the significant volumetric supply loss as well as
the criteria to adverse economic impact in price rises. In the
aftermath of Katrina, President Bush issued a finding of severe
supply emergency and directed the Secretary of Energy to
drawdown and sell crude from the SPR in an attempt to
compensate for the loss of production from the U.S. Gulf of
Mexico.
The real significance of that finding however was that it
triggered a broader release response from the IEA including the
movement of refined products. Which points to one of the
weaknesses of the SPR design. The devastating impacts of
Katrina was not limited to off shore production facilities
alone as it severely affected refining operations in the Gulf
as well as power supply to pipelines and distribution
facilities along the East Coast and elsewhere.
The refinery outages negated in part the actual benefit of
making SPR crude available. The bulk of the real assistance
came from the drawdown of refined products stocks both here and
abroad and the waiving of fuel specs in various states. The
combined crude and products shortage posed a decidedly unique
challenge. But one which can plausibly reoccur if the Gulf is
again assaulted by Category four storms, inland flooding and
power and refining outages.
With respect to managing the Reserve in the current market
one of rapidly increasing prices, the Administration's
performance over the past year is, I believe, highly
questionable. For a while they have repeatedly stated that they
believe this year long price rise is a result of market
fundamentals as they continue to call on OPEC to increase crude
production. They also continue to withdraw oil from the market.
This decision, I believe, has both significantly undermined
our entreaties for additional OPEC supply and concurrently in
bold and continued market speculation, both of which are
driving current prices. Consequently, contributing to a
weakened U.S. economy. Consequently I empathize with Members of
the Congress who have called for suspending the SPR fill at
this moment in time.
My written statement also contains examples of how creative
ideas and thoughtful decisionmaking with respect to management
of the Reserve can both preserve the core objective of the
program while taking into consideration actual, real time
events in the market. These include suspension of previous
bills in order to make more oil available to the market during
times of supply and uncertainty, Secretary Richardson's use of
royalty oil to replace SPR volumes, rebuilding volumes in a
time of low prices, namely 1999, Secretary Bodman's 2006
decision to delay the repayment of loaned oil volumes from the
previous fall to ensure that refiners had adequate crude
supplies to meet processing and product sales requirements. The
periodic swaps of oil to ensure that the crude in storage
continues to match refinery needs and process capability.
My statement also contains several examples of how various
pieces of recent legislation have contradictory impacts. Serve
to undermine the broader energy goals. While I won't go into
them now, I would be happy to elaborate on any of those
examples.
My final point today relates to your question about the
desirability of doubling the size of the SPR. On that point I
would note, as others have, that as we contemplate reducing
reliance on oil as a way to mitigate the environmental impact
of hydrocarbon use. Doubling the size of the Reserve makes
little to no sense. It redirects billions of dollars away from
research, conservation efficiency programs to accomplish
expansion that is both short sighted and I believe, ill
conceived.
I do however agree with Senator Craig that a $50 purchase
price is certainly low in today's market. I also support the
idea that we have domestic resources available and those should
be explored. Thank you.
[The prepared statement of Mr. Verrastro follows:]
Prepared Statement of Frank A. Verrastro, Director and Senior Fellow,
Energy and National Security Program, Center for Strategic and
International Studies
Mr. Chairman, Senator Domenici, Members of the Committee I
appreciate the opportunity to appear before you today to discuss the
creation and use of the Strategic Petroleum Reserve (SPR) and inventory
policies writ large, and also to comment on the need for a more
comprehensive look at energy policy generally, focusing on directives
which while designed to accomplish specific objectives, often produce
unintended consequences that may ultimately undermine national policy
goals.
I currently serve as Senior Fellow and Director of the Energy and
National Security Program at the Center for Strategic and International
Studies (CSIS), but the comments and views I express here today reflect
a professional background that spans over three decades in both
government and the private sector dealing with energy policy issues. In
addition to having held positions within the White House (Energy Policy
and Planning staff) and at the Departments of Interior and Energy
(including Director, Office of Energy Producing Nations and Deputy
Assistant Secretary for International Resources), I have 25 years of
experience in the energy sector--first as Director of Refinery Policy
and Crude Oil Planning for TOSCO Corporation (formerly the nation's
largest independent refiner) and more recently as a Senior Vice
President for Pennzoil Company.
My remarks this morning are primarily aimed at discussing the
objectives and use of the SPR, the timing and consequences of
continuing to fill the reserve in a time of tight markets and rising
oil prices, and more general observations and comments directed at the
notion of policy directives and the role of inventory in a changing
market.
THE ESTABLISHMENT AND USE OF THE STRATEGIC PETROLEUM RESERVE
The US Strategic Petroleum Reserve (SPR) is the world's largest
stockpile of government-owned crude oil held specifically for the
purpose of mitigating the impacts of oil supply disruptions. The SPR
was established under provisions of the Energy Policy and Conservation
Act (EPCA) adopted in 1975, largely in reaction to the Arab Oil Embargo
of 1973, although the concept of a national oil storage system predates
EPCA by at least 30 years.
In 1944, Interior Secretary Harold Ickes advocated the stockpiling
of emergency supplies of crude oil. Eight years later, the Minerals
Policy Commission in the Truman administration recommended the creation
of a strategic oil supply. Following the 1956 Suez Crisis, President
Eisenhower resurrected the notion of a strategic oil stockpile and a
Cabinet Task Force report on Oil Imports Control in 1970 recommended
the establishment of similar reserve.
Directives on the use of the reserve as well as definitional
guidelines as to what constitutes a ``severe supply disruption'' and a
``national energy supply shortage'' are incorporated in the EPCA
legislation. Similarly, the circumstances under which the SPR might be
used are also outlined in EPCA, and these include responding to a
national supply shortage which the President determines ``. . . is or
is likely to be of significant scope and duration, and of an emergency
nature, may cause major adverse impact on national safety and the
national economy . . .'' and is likely to result from an interruption
in the supply of petroleum products (domestic or imported), sabotage or
an act of God.
The statutory definitions also provide that a severe supply
interruption is deemed to exist if the President determines that a
severe increase in the price of petroleum products has resulted from
such emergency situation and such price increase is likely to cause a
major adverse impact on the national economy (emphasis added).
In addition to specifying the conditions under which a ``full
drawdown'' of the reserve may be contemplated, EPCA also provides for a
``partial drawdown'' (with volume limitations) when such action ``. . .
would assist directly and significantly in preventing or reducing the
adverse impact of such shortage.''
SIZE AND MAKEUP OF THE RESERVE
Prior to the passage of EPCA, a variety of studies were undertaken
to determine the optimum size and composition of the strategic reserve.
Assuming continued demand growth in the future, the SPR was
congressionally authorized to be built up to one billion barrels in
volume, with an initial target size of 500 million barrels. For
purposes of comparison, gross oil imports in 1974 and 1975 were
slightly in excess of 6 million barrels per day, representing some 36%
of total US petroleum demand.\1\
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\1\ U.S. Energy Information Administration; historical data from
the Annual Energy Review on petroleum (crude oil and refined products)
imports and consumption.
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The language of EPCA contemplated a petroleum reserve to address
crude oil and refined product shortages, and it also called for the
development of an SPR plan. A 1976-77 study, which formed the basis for
the SPR plan concluded that the domestic refining industry was indeed
robust and capable of processing available crude(s) into a variety of
needed refined products. The study further concluded that a
centralized, crude oil based storage facility was much less expensive
to construct and manage than multiple storage sites handling a variety
of products and the recommendation for a crude oil reserve was
subsequently adopted.
The reserve as currently constructed houses a variety of co-mingled
crudes (30-40 degrees API gravity) in salt caverns located in four
storage sites (Bayou Choctaw, West Hackberry, Big Hill and Bryan Mound)
along the Texas and Louisiana portions of the Gulf coast. The sulfur
content of the various crude accumulations ranges from 0.5 percent
(sweet crude) to 2.0 percent (sour). As of February 22, over 698
million barrels of crude oil were held in SPR storage facilities.
Approximately 40% of the crude volume is sweet.\2\
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\2\ U.S. Department of Energy Website, Office of Fossil Energy,
Facts and Questions related to the Strategic Petroleum Reserve.
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The size of the reserve is frequently described as providing 51-56
days of import protection (total volume in storage divided by average
daily imports), but this is an extremely misleading and somewhat
useless factoid. At current fill levels (roughly 700 million barrels),
the maximum drawdown rate (for the first 90 days) is about 4.4 million
barrels per day (b/d)--which at current consumption rates would meet
about 5 hours of average daily needs. Drawing down the SPR at its
maximum rate would replace roughly a third of US daily oil imports.
In addition to the crude oil facilities, in 2000 President Clinton
directed the establishment of a 2 million barrel home heating oil
reserve in the northeastern United States. The reserve currently houses
just under 2 million barrels of heating oil in three locations in
Connecticut (two sites) and New Jersey.
OPERATING DISCRETION AND MANAGEMENT OF THE SPR
As is the case with other legislation, the EPCA provisions allow
the president significant and broad discretion in managing the SPR. And
not unlike their predecessors, the current administration has chosen to
exercise that discretion, particularly with respect to the conditions
under which they would contemplate the use of the reserve.
Their criteria, however, seems to be somewhat of a moving target.
In August of 2004, Vice President Cheney (in a campaign appearance)
articulated the conditions under the Bush Administration would
contemplate using the SPR. That characterization involved the loss of
some ``5 or 6 millions barrels a day (of supply) out of the 20 million
barrels (per day) that we currently consume.'' In the Vice President's
words, such a supply loss ``would constitute the kind of national
crisis that would drive prices so high and probably bring large parts
of our economy to halt.'' Such a situation, he said, would require
using the reserve.\3\
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\3\ ``US Might Tap SPR if Half Imports Stop--Cheney'', Reuter's
Report, Washington, D.C., August 25, 2004.
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In his characterization the Vice President invoked both the
significant (volumetric) supply loss as well as the criteria of adverse
economic impact and high prices. In the absence of any other formal
pronouncement by the administration on the use of the reserve, the Vice
President's comments were broadly interpreted as working guidelines.
Roughly one year later (September 2, 2005), in the aftermath of
hurricane Katrina, President Bush issued a Finding of a Severe Energy
Supply Interruption and directed the Secretary of Energy to drawdown
and sell crude oil from the SPR in an attempt to compensate for the
loss of offshore production from the US Gulf of Mexico. Energy
Secretary Bodman immediately authorized the sale of 30 million barrels
of crude to US markets. The administration's action resulted in the
actual sale of 11 million barrels of crude and the ``time loaning'' of
an additional 9.8 million barrels.
The disruption caused by Katrina, while substantial and devastating
to the families and economy of the region and throughout the country,
never approached in volumetric terms the loss criteria earlier
articulated by the Vice President. While recognizing that the release
of several millions of barrels of short haul oil was clearly an
important response to the devastation, the real significance of the
Presidential finding was that it triggered a broader release response
from the International Energy Agency (IEA), including the movement of
refined products.
Which points to the one of the weaknesses of the SPR design.
The devastating impact of Hurricane Katrina was not limited to
offshore production facilities alone as it severely affected refining
operations in the Gulf Coast as well as power supply to pipelines and
distribution facilities along the east coast and elsewhere. The
refinery outages negated, in part, the actual benefit of making the SPR
crude available and the bulk of the real assistance came from drawdown
of refined product stocks both here and abroad and the waiving of fuel
specs in various states. This combined (crude and product shortage)
emergency posed a decidedly different challenge than many of the
various crude oil disruption events originally contemplated by
emergency planners--but clearly represents one which can plausibly
reoccur if the Gulf Coast is again assaulted by category 4 storms,
inland flooding and power and refining outages.
CURRENT MARKET CONDITIONS
In 2006, partially as a consequence of increased global supply and
reduced demand due to higher oil prices, oil inventories around the
world began to increase. In September, global inventories were running
some 120 million barrels above the 5 year average. In a marked
departure from the previous two years, a mild 2006 hurricane season
resulted in no substantial losses to US offshore production. Prospects
of a mild winter season, increases in non-OPEC supply, declining demand
due to prices and the inventory build caused oil prices to plummet from
$75 per barrel to the high $50 per barrel range (see Figures 1 and 2
below).*
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* All figures have been retained in committee files.
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Responding to the precipitous plunge in oil prices and looking
ahead to the second quarter (2Q 2007) when demand typically declines,
OPEC members began ratcheting down production--forcing consumers to
meet energy demand by drawing down inventory worldwide. Between
September 2006 and January of 2008, global inventories declined by over
130 million barrels. With limited spare production capacity (mostly in
Saudi Arabia), continued demand growth (albeit not as robust as
previous years), heightened geopolitical tensions (e.g., Russia,
Venezuela, Nigeria, Iran, Pakistan, Iraq, etc.) and the entry of a new
class of investors into commodities trade, the NYMEX price for crude
oil increased from just over $50 per barrel in January to the $100 per
barrel marker by year's end (see Figure 3 below).*
Over this period, the strength of the US economy began to decline.
And while oil prices were not the singular cause, higher energy prices
generally clearly impacted the outcome.
During this period, when asked about price increases,
administration spokespersons continued to attribute the movement to
market fundamentals, while simultaneously calling on OPEC to increase
output. More recently, in response to threats by Venezuelan president
Hugo Chavez to suspend crude shipments to the US, the administration
has indicated that the SPR would be used to offset any loss of
supplies, even though the reduction would fall well below the Cheney
standard. No mention, however, was made of suspending the current fill
in the event of such a drawdown.
And herein, I believe, lies the dilemma. If the administration
truly believes market fundamentals are driving today's prices and they
implore OPEC members to put more oil on the market (see statements by
both President Bush and Secretary Bodman during their recent Middle
East trips), then one should logically be able to conclude they believe
the market is undersupplied--i.e., characterized by more buyers than
sellers.
Against that backdrop, and given the conditions laid out in EPCA,
it might be logical to conclude that one might want to consider putting
oil into the market during such a time of tight or short supply rather
than taking oil out of the market--as the administration continues to
do.
I empathize with Members of Congress who have called for suspending
the SPR fill at this moment in time. As indicated earlier, according to
DOE statistics, as of last Friday, the SPR currently contains just over
698 million barrels of oil, with plans to acquire an additional 29
million barrels (to reach the present physical capacity of 727 million
barrels).
One might well ask why the administration feels compelled to
continue to take oil off the market by adding to the reserve at a time
when oil prices are at/near record highs. A plausible (but incomplete)
explanation might reference the fact that the Energy Policy Act of 2005
(EPAct) directed the Secretary of Energy to expand the SPR to 1 billion
barrels and to fill the reserve as quickly as possible, but such a
reference would ignore certain critical conditions.
In fact, section 301 (e)(1) of EPAct2005 states that . . .'' the
Secretary shall, as expeditiously as practicable, without incurring
excessive cost or appreciably affecting the price of gasoline or
heating oil to consumers, acquire petroleum in quantities sufficient to
fill the SPR to the 1 billion barrel capacity authorized under section
154(a) of EPCA . . .''
The current fill rate (using the royalty in kind program) for crude
oil additions to the SPR is running at about 70,000 barrels per day (b/
d). Statements made by the administration have consistently made the
argument that withdrawing 70,000 b/d of oil from an 86 million b/d day
market, in percentage terms, has a negligible impact on prices. I do
not dispute that statement in terms of simple arithmetic.
I would note, however, that the impact of the administration's
seemingly unwavering determination to not release or imply release of
SPR oil absent a major catastrophic shortfall--i.e., along the lines of
the Mr. Cheney's suggested criteria of 5 to 6 million b/d--has in
today's tight market encouraged and emboldened traders and speculators
to talk up prices without fear of reprisal. These investors remain
confident that the current administration is unlikely to make SPR oil
available to the market under current conditions and that confidence is
only bolstered by the fact that the administration continues to
withdraw oil from an already tight market.
The administration's insistence on continuing the SPR fill, in my
judgment, severely undermined the urgency and impact of recent appeals
by both the President and Secretary Bodman to OPEC producers to
increase their own output. I would further note that the intention to
add roughly 125,000 b/d of light, sweet oil to the reserve this spring
(in pursuit of reaching the 727 million barrel storage target) could
adversely impact the ability of domestic refiners to maximize gasoline
during the upcoming driving season.\4\
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\4\ ``US Government, Senate Democrats on SPR Collision Course,''
Reuters report by T. Doggett and C. Baltimore, February 6, 2008.
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Which brings me to my final points--addressing the broader issues
of enlightened inventory management and the need for consistent and
thoughtful policies to enhance our energy security.
ENLIGHTENED INVENTORY MANAGEMENT
Addressing the broader issue of enlightened inventory management, I
would first note that as our fuels system and threats to the reliable
and uninterrupted delivery of those fuels change, we need to
continually reevaluate how we can best ensure an uninterrupted and
secure supply to consumers. A quarter century ago, ensuring adequate
and reliable supplies to customers were unchallenged business
principles for refiners and distributors. Crude oil supply inventory at
the front end of the refinery and products stocks at the back end were
constantly adjusted to ensure adequate and reliable delivery.
With the advent of computerization, a more robust delivery system,
``just in time'' inventory management and Wall Street's emphasis on
eliminating the cost of carrying non-productive assets, stock levels
invariably began to decline. The reduction of stock levels improved
financial performance and served to lower prices. It also depleted the
cushion or excess in the system that we used to rely on in times of
disruption or short supply. Working group discussions during the
preparation of a recent report by the National Petroleum Council
looking at refining and inventory issues conveyed the frustration of
pipeline and terminal operators that with the expansion in product
specs and boutique fuels, tighter delivery schedules and declining
storage, tanks were often literally hours away from being emptied
(until new deliveries arrived) and hic-cups in the system frequently
resulted in temporary outages and/or higher prices.
As we move to a system of increased diversification of fuels and
suppliers--including some from agricultural sectors that can be
influenced by new risk factors like weather and drought--we will need
to continually monitor and revamp our inventory policies and may need
to provide additional incentives and assurances to investors to make
sure needed infrastructure enhancements actually occur in a time frame
that works.
Additionally, in the absence of new refinery construction, as
product imports continue to increase, and faced with the prospects of
more frequent and high intensity storms in the US Gulf and coastal
areas where refineries tend to concentrate--all of which heighten the
threat to refined product supply--we should evaluate the need for
expanded product inventory in addition to relying on a crude oil
reserve.
With specific regard to the management of the SPR, it should be
noted that there are many instances where thoughtful decision making
has resulted in actions that have preserved the core objective of the
program while introducing creativity and flexibility in aligning those
objectives with actual events in the market. Such exemplary actions
include the suspension of previous fills in order to make more oil
available to the market during times of supply uncertainty, Secretary
Richardson's use of royalty oil to replace SPR volumes previously sold
and rebuilding volumes in a time (1999) of notably low prices,
Secretary Bodman's 2006 decision to delay the repayment of loaned oil
volumes from the previous fall in order to ensure that refiners had
adequate crude supplies to meet processing and product sales
requirements and ease price pressure, and periodic swaps of oil to
ensure that the crude in storage continues to match refiner needs and
processing capabilities.
UNINTENDED CONSEQUENCES AND CONFLICTING POLICY SIGNALS
Before beginning this particular discussion, let me first commend
the Members of this committee for their efforts in passing significant
pieces of energy legislation in each of the last two Congressional
sessions. In particular, I applaud your efforts in promoting improved
energy efficiency and the development of supplemental alternative fuels
while noting that more could be done to improve domestic supply
opportunities.
But, as a cautionary note, let me also emphasize, particularly in
this uncertain and volatile market climate, the need for more
thoughtful and comprehensive policy directives and specifically the
elimination of contradictory signals.
By way of illustration, let me just identify a few examples of this
problem. In EPAct2005, Congress provided incentives for the
construction/expansion of domestic refining capacity as a way to
improve supply deliverability and enhance the reliability of domestic
fuels delivery. After an extended period of excess capacity and poor
economic performance, higher utilization rates and better margins were
finally improving conditions for refiners and additions/expansions were
beginning to gain traction. Yet, less than two years later, additional
provisions were enacted into law that aim to reduce the need for
petroleum based fuels and mandate their volumetric replacement by date
certain by employing, in some cases, technologies that don't yet exist
at scale or cannot compete without significant subsidies.
While accepting the policy advantages of such diversification, one
needs to at least recognize the difficulty this change presents for
businesses with shareholder responsibilities and investment projects
underway. Faced with the prospect of declining demand for one's
products and increasing environmental and construction costs, it is
highly unlikely that many of these announced expansion projects will
ultimately go forward as originally envisioned.
Further, in the case of projects which continue to progress--and a
great case in point involves Motiva (a joint venture between
SaudiAramco and Shell and the largest announced domestic refinery
expansion)--the consequences of the adoption of NOPEC-type legislation
can be directly contrary to the objectives of the EPAct2005 in terms of
promoting security of supply and enhancing refining capability.
As we continue to expound on the benefits of secure energy
supplies, driving resourcerich and reliable suppliers to invest
elsewhere may ultimately result in redirecting supplies away from the
United States to other joint venture operations around the globe.
Similarly, as we contemplate reducing reliance on oil as a way to
mitigate the environmental impacts of hydrocarbons use, doubling the
size of the SPR make little to no sense at all--and appropriating
dollars away from conservation and efficiency programs to accomplish
the expansion is both myopic and ill-conceived.
Thank you for the opportunity to appear before you today. I would
be pleased answer any questions.
The Chairman. Thank you very much. Ms. Kenderdine, please
go right ahead.
STATEMENT OF MELANIE A. KENDERDINE, ASSOCIATE DIRECTOR,
STRATEGIC PLANNING, MIT ENERGY INITIATIVE, CAMBRIDGE, MA
Ms. Kenderdine. Mr. Chairman, Senator Domenici, members of
the committee, thank you for giving me the opportunity to
testify today.
During my 8 years at DOE I had the opportunity to work with
the SPR team. Many of them are in the audience. They are, in my
view, some of the finest public servants in the Federal
Government.
DOE recently lost the SPR Director, John Saugus, who's also
here. His retirement--his gain is DOE's loss. I think that the
Government should be proud of these public servants.
I am and always have been a strong supporter of a large and
robust reserve as our primary line of defense in the event of
an emergency oil supply disruption. Each day however, the
current RIK program is pulling 70,000 barrels off oil off tight
markets at a time of record high prices and volatile
geopolitics. Attention to market conditions and the willingness
to act in a more flexible and creative manner could achieve the
same result but enable lower cost options for filling the SPR
through time exchanges, for example. This could also help
address other key energy priorities.
The purposes and implementation of the original RIK program
in 1999 provides an example of such creativity. In late 1998
oil prices hit historic lows. While moderate oil prices are
good for consumers, extremely low prices shut in wells,
decimate the work force and destroy the technical
infrastructure of the industry, impacts that ultimately lead to
lower supplies and then higher prices in the future.
To help mitigate these adverse impacts the Clinton
Administration established the RIK program. This provided a
market outlet for domestic oil in a glutted market and enabled
DOE without the need for new appropriations to replace 28
million barrels of oil in the SPR that had been sold 2 years
earlier, largely at the direction of Congress simply to
generate revenues. That was about $420 million of oil that we
had to sell.
Quotes from the key policymakers at the time of the
announcement bear repeating. Then Energy Secretary Bill
Richardson said, ``We are taking advantage of today's low oil
prices to rebuild our Strategic Petroleum Reserve. Senate
Energy Committee Chairman at the time, Frank Murkowski, said,
``Buying oil back in the SPR would drawdown oil from a glutted
world market and it benefits the country's small domestic
producers.''
These quotes emphasize a key driver for establishing the
RIK program in the first place, taking advantage of low oil
prices to get the best deal for the taxpayer. In this respect
the current RIK effort is operating under market conditions
that are precisely the opposite of those that the original
program was established to exploit. In fact two Energy
Secretaries and both Democratic and Republican Administrations
elected to pursue the path of do no harm with the RIK program.
Secretary Richardson in 2000 and Secretary Abraham in 2003
deferred deliveries under the RIK program for fear that
removing even small amounts of oil from the market would
increase prices to consumers.
Another authority where creativity and flexibility can and
should be employed is exchanging oil to acquire oil. We first
used this in a significant way to establish a home heating oil
reserve in the Northeast in 2000. The rapid stand up of this
reserve absent any appropriations, to do so, was accomplished
by using this authority. I would just like to weigh in and
support Mr. Verrastro and the notion of revisiting product
reserves.
We also conducted a time exchange of oil in September 2000
when heating oil inventories in New England were 72 percent
lower than in the previous winter. On September 22, the
President directed the Secretary to conduct an exchange of SPR
oil in effect loaning the market 30 million barrels of oil. The
results were immediate. Stock prices dropped almost 20 percent.
By the end of the year actual oil prices had decreased by 34
percent and there was adequate heating oil supplies for the
winter.
Importantly, this exchange of 30 million barrels ultimately
turned to over 35. Returned 5 additional--5 million barrels
back to the Reserve, that's a 17 percent interest payment on
that loan to the market. At today's prices this equates to an
additional half billion dollars of oil in the Reserve at no
cost to the taxpayer.
There is one more point I would make before closing. We
typically gauge the insurance value of the SPR in total barrels
of oil or days of import protection. An additional and critical
data point is the SPR's drawdown capacity of 4.4 million
barrels per day, a significant limiting factor in responding to
disruptions. The incremental 13 million barrels destined for
the SPR right now, contracts were just let in that amount, will
do very little in the face of this limitation.
Mr. Chairman, the Energy bill passed last December
established the foundation for alternative energy security
pathways. Conservative estimates are that by 2022 provisions in
that law will reduce net oil imports by well over two million
barrels per day and rising thereafter in effect increasing the
insurance value of the SPR without adding any oil to the
Reserve. Between now and then however we need new ways to
finance and develop key energy technologies.
According to GAO, DOE's total budget authority for energy R
and D has dropped over 85 percent since 1978. Temporarily
suspending the current RIK program could provide at least a
billion new dollars to fund critical research programs. Such as
large commercial scaled sequestration demonstrations or
efficiency programs that have strong policy, analytical and
bipartisan support.
Mr. Chairman, in closing the current policy of taking
royalty oil in a continuous flow regardless of market signals,
ignores many of the lessons learned over the last decade on how
to use the SPR. It is literally a waste of taxpayer's money to
put oil in the Reserve today, at today's top prices, when
futures markets offer the same oil at a lower price 12 months
from now. We need a clearer articulation of the value of a
larger SPR relative to other policy options such as increased
efficiency or alternative fuels.
I hope that this testimony has provided some food for
thought in this regard and look forward to the committee's
questions. Thank you.
[The prepared statement of Ms. Kenderdine follows:]
Prepared Statement of Melanie A. Kenderdine, Associate Director,
Strategic Planning, MIT Energy Initiative, Cambridge, MA
Mr. Chairman, Senator Domenici, Members of the Committee, thank you
for giving me the opportunity to testify before your committee today.
Let me start by noting that I am here as the Associate Director of the
MIT Energy Initiative, but in the tradition of academic freedom, the
views I express today are my own. In addition to my current position at
MIT, I worked at the Department of Energy from 1993 through 2001.
During that time, I was the Director of the Office of Policy as well as
the Senior Policy Advisor on Oil, Gas and Coal to Secretary Richardson;
policy aspects of the SPR were included in my portfolio.
I have been asked to address policy issues related to the Strategic
Petroleum Reserve and specifically to discuss issues surrounding the
Administration's current policy to fill the Strategic Petroleum Reserve
utilizing the so-called Royalty-in-Kind or ``RIK'' program. This
program provides a mechanism for the federal government to accept oil
in lieu of federal royalty payments for industry oil production from
federal lands.
AUTHORITIES FOR USES OF THE SPR
The SPR is our primary line of defense in the event of emergency
oil supply disruptions. It also provides the U.S. with additional
energy security assets over and above this essential function that can
be utilized to support other energy policy objectives.
In general, the legal authorities for the use of the SPR include
but are not limited to:
Drawdown in the event of an emergency supply disruption,
amount unlimited, Presidential finding required
Drawdown in anticipation of a supply disruption, 30 million
barrels limitation, Presidential finding required
Test sale, five million barrel limitation, discretionary on
the part of the Secretary
An ``exchange of oil to acquire oil'', discretionary on the
part of the Secretary
A royalty-in-kind exchange program, administrative action
Leasing space in the Reserve, administrative action
I highlight these authorities for three reasons.
First, it has been widely represented in the press and public
domain that the SPR is to be used only in the event of an emergency
supply disruption. It is worth repeating here today that this is not
the case, as demonstrated by this listing of authorities. This
misconception has caused us to undervalue a very powerful tool and to
inhibit management flexibility that could maximize the value of the SPR
to achieve energy and foreign policy objectives.
Second, each of these authorities was either extensively debated or
utilized to support broader policy objectives when I was at DOE, and
highlights the spectrum of SPR policy options that may be employed
under certain oil market or security conditions.
Third, and equally important, these authorities create
opportunities for Congress as it seeks to satisfy and balance competing
energy policy priorities going forward.
TODAY'S OIL MARKETS VS. OIL MARKETS IN 1973
To fully appreciate this range of possible uses of the SPR, it is
important to recognize the significant changes in oil markets since the
time of the establishment of the Reserve.
Oil markets have become more efficient. In 1973, the Nixon
Administration had, since 1971, placed US crude and refined
products under price and allocation controls. Markets were
inefficient and uncertain, leading refiners to hold greater
working stocks to meet demand. Today, markets are deregulated
and market forces are deemed most appropriate for managing
scarcity and risk. Oil supplies are more diversified, robust
futures markets have evolved, and inventories are more tightly
managed.
The energy efficiency of the economy has improved. Oil
intensity (unit of oil per unit of GDP) was relatively high
when the SPR was established, but has improved significantly.
In 1973, we used 1.45 barrels for each $1000 of GDP and now use
0.67 barrels for each $1000 of GDP--down 54% in 33 years.
Oil consuming nations have built collective measures to
address energy security. The formation of the International
Energy Agency (IEA) led to the establishment of information
collection and policy coordination mechanisms to collectively
act on oil matters including a mechanism for a coordinated
response to supply disruptions, and the establishment of large
strategic reserves, both public and private.
In short, today's robust global oil markets and vehicles for
collective action did not exist when the SPR and the authorities for
its use were established. One could reasonably argue--and many do--that
in today's markets, in which product and crude moves around the globe,
and where markets manage price through scarcity and risk through market
instruments, there are no true physical disruptions of oil, just price
volatility in response to market conditions, resultant arbitrage, and
transaction costs. To illustrate this point, after Hurricane Katrina
devastated offshore production facilities, the Director of the
Congressional Budget Office noted that ``. . . if rationing is done
through the price mechanism alone--energy use will tend to be put to
its highest-value uses, and economic activity will not be seriously
affected.'' (see letter from Holtz Eakin to Senate Marjority Leader
Frist, September 6, 2005).
Indeed, the federal government has relied on such market forces to
accommodate very large supply disruptions in the recent past. Two of
the largest disruptions since the Arab Oil Embargo of 1973--the
Venezuelan labor strike of 2002-2003, and the first year of the second
Iraq war--resulted in sequential losses starting in December 2002 of
2.6 million barrels per day, followed immediately by a gross peak loss
of 2.3 million barrels per day and sustained losses for the remainder
of 2003 (See IEA Fact Sheet, DOE Office of Fossil Energy Website). In
neither instance did the U.S utilize the SPR to minimize the impacts of
these major shortfalls.
WHAT ARE THE TRIGGERS FOR USE OF THE SPR?
Historical experience shows that the trigger for using the SPR--
based on the definition of what constitutes an emergency supply
disruption--has been inconsistently interpreted and used. As noted, a
peak loss of 2.3 million barrels of oil per day and a sustained loss of
around a million barrels per day for almost a year after the start of
the Iraq war in 2003 was deemed an insufficient disruption to trigger
the use of the SPR.
Compare this to the response to Hurricane Katrina. According to the
Minerals Management Service (MMS), Gulf of Mexico (GOM) oil production
was reduced by a relatively modest 837,648 barrels per day, less than
half the shortfall of the Iraq war. In this instance however, the
President made an emergency finding and the Department of Energy
announced an offer to sell 30 million barrels of SPR oil.
Not all oil offered for sale in response to Katrina, however, was
actually purchased (only 11 million of the 30 million that was
offered)--a clear signal from the market that it did not need the crude
oil the SPR was offering. Instead, what was needed was refined product
as Katrina was much more devastating to refineries in the Gulf than to
regional crude production. The U.S. energy markets were, however, able
to essentially swap crude oil for European product, a transaction that
hinged on the emergency declaration by the President.
The structure and nature of the Katrina response raises two
concerns beyond that of consistent use of triggers for release of oil
from the Reserve: the need to revisit the issue of product reserves as
originally envisioned in the SPR organic statutes; and the requirements
for an emergency declaration by the President. In this circumstance
such a declaration was required to effect what was essentially a swap.
More response flexibility on the part of the Secretary could expedite
actions and help diminish the counter-productive market psychology
reactions that come with Presidential emergency declarations.
SPR DRAWDOWN CAPACITY LIMITS RESPONSE
It is also important to understand the impacts of key operational
features of the SPR as we consider the current RIK program to fill the
Reserve. The SPR has a capacity of 727 million barrels of oil and
currently holds around 698 million barrels. The DOE recently awarded
three contracts to add an additional 13 million barrels of oil to the
Reserve through the RIK program.
While the total number of barrels in the SPR or ``days of import
protection'' is the gauge by which the public and policy makers
typically measure the amount of import insurance the SPR provides the
nation, an additional and critical data point for our emergency
response capability is the SPR's drawdown capacity. This is currently
around 4.4 million barrels per day (an untested number as the systems
and commercial interfaces have not been stressed at a rate higher than
one million bpd for a sustained period). Because drawdown capacity is
fixed, at a certain point, total capacity or ``days of import
protection'' becomes less important as the size of the SPR increases,
because drawdown capacity is the limiting factor in our ability to
respond to disruptions.
One could argue that in spite of the drawdown rate, larger volumes
in the SPR could enable us to respond to disruptions over greater
lengths of time. However, the incremental benefits are smaller because
history demonstrates that we are not inclined to authorize a drawdown
over long periods of time. Also, the Reserve can only maintain a
drawdown rate of 4.4 mbpd for 90 days. After that the rate of
production declines precipitously and the SPR inventory will be
exhausted within 180 days whether the inventory is 700 million barrels
or 727 million barrels.
REQUIREMENTS FOR STRATEGIC OIL STOCKS
The current case for filling the Reserve utilizing the RIK program,
in spite of record high oil prices, hinges in part on the assertion
that current capacity offers only 57 days of import protection, when
the U.S is required to have 90 days of import protection as a
participant in the International Energy Agency. However, the IEA 90-day
requirement is based on total level of strategic stocks, including both
government-owned reserves as well as privately-held stocks available
for use in an emergency. Other IEA countries rely on privately-owned
stocks, under varying degrees of government control, to meet some or
all of their respective commitments. Indeed, the DOE SPR website
indicates that the current U.S. inventory equates to 118 days of import
protection as defined by the IEA. These volumes are reported to IEA on
a regular basis and IEA periodically reviews them; presumably the 118
day figure on the DOE website reflects this process as well as official
U.S. representations to the IEA.
The Administration is also responding to EPACT 2005 which directs
that the Reserve be expanded and filled to a capacity of one billion
barrels. In this regard however, the statute provides DOE with
significant latitude in the timing and manner in which this requirement
is met. There are strong supporters for such an expansion, particularly
for expanding its storage capacity, myself included. There are however
many available tools to achieve this end in ways that avoid potential
and real adverse impacts on American consumers.
The analysis supporting the DOE Environmental Impact Statement for
proposed expansion of the SPR to one billion barrels was conducted
prior to the passage of key energy laws which would both increase
unconventional domestic oil supplies and reduce oil demand in the
future. These new policy tools could have a material impact on the need
for SPR expansion or, at a minimum, both the manner and rate at which
this expansion occurs.
A RANGE OF USES OF THE SPR
I would also like to briefly discuss four actions that utilized the
SPR during my tenure at DOE with relevance to today's hearing. These
are: the Congressionally-directed sale of $420 million worth of SPR oil
in fiscal years 1996-97; the related development and implementation of
the original RIK program in 1999; the creation of the Home Heating Oil
Reserve in the Northeastern US and; the exchange of 30 million barrels
of SPR oil in September of 2000.
Directed sales of SPR Oil.--In appropriations bills in 1996,
the Congress directed the sale of $420 million worth of SPR oil
in the absence of any market anomaly, disruption or product
shortfall; the sole purpose of the directed sales was to
generate revenues for purposes not related to energy security.
Around 23 million barrels of SPR oil were sold to meet the
statutory direction and requirements to sell the oil within a
fixed timeframe; as such, SPR managers were constrained in
their efforts to get the best value for the taxpayer.
In that same timeframe, the Weeks Island SPR storage facility
showed signs of potential failure and needed to be
decommissioned. This occurred after the Administration's budget
for the fiscal year was set. To avoid a catastrophic failure of
the facility which would have compromised the oil in the cavern
and caused environmental harm, the department proposed and the
Congress authorized DOE to sell five million barrels of oil to
pay for this decommissioning. The combined total of SPR oil
sold during calendar year 1996 was around 28 million barrels.
In addition, in 1997 as part of the appropriation for FY 1998
Congress directed additional sales for the purpose of
generating revenue, although this action was effectively
overturned (see below).
Use of the RIK Program to Prevent Shut-in of Domestic
Production.--In late 1998, oil prices hit historic lows, with
WTI bottoming out at $8.73 per barrel. The Economist Magazine's
cover headline at that time was ``$5 Oil Forever?''
Lower oil prices are good for consumers and the global economy.
However prices at extremely low levels such as those in late
1998 force wells to be shut in, discourage necessary investment
in research, exploration and production, decimate the workforce
and destroy the technical infrastructure of the industry--
impacts that ultimately lead to lower supplies/higher prices in
the future. Such impacts were strongly felt in producing
regions of the country--Texas, New Mexico, Louisiana, Alaska,
Colorado, Wyoming, etc.
Congress responded by passing an emergency appropriation act
allowing the Department of Energy to stop oil sales from the
SPR that had been directed in the FY 1998 appropriations bill,
if the President found that the situation was an emergency.
President Clinton made the requisite finding and the sale of
oil for FY 1998 was cancelled.
More proactively, the Administration activated the transfer
authorities for DOE to take oil owed to the Department of the
Interior as royalty from Federal leases. The establishment and
implementation of the RIK program in 1999 served two purposes:
it provided a market outlet for domestic oil in a global market
that was glutted; and it enabled DOE, without the need for new
appropriations, to replace the 28 million barrels of oil in the
SPR that had been sold two years earlier. At the time of the
announcement, the SPR held 561 million barrels of oil; when the
RIK exchange was completed, the SPR would have contained around
590 million.
Direct quotes from the key policy makers at the time of the
announcement bear repeating [see DOE press release, January 11,
1999]:
Then Energy Secretary Bill Richardson: ``We are taking
advantage of today's low oil prices to re-build our strategic
oil reserves . . . By putting royalty oil in the Strategic
Petroleum Reserve today we will get a high rate of return
tomorrow--enhanced national energy security, increased
strategic assets--and a very good deal for the American
taxpayer.'' [emphasis added]
Then Senate Energy Committee Chairman, Frank Murkowski: ``.
. . Buying oil back into the SPR is a win-win-win. It would
bolster America's energy security, it would drawdown oil from a
glutted world market and it would benefit the country's small
domestic producers.'' [emphasis added]
Senator Bingaman, then-ranking member of the Senate Energy
Committee: ``With oil prices at an all-time low, now is the
time to strengthen our national energy security by replacing
the oil we've drained from the Strategic Petroleum Reserve.''
[emphasis added]
Each of these key policymakers emphasized--in addition to the
positive security implications of the program--that a key driver for
this program was taking advantage of low oil prices to get the best
deal for the taxpayer or taking oil off a glutted market, presumably to
have some price impact. The major oil trade associations similarly
applauded the action as a way to lower the glut of oil on world markets
and assist the industry at a time when it was reeling from historically
low prices. Current efforts to fill the SPR with RIK oil are occurring
under market conditions that ensure the opposite result of the program
as it was originally envisioned.
It is also important to note here that Secretary Richardson
directed the SPR office to defer deliveries to the SPR under the RIK
program when prices started to rise sharply. His motivation was concern
that pulling even small amounts of oil off the market (at that time,
about 100,000 barrels per day) would increase consumer prices.
Establishment of a Home Heating Oil Reserve.--The winter of
1999-2000 was mild until a late cold snap placed huge demand on
heating oil supplies in the Northeast and New England. The EIA
Administrator warned that without a break in the weather the
region would run out of heating oil. DOE began daily monitoring
calls with the requisite state officials and reviewed
curtailment options but beyond this, had very few tools at its
disposal to address this potential crisis. Fortunately, the
weather broke and the significant heating oil price spike in
the U.S. attracted supplies from Europe, which arrived in time
to avoid a crisis.
This vulnerability of the region to supply shortages prompted calls
from elected officials and some within the Administration to
establish a regional heating oil reserve. The White House
ultimately sided with these officials and ordered the creation
of the Northeast Heating Oil Reserve in the summer of 2000. The
rapid stand-up of this reserve, absent appropriations to do so,
was accomplished by using the authorities that allow DOE to
``exchange oil to acquire oil.''
I highlight this action for two reasons: first to demonstrate some
of the energy policy objectives that can be met through creative
application of SPR authorities. Second, it underscores the possible
need for additional product reserves. When the SPR was authorized, it
contemplated the possibility of product as well as crude oil reserves.
At the time of the SPR's first plan, it was determined that product
reserves were too expensive, there was a robust refining industry and
significant product stocks, and that the real need was for a crude oil
reserve. Since that time, the refining industry in the US has operated
at a much higher utilization rate, just-in-time inventory practices
eschew the holding of product inventories, and imports of refined
product have increased fairly dramatically. Product reserves present a
range of difficulties as product does not store over time and must be
swapped out on are regular basis. As we consider SPR expansion however,
it might be worth studying the inclusion of strategically located
product reserves as part of any SPR expansion plan.
Use of an SPR Time Exchange in September, 2000.--As noted,
heating oil inventories were a major concern throughout 2000
and were closely monitored by the federal government.
Notwithstanding political charges made prior to the
Presidential election in November, a range of options had been
discussed within the Administration as early as April of that
year.
While the new heating oil component of the SPR gave the country
more emergency stocks in the fall of 2000, commercial
inventories of heating oil were still dangerously low. In
August, 2000, heating oil inventories in the Northeast Region
were around 40% lower than the previous winter (when we faced
the prospect of running out); in the New England sub-region,
they were 72% lower. In addition, oil prices were increasing in
spite of OPEC's actual or announced production increases of
almost three million barrels since March of that year.
After a review of all options, consultation with IEA and other
allies, and a determination that refining capacity was
sufficient to accommodate additional oil, on September 22nd the
President directed Secretary Richardson to utilize SPR exchange
authorities to conduct an exchange of SPR oil, in effect
loaning the market 30 million barrels of oil, with the
potential for loaning an additional 30 million.
The results were immediate, in spite of the fact that oil had not
yet moved into the market (demonstrating the psychological
impacts on the market when the U.S. signals its intention to
act). All of the oil was refined in spite of charges that there
was insufficient refining capacity; there were adequate heating
oil supplies for the winter. In addition, the exchange backed
out cargoes on their way from Europe to the US, in effect,
reducing pressure on overheated markets and prices on both
sides of the Atlantic. In this regard, oil spot prices dropped
almost 20%, from $37.22 to $30.26 a week later. Prices stayed
down until the bombing of the Cole on October 12. By the end of
the year, actual oil prices had dropped from $30.94 to $20.38
per barrel, a 34% decrease.
Importantly, as we discuss using SPR authorities to increase the
size of the Reserve, the 2000 exchange of 30 million barrels of
oil loaned to the market ultimately resulted in a return to the
reserve of 35.1 million barrels (after the original 1.35
million barrel premium from the exchange, a series of contract
deferrals ultimately brought the total to 5.1 million). This,
in effect, represented a 17% interest payment on the loan and,
at today's prices, equates to an additional half billion
dollars of oil in the Reserve at no cost to the taxpayer.
It is also worth noting that the deferrals involved in this
transaction took place over several years; the 2000 time
exchange was not completed until 2004. In fact, contract
deferrals for SPR oil are common practice. The SPR website
notes that:
On several occasions, the Energy Department has agreed to
reschedule incoming oil shipments to the Reserve at the request
of contractors, deferring the deliveriesfor several months to a
year or more. In these instances, companies under contract to
deliver crude oil to the Federal Government agree to increase
the volume of oil delivered to theReserve at the later date at
no additional cost to the taxpayer. The additional volumes, or
premium barrels, aresimilar to interest payments.
IMPACTS OF CURRENT RIK PROGRAM
The current RIK program is pulling 70,000 barrels per day off oil
markets at a time of record high prices, very tight supply/demand
balances, and high geopolitical volatility. Attention to market
conditions and the willingness to act in a more flexible and creative
manner could afford lower cost options for SPR fill through time
exchanges and other measures. Moreover, as I noted earlier in my
statement, the current RIK program provides very little incremental
insurance value.
I offer several sources of information, anecdotal evidence, and
past Secretarial actions for the Committee's consideration.
The 2000 time exchange is instructive in this regard. While
it involved putting oil on the market as opposed to taking oil
off the market, it demonstrated how a very small amount of oil
compared to world market totals (30 million barrels into an
annual oil market approaching three billion barrels) could have
a major impact on price.
This point was also driven home by Alan Greenspan's
testimony before the Senate Finance Committee a year ago in
which he noted that: ``. . . the balance of world oil supply
and demand has become so precarious that even small acts of
sabotage or local insurrection have a significant impact on oil
prices.''
Last week when oil prices topped $100 per barrel for the
first time, the New York Times article on February 20, 2008,
noted from its discussions with traders that ``The immediate
cause that sent prices up today was the fire at a Texas
refinery . . . [which] will halt processing of about 70,000
barrels per day for several weeks at least.''
The same trade associations that strongly supported the
initial RIK program, (a type of exchange) which removed oil
from the market when prices were at historic lows, opposed the
2000 exchange which put oil onto the market when prices were
relatively high.
Phillip K Verleger, a well-known petroleum economist, cited
Goldman Sachs in testimony on the impacts of the RIK program
from 2001-2004, noting that:
. . . Goldman Sachs economists made the following statement:
Government storage builds have lowered commercially available
petroleum supplies. OECD strategic petroleum reserves built in
excess of 51 mmb during 2003 (40 mmb in the United States
alone), which reduced commercially available supplies by the
same amount and lowered the inventory coverage ratio. We
estimate that these builds alone have supported crude oil
prices by $2.25/bbl.
While respected analysts disagree with some of these conclusions,
two Energy Secretaries in Democratic and Republican Administrations
elected to pursue the path of ``do no harm'' when confronted with
increasing oil prices and an active RIK program. Both Secretary
Richardson in 2000 and Secretary Abraham in 2003 chose the path of
prudence and deferred deliveries under the RIK program for fear that
removing even small amounts of oil from the market would increase
prices to consumers.
FUTURE SPR POLICY ISSUES AND OPTIONS
Expanding the size of the SPR, while an important undertaking, is a
very expensive proposition. The current DOE program threatens to place
additional and unnecessary burdens on consumers, who are already
weighted down by historically high energy prices. The use of RIK oil to
fill the Reserve in the current environment calls into question many
issues about the SPR, including:
Inconsistent Past Practices on SPR Use.--Confusion exists
about the size and duration of a given disruption that triggers
emergency disruption responses and authorities, raising
questions about the need for expansion, certainly about the
urgency of the need. Clarification of the policy underpinnings
for the rapid expansion of the SPR currently being pursued by
the Administration is warranted, when the law directing it to
do so provides significant latitude in this regard, and
triggers for the use of the Reserve are inconsistently applied.
The Rate vs. the Length of Drawdown.--The practical as well
as security impacts of limited drawdown capacity, its
relationship to IEA requirements, and the need for additional
import protection are not well understood or appreciated. Is
the development of additional drawdown capacity (beyond
expected demand increases) an investment worth pursuing?
Petroleum Product vs. Crude Oil Reserves.--We have
significant evidence of product as opposed to crude disruptions
and shortages, as seen in both Katrina and the run-up to the
exchange in 2000. Are there changing refining market/industry
conditions including increased product imports that point to
the need to re-visit and study product reserves as part of any
contemplated expansion of the Reserve?
Better Leveraging of the SPR as an Asset to Support Energy
Policy Objectives.--There appears to be a need for greater
Secretarial authority and flexibility to use the SPR in ways
that enhance the value of the SPR while minimizing market
impacts, taxpayer costs, and consumer burdens. Also, are there
reasonable uses of the Reserve that should not require
emergency declarations and, if so, do authorities need to be
revised?
Related to the last point, GAO convened a group of policy experts
to analyze the size and uses of the SPR, including fill policy and made
a series of recommendations on SPR size and fill; many of these bear
repeating. Specific to RIK, they indicated that the current ``steady
volume approach of the RIK program'' has effectively cost the taxpayer
an additional $590 million for the same amount of oil. They recommended
instead that we ``fill the SPR more cost-effectively, including
acquiring a steady dollar value of oil for the SPR over the long term,
rather than a steady volume, to ensure a greater volume of fill when
prices are low and a lesser volume of fill when prices are high.'' In
essence, the GAO is suggesting that application of a ``dollar cost
averaging'' investment philosophy would increase its longer-term value
to consumers [See GAO Report 06-872].
They also suggested greater flexibility in the RIK program, giving
industry the ability to delay deliveries in tight, backwardated markets
(backwardation is the condition under which the price of future
deliveries for the commodity is below the price for present (or spot)
deliveries. Especially relevant to many of the issues raised in this
testimony, they recommend that we ``periodically reassess the
appropriate size of the SPR in light of changing oil supply and demand
in the United States and the world.''
REASSESSING THE VALUE OF ADDITIONAL SPR INSURANCE IN A CHANGING
ENERGY FUTURE
This takes me to my closing points. Policy and research leaders are
increasingly faced with the need to balance competing energy concerns:
the need for energy security that comes, in part through the insurance
provided by the SPR; as well as providing for an energy future in which
such insurance will no longer be required (or required to a lesser
degree).
Specifically, the Energy Independence and Security Act of 2007
established the foundation for alternative energy security pathways.
Indeed, the Renewable Fuels Standard and new CAFE requirements have the
potential to significantly reduce oil imports, in effect reducing
pressures on the SPR as the only option for ensuring oil security.
Conservative estimates provided by the Secure America's Energy
Coalition show that this new law would reduce net oil imports by 1.75
million barrels per day by 2020, increasing to 2.26 million barrels per
day in 2022 and rising thereafter. These estimates represent roughly
half of the theoretical SPR drawdown capacity of 4.4 million barrels
per day. They also increase the number of days of protection afforded
by a given quantity of oil in the Reserve. Thus, the new Energy bill
could, over time, increase the insurance value of the SPR, even if the
actual inventory level is frozen or slightly decreased.
We also need new ways to finance the research, development and
demonstration of key technologies to enhance our energy security and
sustainability and mitigate the impacts of climate change. The GAO has
documented that DOE's total budget authority for energy R&D dropped by
over 85 percent (in real terms) from 1978 to 2005. While Congress
continues to authorize new and expanded critical energy research
programs, it is apparent that the current Administration will not pay
for these programs, and has opposed efforts by Congress in the last
appropriations cycle to increase energy R&D investment levels.
Suspending the current SPR fill program in ways that result in a
positive budget score could provide a new source of funding of at least
a billion dollars of key research programs such as carbon sequestration
demonstrations or efficiency programs that have strong policy,
analytical and bi-partisan support.
In short, we need a clearer articulation of the value of a larger
SPR relative to other policy options such as increased efficiency or
the introduction of alternative fuels that would reduce oil
consumption. I hope that this testimony has provided some food for
thought in this regard and look forward to the Committee's questions.
Thank you.
The Chairman. Thank you. Thank you all for your testimony.
Let me start with a few questions and then defer to others
here.
Let me ask you, Ms. Fredriksen, about the suggestions that
the General Accountability Office has in their testimony. Mr.
Rusco has made three suggestions, as I understand it. Very
briefly, he suggested that we should be buying more heavy oil
into the SPR.
Second, that we should be buying the oil on a dollar-cost
averaging basis where we spend a specific amount each day for
oil rather than buying a specific quantity of oil each day as I
understand your recommendation. Third, that we quit trading
royalty oil instead of just buying it in the market that is a
system that is not serving us well and is not properly
auditable and we don't know whether we're getting what we're
hoping to get out of that or not. What's your reaction? What's
the Department of Energy's reaction to those three
recommendations?
Ms. Fredriksen. Thank you, sir. In response to the question
or the position on heavy oil, I think I tried to make that
clear in my testimony that we do plan to consider the
expansion. Our expansion plans to the one billion the creation
of our ability to handle heavy crude oil.
It does have management challenges that are unlike handling
sweet and sour crude and the underground cavern. It also
minimizes the amount of capacity that we would have available.
So that is why the Department did the study. We do have plans
to include that in our expansion of analysis.
As regards to the study dollar verses the----
The Chairman. Let me just interrupt there. You don't think
it makes sense to change the mix of oils that you're purchasing
at this time?
Ms. Fredriksen. There's only 11 refineries out of 150 that
can process heavy crude oil in the United States currently. So
we do recognize that a disruption in heavy crude oil imports
would actually impact those refiners. Although they could still
process the crudes that we do have in the SPR, it would be at a
lesser amount of refined product that they could produce from
those refineries.
So we do want to provide that import protection for those
11 heavy crude oil refineries.
The Chairman. I didn't understand. Is that a yes or a no? I
mean, do you think it makes sense to change the mix? As I
understand----
Ms. Fredriksen. Yes. That is why we're going to plan to do
that in our expansion to the one billion.
The Chairman. But not at the current time.
Ms. Fredriksen. Not in our current reserves.
The Chairman. Why not?
Ms. Fredriksen. Due to the one, the limitation and the
capacity that we have available at the 727 heavy crude will
take up more volume in those, leaving less reserves therefore
less net import protection, our consumption protection. Two, it
does offer management challenges. It is a little harder to
store and manage and actual to distribute. So we have to
address those and that's what part of our expansion plans.
Does that answer your question, sir?
The Chairman. Yes. You can go right ahead with the other
two suggestions. What are your thoughts on those?
Ms. Fredriksen. On steady volume verses steady dollar the
Department has a policy that relies on a clear, transparent
expectation that the markets can't understand. We believe that
steady volume provides that protection. It's a minimal amount
of oil, less than one tenth of 1 percent of the world
production capacity, current volumes.
It is at a steady amounts. We announce--we do a
preannouncement. It's for a 6-month period of time. Therefore
we can fill our SPR for the protection reasons that we do need
that SPR.
The Chairman. OK.
Ms. Fredriksen. OK. On the third one which was the royalty
in kind verses direct purchase. As Congress sees to appropriate
funds to allow for direct purchases back in the mid `90s, which
is why the Clinton Administration instituted the RIK program.
That RIK program has been used to steadily fill. It
undergoes the--before any acquisition or from a direct purchase
or a RIK transfer of asset. It still undergoes a market
analysis that we have to conduct to ensure that the market can
handle that transfer of oil.
We still have the $584 million from the sales following
Hurricane Katrina that will be used for direct purchase. So the
Administration has not put in an appropriations request for
additional funding at this time. Because we still have that
money left to use.
The Chairman. Let me just understand. Why isn't that money
being used today rather than taking it royalty in kind?
Ms. Fredriksen. Um, we----
The Chairman. I understand Mr. Rusco's suggestion is that
you go ahead and use that money and then request Congress
continue to appropriate money so we can just go ahead and buy
the oil we need.
Ms. Fredriksen. We did go out last year with a bid offer
for two different occasions to repurchase that 11 million
barrels using that money. At the time it was about a year ago
at this point, March-April timeframe. We determined that the
market conditions, the amount of production capacity, the
amount of inventories and the amount of refined product on the
market was insufficient in the advent of a driving season, the
summer driving season. The bid that we received were not
appropriate we felt for the market. We chose not to purchase at
that time.
We have notified Congress in our FY 2009 budget submission
that that is a plan that we will pursue this year, if market
conditions can support that.
The Chairman. What I'm not understanding is if you take the
royalty in kind, aren't you essentially buying the oil at the
price you could turn around and sell that royalty in kind for?
Ms. Fredriksen. That's a transfer of an asset from the
Treasury Department to the Department of Energy verses a direct
appropriation for an expenditure for direct purchase.
The Chairman. But from the perspective of the American
taxpayer, I mean, if you take a barrel of oil in kind when the
price of oil is $100 a barrel, you are essentially purchasing a
barrel of oil for $100. Am I not right?
Ms. Fredriksen. I think it's a little complex and I would
like to be able to provide a written response to that question
that will give you a much better response from our economists
and our SPR office.
Senator Dorgan. Mr. Chairman, would you yield on that
point?
The Chairman. I'm glad to.
Senator Dorgan. The simple answer, not very complex. The
simple answer is they're putting $100 barrel oil underground.
That's the value of the oil that they're sticking underground.
Absolutely. It's the same as buying it for $100 a barrel.
The Chairman. Thank you very much.
Senator Domenici.
Senator Domenici. Sorry. That may be the simple answer and
I don't challenge or question you, but I think if she wants to
answer it another way in writing because she thinks there's
something important, then she should be permitted to do that.
Senator Dorgan. I agree.
Senator Domenici. So you will do that. Don't do it for me.
Just do it for the committee.
[The information referred to follows:]
The Royalty-in-kind program exchanges an asset from one Federal
agency to another. The quantity of exchange oil delivered to the SPR is
calculated relative to the value of the royalty oil the contractor
received and thus is independent of market price level.
Furthermore, the potential revenue that the Government would
otherwise receive if the royalty oil was sold is not forgone in this
exchange. The exchange oil placed in storage is an asset which retains
its full value to the Government. Revenue is simply delayed until such
time as the oil is sold. Historically, when oil has been sold from the
SPR it has led to a substantial return on the initial investment.
Ms. Fredriksen. Thank you, sir. I will.
Senator Domenici. All right. Let me ask, Mr. Verrastro.
We've seen oil reach prices that I assume you and I would not
have expected--$100 a barrel of oil--at this point in history.
Is that a fair statement?
Mr. Verrastro. I think that's a very fair statement,
Senator.
Senator Domenici. Yes, but the thing that intrigues me the
most is that you keep having experts advise those involved in
America's energy destiny that prices might come down in a big
way sometime. They put dollars up there and say in 10 years it
might be 50 or during a 10-year period it might go down to an
average of 70. Those are all over the place.
You don't agree with those who are predicting that there
will be a large decrease in oil over the next 20 years, do you?
Mr. Verrastro. No, Senator. I think that two things are
happening here. If you have flexibility to purchase when you
want or select when you start filling, the market does move
back and forth. It was $50 at the beginning of 2007. It moved
to $100 by the end of the year.
There's a strong belief that OPEC at this point, if prices
stay at this range, $95 to $100, OPEC will not cut production.
As a result of that when you look at the second quarter demand
drop, my suspicion is that prices will ease back from where
they are today. U.S. stocks are in pretty good shape. Gasoline
stocks are in pretty good shape.
Senator Domenici. But----
Mr. Verrastro. But I also make the case that by 2009 you
could have a surplus.
Senator Domenici. But, sir.
Mr. Verrastro. Projects come online and demand affects the
consumption that you might actually have a price drop. But,
yes, predicting it, a dollar value at any point in time. We
haven't been particularly good at it.
Senator Domenici. No.
Mr. Verrastro. I suspect we won't be.
Senator Domenici. Even if you're talking about the change,
you're not really talking about large change that would remain
over any sustained period of time. We're living in an era of
high prices and those who supply it know they'll get paid high
prices. It looks like that on the demand side, in particular
because of India and China, we're in there at the trough using
more than we ever have.
It looks like, unless something disastrous happens to the
world we're going to continue to pay a very high price for
energy, is that----
Mr. Verrastro. We're definitely in a higher price
environment than we've seen in the past, definitely, Senator.
Senator Domenici. Right. Energy as it pertains to crude
oil.
Mr. Verrastro. Yes.
Senator Domenici. If that's the case, then I don't
understand why filling the SPR was good, but now it's not good.
Mr. Verrastro. I think there's two points. One is the
timing on when you put, as Senator Dorgan or Senator Bingaman
said. At this point at $100 oil if you're putting it in the
ground, I think you're actually exacerbating the price
movement.
You have more takers from the market then you----
Senator Domenici. But what is exacerbating going to do to
the price when it's such a small amount of the demand?
Mr. Verrastro. I don't think it's volumetric, Senator. This
idea that----
Senator Domenici. It's not volumetric.
Mr. Verrastro. 100,000 barrels a day in an $86 million a
day market. I understand the arithmetic of that.
Senator Domenici. Yes.
Mr. Verrastro. But I believe if you're not willing to put
more oil out there and you believe that a tight market exists,
you should be putting more oil in the market, not taking oil
out of the market.
Senator Domenici. Do you have evidence that such a small
amount would cause these big problems?
Mr. Verrastro. Senator, we had a refinery go down a week
ago.
Senator Domenici. Yes.
Mr. Verrastro. 70,000 barrels a day and the price of crude
jumped $2. It's a disproportionate increase relative to the
volume. But that's not what's moving this market.
Senator Domenici. How long did it stay there?
Mr. Verrastro. No, it drops back. I mean the price has been
moving. We've been in a $85 to $100 weigh in for about the past
2 months.
Senator Domenici. So, the 70,000 barrel accident didn't
have a very significant impact in terms of lasting effects?
Mr. Verrastro. In terms of the staying price, right.
Senator Domenici. So if we are going to fill the SPR why
would you conclude that it would be any different than what we
just saw? If there was a fluctuation it's going to be just for
a while and it would go back.
Mr. Verrastro. I think it's two sides, Senator. I think one
side is that if you decide that you're not going to use the
Strategic Reserve. I think that the Administration, while there
hasn't been an articulated policy on volumes except for Vice
President Cheney's statement of the five or six million
barrels, that there's a presumption that it's not going to be
used. If it's not going to be used in a tight market there's no
penalty for people to talk the price up.
We did an analysis back in 2004. We took Ivan and Katrina
and Rita out of the analysis. So this is a time when prices
were going to 50 for the first time.
Senator Domenici. Yes.
Mr. Verrastro. The wonderful old days. Over that summer the
price moved from 36 to 50. Nothing happened in the market.
There was concern about UCOS, concern about the Venezuelan
referendum. There was a small strike in Nigeria. In 3 days at
the end of August, beginning of September, we had a standoff at
Mjaf, so it looked like Iraq wouldn't come apart at the seams.
We had President Clinton saying that no matter what happens to
UCOS that the Russians would continue to export. Claude Vandeel
made a statement that if prices exceed, you know, $50 we'll
consider drawing down the IEA and stocks dropped, their prices
dropped $9 in 3 days. That's not fundamentals.
So by making statements that you're continuing to take oil
off the market in a tight market. Especially when you've just
talked to OPEC, both the President and Secretary Bodman about
increasing supply. I think it undermines one's credibility.
The Chinese is a great example. The Chinese announced stock
bills. When the price goes high they say we're going to suspend
that. A lot of times they keep on buying, but they announce
that they're going to suspend ESA prices. They continue to buy,
but now they're buying at a lower price. It's just smart
management of what you do when you have a tight market.
Senator Domenici. I just want to say to my friend who's
taking the lead on this, Senator Dorgan, I see a reason for
doing this that I have not said yet said anything about. But I
might just say it. If we don't do this we would have some money
to spend on something else which is not too bad. You'd be in
charge of spending it.
So that I've been thinking that I'd be your brother until
you got me there and going on. So that would be nice. But
actually I believe that this is a dangerous world and I don't
think we can predict when something can happen that demands
that we use that Reserve without anybody being talking about
whether they will or they won't. I mean things could happen
next week that belie everything you've said and we will use it
and we'll be glad we have it.
Mr. Verrastro. Oh, I'm glad we have it, Senator. Let me
make one comment. In my statement the idea of setting a price
range that you won't buy back until the price reaches or drops
to $50, I think that's probably unrealistic in the current
market.
Senator Domenici. You bet.
Mr. Verrastro. But the idea that you ought to have some
flexibility and just manage it correctly, I would stand by my
statement.
Senator Domenici. Ok. I thank you. Thank you.
The Chairman. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman. Ms. Fredriksen,
I'd like to pursue with you some of these concerns. I mean, it
seems to me it makes no sense to fill the Reserve when all oil
prices are at an all time high. Not only that when the
Administration is talking about doubling its size to 1.5
billion barrels and beyond the question of the cost at this
high rate now, what does that say about your vision, meaning
the Department's vision and the Administration's vision for the
future?
You're planning a future in which we have doubled our oil
imports. A future where we are more dependent than ever on oil
and if that is the future we build, the one thing we can be
assured of is that oil prices will continue to rise, so will
the temperature of the planet. Is that really the Department's
long term plan?
Ms. Fredriksen. As I stated in my opening testimony, sir,
that it's a contextual approach. One is the fact that we have a
reality of our imports are at 60 percent of our consumption. We
must address that for national and energy security reasons.
But we don't stop there. Clearly this Administration has
endorsed the use of alternatives: alternative vehicles,
alternative fuels. We've supported the increase and Congress
passed and the President signed into law the increase in their
noble fuel standard.
All designed to lessen our dependence on foreign oil. We've
increased CAFE standards. We're working to put into
regulations----
Senator Menendez. But that, first of all, we would be
better off putting the resources behind making the alternative
energy opportunities a reality. Because what you send a
message. This is what I don't understand.
You send a message on one hand that you supposedly support
these things. Then on the other hand you want to increase the
overall capacity by 1.5 billion barrels. That sends a totally
different message, a totally different message, especially when
we're paying $100 a barrel.
How do you reconcile that? Just give me a brief answer. How
do you reconcile that?
Ms. Fredriksen. We reconcile it because the President feels
that our national and energy security, are most important to
this country following our experience on 9/11. He has directed
us to fill the SPR to its capacity as expeditiously and
practicable as possible.
Senator Menendez. Filling it to its capacity is one thing,
doubling its size is totally another. Ms. Kenderdine, let me
ask you, in your testimony you explain how energy efficiency
measures such as the CAFE standards, which we passed last year,
reduce the amount of the oil that we need to import. But also
increase a number of days of protection afforded by the
Strategic Reserve. I'd like you to elaborate on that idea.
The President wants to double the size of the Reserve as I
was just speaking to Ms. Fredriksen, with $100 a barrel oil.
That would cost us about $75 billion for the oil alone. If one
were to extrapolate at the present course.
Now, for example, we had the Secretary of Energy here. They
eliminate the Weatherization Program. That in my home State of
New Jersey produced very effective results in reducing our
demand. Wouldn't it be smarter to look at some of the $75
billion on alternative energy sources and conservation then
putting it into doubling the Reserve?
Ms. Kenderdine. Yes, sir. As I said in my statement if you
suspended just the current RIK program where there's 13 million
barrels that they intend to put into the Reserve. If you
temporarily suspended that and you structure, the scoring on
that is very difficult. We've been round and round on that.
But if you could structure it in a way that it scores
correctly and the scoring is complicated by EPACT '05 which
directs the fill of the SPR. There are however, significant
caveats in that legislation or in the statute that would--it's
not directional. So if you got this to score correctly, it
would be a billion dollars.
I spent a lot of time looking at different ways that, you
know, I would spend the money if I were chairman of the
Appropriations Committee or Energy and Water Appropriations
Committee and have my own views. But I think efficiency would
be critical. Alternative fuels obviously, because here talking
about displacing oil.
But as I said in my testimony the SAFE, Securing America's
Future Energy, did an analysis of the bill and said that if by
2022 you could save 2.2 million barrels of oil per day. I went
through and tracked the demand increases and surprisingly
enough the demand increases over the next 20 years. According
to EIA forecast demand for oil are not that great because they
are factoring in some of those things. So I think it is a wise
investment to put more money into what you would get greater
savings over time.
So I'm a strong advocate of that. I think that the
Strategic Petroleum Reserve is a fundamental part of our energy
security. It's important. I think it's a very large Reserve.
It's the largest in the world.
Throwing out the 58 days of import protection, it's a
somewhat meaningless statistic if you look at drawdown capacity
as well as the IEA definitions of import protection. The DOE
Web site says we have 118 days. So I think that it is a--you
want to fill it over time, expanding it to a billion barrels is
fine.
Do not affect the market or prices. Don't pull oil off
tight markets. Don't put $100 oil in the ground and try to
figure out how to balance the energy priorities that we have. I
would invest some money in alternatives, sir.
Senator Menendez. Thank you, Mr. Chairman.
The Chairman. Senator Barrasso.
Senator Barrasso. Thank you very much, Mr. Chairman. I do
support the goal of promoting America's energy security. It is
very important. We continue to become more and more reliant on
imported fossil fuels.
Ms. Fredriksen, that chart that you showed illustrated
clearly that even though you're putting more into the Reserve
over time, the number of days available has dropped. It's
because of our consumption. Not that you're not saving as much.
But I really get into the issue of accountability. That's
what people in Wyoming want to know about. The people in
Wyoming are no strangers to the impact of $100 a barrel for oil
and what that does to their weekly budget, to their
pocketbooks, and wallets.
In Wyoming, we rank highest in terms of the amount of miles
that we drive. The distances are long. So people notice it at
the pump. Talking to the guard at the airport yesterday in
Casper, Wyoming--what he knows is what it now costs, you know,
to go out to go hunting verses coming back because of the
amount of money at $2.89 a gallon in Wyoming for gasoline.
It costs a lot to heat a home in Wyoming. We have a number
of cold days. It's a cold climate. So there's that impact. So I
think I need to ask questions that make sure that the taxpayers
are getting their fair share on this and getting the right
deal. So those are the questions that I want to ask.
It seems that this move to go to a higher volume from what,
about 750 million barrels now or 727 to get to a billion and
then a billion five. At these high prices, I mean, it's either
because we believe that the prices are going to go up or we
think that there is an immediate threat. I don't know if it's
one or the other. If you like to first address that.
Ms. Fredriksen. First, it's an issue of the law since we're
required to get to the one billion. We've asked for the
necessary appropriations to do those expansion activities. On
the filling to the capacity of 727, it's not at the expense of
investing in our energy future with renewables, with
alternative technologies.
Certainly the Department spends, the U.S. spends the most
amount of money on energy technology, R and D, of any country
in the world, which is proper as the largest energy consumer in
the world. We have to be leaders in that respect. So our
filling of the Reserve is a commitment we have for energy
security protection.
But we do not take that responsibility, that fiduciary
responsibility lightly. As I stated we conduct a thorough
market analysis before doing either an RIK or going out for a
direct purchase from the market. We look at all of the factors.
The factors of capacity, the factors of production
capacity, refining capacity, what do the inventories look like,
will the market sustain this without an exacerbated impact. We
have found on these occasions, last year and this year, for our
RIK filling that we will not have an exacerbated impact on the
market. So we have commenced those RIK activities.
Your other question I'm--you can remind me of the latter
part of the question.
Senator Barrasso. I'll go onto the next question. Looking
at this you're trying to put about 100,000 barrels a day. Is
that about what you're looking for? Is that what I've heard?
Ms. Fredriksen. It's about 70,000 barrels per day.
Senator Barrasso. At that rate, it takes what, almost 2
weeks to put a million barrels away? You're trying to go. So
you'd put in 26 million a year.
Then if you think that you're trying to get from 750 to a
billion. I mean, that's right there. You're talking about the
number of years that it would take.
Then to get to a billion and a half you'd have to do 70,000
a day for 30 years to get you to a billion and a half barrels
in the Reserve. I look at that and say, ok, that is clearly a
demand on the world system that, as Mr. Verrastro talked about,
is already vulnerable because we're kind of peaking out. I just
think that it could have a significant impact on what consumers
are paying at home and at the pump.
Ms. Fredriksen. Yes, sir. I would like to remind everyone
that the reason for the numbers of roughly 55 or 58 days of
protection that the SPR provides. Those are the strategic
stocks. Strategic is only something that we, the government,
have control over.
While we do depend on the privately held, commercial stocks
to meet our obligations under the IEA commitment, we none the
less do not have any ability to direct what the commercial
entities do with their oil. So we're very conscious of that.
Therefore find that we need to increase what the government has
for strategic use in the case of a severe supply disruption.
Senator Barrasso. Mr. Chairman, I know my time is up. I
just like Dr. Rusco's approach to dollar-cost averaging. It
works in investing. They recommend the public do that sort of
thing in terms of proper investing and I think that was your
point. I think there's some value in at least examining that
for these purchases.
Thank you, Mr. Chairman.
The Chairman. Thank you.
Senator Dorgan.
Senator Dorgan. Mr. Chairman, I was chairing the bill on
the floor of the Senate, so I was not able to be here early.
Let me just make a couple of comments first.
You know, timing, and this is really an issue about timing.
Timing is everything. There's an Indian chief who once said,
the success of a rain dance depends a lot on timing.
You know, timing is critically important to a lot of
things. This is all about timing. The question, Ms. Fredriksen,
for me is why would we take $100 a barrel oil and stick it
underground at a time when the price of oil is bouncing around
in the stratosphere? You almost have to get a loan to fill your
tank with gas these days.
Here's what I see happening. Unbelievable speculation in
the energy markets and the futures markets, unbelievable
speculation. Hedge funds and investment banks neck deep in
these processes. In fact I'm told investment banks are buying
storage capacity in order to store oil. They are taking oil off
the market to store it for future opportunities and sell it at
a higher price. This is the first time that's happened.
So you have a carnival of speculation in the futures
market. It has dramatically increased the price of oil. Well
above that that the fundamentals would suggest be the price of
oil today.
Now at this point I believe, because of that, I believe we
ought to have a pause with respect to filling the SPR. I
understand the points you just made about the oil that's under
the government's control, but your own Web site describes the
reserves that exceed that amount that we are required to have.
I mean, that's on the Web site. So I assume that you're proud
of those reserves that meet our international obligations.
But the--we have had testimony before this committee on the
issue of the sweet, light crude that you're taking as royalty
in kind and putting underground. Mr. Berger, was here, as one
of our witnesses. He indicated that because that's a subset of
oil and a very valuable type of oil, sweet, light crude, he
estimated that what you have done by putting that underground
is increased the price of oil by about $10 a barrel.
That's testimony we've received in this committee by at
least one expert. We had another expert sit in this committee
recently, who said there is not a bit of justification for oil
to be with respect to the fundamentals, above about $55 or $60
a barrel.
So there's an unbelievable amount of speculation going on.
We got this price up there bouncing, both the price of oil and
at the gas pumps. At this point we're going to put 60, 70,000
barrels underground relentlessly just because we decided that's
what we're going to do, not withstanding any other issue. I
mean, I think that's nuts, frankly.
I just think that we have to worry about timing, about the
economic consequences. So I want to ask you, I guess, a couple
of questions. No. 1, the cost of the money that we're putting
underground in oil, we're taking it out of supply, which by
definition increases price, I mean, I used to teach economics.
So supply demand means you reduce supply, you increase price,
right?
You're saying it's insignificant. Other experts have told
us that it is not insignificant at all. I want to ask you, No.
1, what's it going to cost to do what you are suggesting? It
looks to me like $80 billion or more. I don't see that money
being recommended to fill the SPR the way you want to spill
it--fill it rather, relentlessly, without concern to what's
happening in the marketplace.
Second, is doing this the most effective way to reduce our
dependence and provide energy security for our country or are
there other subset of investments that we ought to make in
renewable energy. For example say we're talking about $100 a
barrel oil and sticking it underground. Are there other
investments you could have made with that equivalent amount of
money in other energy technologies or energy investments that
would have been much, much more effective?
Now I've bled away most of my time because I wasn't able to
be here to start. But I want to ask, Ms. Fredriksen, have you
priced out what this is going to cost in terms of reaching the
billion and a half barrel goal in terms of the cost of
purchasing the oil over a long period and the facilities that
would have to be built or expanded? Is there an estimate of the
price?
Ms. Fredriksen. We have submitted those plans to Congress
for our expansion plans to the 1.5 which Congress has not
currently authorized us to go to.
Senator Dorgan. But do you know what the price would be if
you're suggesting we do that? Do you know what the cost will
be?
Ms. Fredriksen. I'm assuming your asking me based on
today's conditions.
Senator Dorgan. What do you expect? I mean I assume that
would estimate from your standpoint what the price of oil would
be in the future. But what I assume that because you're
planning to do this you have some notion of what the cost might
be in the future.
Ms. Fredriksen. I, unlike you, sir, am just an engineer. So
I won't even claim to be smart about economics. But I will say
that from what I understand from the Energy Information
Administration this is a backward dated market right now and
that means that the prices today are higher than what they
expect the future to be.
But none of us can predict the future. So we have taken a
true market look at our impact of taking the RIK oil to fill to
our capacity of 727. We have not found based on that analysis
that there is a significant impact on the market.
Senator Dorgan. I'd like to see that analysis. I understand
the analysis exists but has not been made available. We have
had other experts testify to say it is having an impact on the
market because it's a subset, the sweet, light crude.
I tell you I've introduced this legislation that has
bipartisan support. I'm going to try to find every way possible
in the coming couple of months to stop the Department from
putting oil underground when oil is $100 a barrel. I think that
is unbelievable to do.
So, let me ask another question about--I appreciate your
being here and representing the Department's views. But could
you send me the analysis that there is no impact?
[The information referred to follows:]
Department of Energy,
Washington, DC, January 26, 2007.
Memorandum for the File
From: John D. Shages, Deputy Assistant Secretary, Petroleum Reserves
Subject: Resumption Of Strategic Petroleum Reserve Oil Acquisition
BACKGROUND
The Energy Policy Act of 2005 directs the Secretary of Energy, ``as
expeditiously as practicable, without incurring excessive cost or
appreciably increasing the price of petroleum products to consumers,
acquire petroleum in quantities sufficient to fill the Strategic
Petroleum Reserve to the 1,000,000,000 barrel capacity authorized under
section 154(a) of the Energy Policy and Conservation Act''.
The Strategic Petroleum Reserve Office under direction of the
President resumed oil acquisition for the Strategic Petroleum Reserve
(SPR) in early 2002, with a goal of 700 million barrels. That goal was
achieved in August 2005, however, Hurricane Katrina caused us to loan
and sell a total of 20.8 million barrels of oil. Most of the loaned oil
was returned by the Spring of 2006. In March 2006, as part of a four
point program to address high oil prices, the President directed us to
stop filling the SPR. In response we deferred 1.7 million barrels of
oil deliveries which are now scheduled for the second quarter of 2007.
Upon receipt of that oil we will have an inventory of 691 million
barrels. Otherwise the Department of Energy is not acquiring oil to
fill the SPR.
ISSUE
Is the present time appropriate to resume oil acquisition to
satisfy requirements of the Energy Policy Act of 2005 requiring us to
fill the SPR to authorized one billion barrel capacity, ``as
expeditiously as practicable without incurring excessive cost or
appreciably affecting the price of petroleum products to consumers''?
DISCUSSION
The Energy Policy Act of 2005 also required the Department to issue
procedures for oil acquisition. Those procedures were finalized as
regulations and prescribe the issues that must be addressed when the
Department intends to resume oil acquisitions after a hiatus. The
attached report authored by staff of the Strategic Petroleum Reserve
offices, satisfies the regulations. It addresses all the issues of
consequence that should be considered prior to a substantial oil
acquisition. The report indicates in every area of concern that the
present is an acceptable time to begin an acquisition of approximately
37 million barrels of oil.
FINDING
I find that the attached analysis satisfies our codified procedures
for oil acquisition. I also agree with the particulars of the analysis
and its conclusions. Furthermore, in my judgment the recent actions of
the Organization of Petroleum Exporting Countries to reduce exports,
and indications that they are ready to further reduce exports if
necessary to defend current levels of commercial inventories and
prices, makes it unlikely there would be any benefit in delaying the
resumption of crude oil acquisition. Therefore, I am directing Director
of the Office of Operations and Readiness and the Strategic Petroleum
Reserve Project Management Office to take all necessary actions to
solicit for and procure oil to the extent practicable and as limited by
available funding, and additionally to initiate resumption of the
transfer of oil royalty oil from the Department of the Interior. Our
intention is reach the target inventory of 727 million barrels by the
end of calendar year 2008.
______
Department of Energy,
Washington, DC, January 18, 2007.
Memorandum for John D. Shages, Deputy Assistant Secretary, Office of
Petroleum Reserves
Through: Lynnette Le Mat, Director, Office of Operations and Readiness
From: Nancy Marland, Industrial Specialist and Jeremy Cusimano,
Economist
Subject: Assessment of prevailing market conditions prior to the
resumption of Strategic Petroleum Reserve fill.
BACKGROUND
The Procedures for the Acquisition of Petroleum for the Strategic
Petroleum Reserve (10 CFR Part 626) establishes the rules and
procedures for acquiring Strategic Petroleum Reserve (SPR) crude oil.
This rule stipulates that prior to the resumption of SPR fill, ``DOE
will consider various factors that may be affecting market
fundamentals, current and projected SPR and commercial receipt
capabilities, and the geopolitical climate.'' The Department of Energy
wishes to resume activities to acquire approximately 37 million barrels
of crude oil to fill the SPR to its current capacity of 727 million
barrels. These activities will include open market purchases and the
resumption of the Royalty-in-Kind (RIK) Exchange Program with the
Department of the Interior. Therefore, as prescribed by the rule, DOE
must make an assessment of the impact of these acquisition activities.
ASSESSMENT
To assess the potential impact on markets of DOE's acquisition of
crude oil for the Strategic Petroleum Reserve, the SPR office reviewed
current and future prices, a wide variety of industry assessments and
expert opinions as contained in studies, trade publications and news
reports, and official outlooks published by the Energy Information
Administration and international Energy Agency. The factors considered
are not limited to those being enumerated below.
(1) The current inventory of the SPR
The current inventory of the SPR is approximately 690 million
barrels. The peak inventory of 700.8 million barrels was achieved in
August 2005 before the sale of 11 million barrels as a result of
Hurricane Katrina. On April 25, 2006 President George W. Bush directed
the Department of Energy to defer filling the SPR for a short period of
time in response to prevailing market conditions.
The Department seeks to acquire a total of 37 million barrels to
fill the Reserve to capacity in the near term. Filling to the current
capacity is consistent with the Energy Policy Act of 2005 (P.L. 109-58,
Sec. 301 (e)) direction to fill as expeditiously as practicable to the
authorized one billion barrels capacity. The volume of crude oil that
is sought to fill the SPR represents less than one-third of total
global daily production. Specifically, $584 million of the proceeds
from the 2005 hurricane Katrina drawdown sale will initially be used to
purchase from the open market starting in the second quarter of
calendar year 2007 at a rate that will average approximately 100,000
barrels per day. Subsequently, transfers under the RIK exchange program
will recommence on July 1, 2007 at a rate of approximately 50,000
barrels per day for 90 days, and then increase to a rate of 100,000
barrels per day until the capacity is filled. At these rates it would
take more than a year to fill the SPR to the 727 million barrel
capacity.
(2) The current level of private inventories
As of January 5, 2007, the Energy Infonnation Administration (EIA)
reports total petroleum stocks (excluding the SPR) of 1031.3 million
barrels. This level is above the upper end of the 5-year average for
this time of year, and in general inventories throughout 2006 were near
or above the average range.
Crude oil (excluding the SPR) stocks accounted for 315 million
barrels of total private stocks. While declining from peak levels in
the autumn of 2006, crude oil stocks are nonetheless also above the
upper end of the 5-year average for this time of year.
The crude oil futures market is currently in ``contango''. This is
a market condition where near-term prices are lower than future prices.
This market condition typically encourages the building and holding of
private stocks and is likely a driving force behind the observed build
and maintenance of private stocks over the past year.
While the significant overhang of stocks from autumn highs has been
worked off to some degree, the continuance of the contango structure
makes it highly unlikely that, at a modest fill rate, the diversion of
37 million barrels of crude oil into strategic storage over the next
year will displace private industry stocks and discourage industry
stockpiling. Private inventory levels arc more influenced by market
forces that would not be significantly impacted by the quantity of oil
being added to the SPR.
(3) Days of net import protection
As a member nation of the International Energy Agency, the United
States is committed to maintaining stocks of crude and products in
reserves equivalent to 90 days of net petroleum imports. Computations
of member stockpile requirements are based on both public and privately
held stocks.
The SPR crude oil inventory of 690 million barrels is equivalent to
approximately 58 days of import protection. Together with all usable
private petroleum stocks, the total days of import protection is
approximately 138 days. Filling to the 727 million barrels of SPR
capacity would add an additional 3 days of import protection at current
import levels.
While currently healthy, the days of import protection afforded by
the current stock levels will decline as the import rate goes up and
especially if the futures market reverts to backwardation over time,
discouraging private stockholding. Based on EIA's Annual Energy Outlook
import projections, days of net import protection provided by the SPR
will decline to 57 days by 2010 and to 53 days by 2015. However, the
three extra days in SPR storage would help to reduce reliance on
private stocks to meet IEA compliance standards.
(4) Current price levels for crude oil and related commodities
Recent crude oil prices have varied between $51 and $64 per barrel,
down from a mid-July 2006 high of $78.40. The price of West Texas
Intermediate has fallen 15 percent from January 2. Product prices
reflect this overall decrease, and refinery margins have come off
sustained highs that characterized the spring and summer. An
unexpectedly mild winter, particularly in the Northeast, has not put a
strain on supplies, and prices have continued to decline Any short-term
price spikes or supply issues should easily be addressed by the
petroleum stocks held by industry. Although prices have receded from
2006 highs, most forecasters nonetheless predict crude oil prices to
stay at or above current levels for the near future. Although it can
not be said with certainty, rising demand from global economic growth,
especially in developing countries, producer (OPEC)-managed supply,
investment funds moving in and out of commodities to balance their
portfolios, and the risk of market volatility driven by geopolitical
events would suggest that if the SPR were filled at a later date it
could be done at a higher cost.
(5) The outlook for international and domestic production levels
According to the Energy Information Administration (EIA) January 9,
2007 Short-Term Energy Outlook, ``Domestic oil production in 2006 is
estimated at 5.14 million barrels per day. In 2007 and 2008, crude oil
production is projected to average 5.31 and 5.45 million barrels per
day, respectively, reflecting not only recovery from the impact of the
2005 hurricanes that continued to depress Gulf of Mexico production in
the first half of 2006, but also the startup of new deepwater
production.''
Citing high global inventories, OPEC announced in October 2006 its
intentions to cut production by 1.2 million barrels per day from
November 1, reportedly to stabilize the market, to reduce the
previously cited stock overhang, and to keep prices in the range
necessary to support investments for maintaining or increasing future
production capacity. A second cut of 0.5 million barrels per day is
scheduled to go into effect on February 1, 2007.
EIA projects non-OPEC production to rise by 1.1 million barrels per
day in the near term. Most of this increase in production will come
from the Caspian region and increased BTC pipeline throughput. In
addition, significant expansion projects in places such as Russia,
Africa, Brazil, and Canada's oil sands will offset declines in mature
fields such as those in the North Sea and Mexico, and add additional
crude oil supply to the global market.
The dedication of 100,000 barrels per day into strategic storage
represents approximately 0.12 percent of world crude oil production.
Given the positive near-term supply picture the daily removal of that
quantity of crude oil from the world market will have a negligible
impact crude oil prices.
(6) Existing or potential disruptions in supply
Many petroleum market analysts attribute a significant portion of
recent crude oil price increases to changes in either perceived or real
global supply risk. The political climate in several major oil
producing regions (e.g. Nigeria, Venezuela, and the Middle East) has
created concern within the market over short-term and long-term supply.
By continuing to rely on these regions for imported crude oil, the
United States is highly vulnerable, both strategically and
economically, to disruptions in supply. The 2005 Energy Modeling Forum
assessment of crude oil market risk identified an increasing likelihood
of crude oil supply disruptions within these regions.
As long as the United States relies on imported oil for unstable
regions, the Strategic Petroleum Reserve provides the first line of
defense from supply disruptions. With the share of U.S. crude oil
demand that is supply through imports projected to rise significantly
over the coming years, it seems prudent to increase the level of
protection supplied by the SPR. Adding this additional 37 million
barrels to the SPR will provide additional protection of over three
days worth of net imports.
Prior to engaging in SPR fill activities, the Department of Energy
should consider the potential for large crude oil supply disruptions
that would affect fill activities as well as the potential for SPR fill
activities to increase the likelihood of supply disruptions. In recent
years there have been a number of relatively small (up to 2 million
barrels per day) crude oil supply disruptions and the current
production from a number of less stable regions can fluctuate daily;
however, the market is not currently considered to be `disrupted' in
any way. There is no readily available evidence that would lead us to
expect a crude oil supply disruption in the coming months that would be
of sufficient size to interfere with the fill of the SPR. Additionally,
given the rates at which the SPR will be filled it is highly unlikely
that this fill activity will adversely impact the level of global crude
oil production.
(7) Existing refining capability
Refinery utilization rates can act as an indicator of petroleum
market tightness. High utilization rates (well in excess of 90%)
suggest an elevated demand for petroleum products and therefore crude
oil. As discussed herein, during periods of market tightness small
changes in supply or demand will have an amplified market impact. With
the exception of normal autumn and spring turnarounds to adjust for
seasonal product slates, domestic refineries have by and large
recovered from the 2005 hurricane impacts and have been running between
87 and 92 percent utilization, lower than in recent years but adequate
to supply demand for and maintain stocks of all major products. The
January 9, 2007 EIA Short Term Energy Outlook projects distillate
inventories to be within the five-year average range and motor gasoline
stocks to be slightly higher than at this time last year. Refining
margins have retreated from earlier elevated levels, and the current
level of refinery utilization reflects that sufficiency of supply. The
recent periods of high refinery utilization and handsome refining
margins have lead many U.S. and international refiners to plan
significant capacity expansions. Virtually all U.S. expansions are
designed to increase the refineries capability to process the cheaper
heavy sour crudes as feedstock. The numbers of refinery expansions that
are planned lead us to believe that refinery utilization rates should
remain at a comfortable level in the near term.
When jointly considering this trend in refining capacity and the
current `contango' in the futures market, which should continue to
encourage high industry crude oil stocks, there does not appear to be
any potential for negative impacts from filling the SPR at the proposed
rates. High levels of private crude oil stocks and slack in the
refining system should help attenuate the impact of any small market
disruptions. The total proposed fill volume and the rate at which fill
will occur are such that they should not disrupt this market
relationship.
(8) Futures market price differentials for crude oil and related
commodities
The contango market structure seems to be firmly entrenched for
NYMEX crude oil and products futures prices. This market condition will
continue to encourage high levels of industry stockpiling. This is
driven by the market's perception of ample supplies available in the
near term and the expectation that prices in the future will be higher
than they are today. The WTI futures price curve is increasing from the
current month price of roughly $52 per barrel to between $58 and $59
per barrel 18-22 months out. This suggests that filling the SPR now, at
the pace that is proposed, will likely not have a significant market
impact and will proved to be more fiscally responsible than filling at
a later date.
(9) Any other factor the consideration of which the Secretary deems to
be necessary or appropriate
China has recently begun to fill the 33 million barrel first phase
of its strategic reserve, reportedly now two-thirds towards that
milestone. The re-entry of the United States into the market may
introduce competition with China to pick up the marginal barrels for
filling respective reserves.
Recent reports indicate China may fill its reserve to 100 million
barrels in the next two years, an average fill rate of 150,000 barrels
per day. While statements by China indicated their acquisition may be
tied to a target price threshold, the actual pattern of those future
acquisitions, in terms of both volume and timing, is unclear, and this
uncertainty may result in periodic market forays having a marked
impact. In contrast, DOE would follow past practice of acquiring stocks
at a low, steady rate under term contracts or continuous open spot
closings until an advertised goal is reached. The transparency inherent
in this process allows market participants to factor it into their
planning. The anticipated 100,000 barrels per day anticipated combined
purchase and royalty transfer rate would be expected to be accommodated
in the same way, and is a mere fraction of OPEC's discretionary
production.
As China has opened up the facilities for Sinopec stocks, despite
pubic statements that it will be used only in instances of supply
shortage, it is at yet unclear what the use policies will be, i.e., in
response to price signals or for supply security. While there is some
`freerider' benefit to the U.S. from other countries developing
strategic stockpiles, the uncertainty over how large the Chinese
reserve actually will be and their future use policy brings these
benefits into question. To ensure the energy security of the United
States it is recommended that the SPR be filled with this incremental
volume rather than relying on others to develop the reserves.
RECOMMENDATION
Based on the considerations described herein, we recommend the
Department of Energy issue a public solicitation to purchase crude oil
and then reinstate the Royalty-in-Kind program with the Department of
the Interior to acquire a total of approximately 37 million barrels of
crude oil at an average rate of 100,000 barrels per day. Given the
above considerations, the market impact of transferring these 37
million barrels to the SPR should be negligible.
______
Department of Energy,
Washington, DC, September 20, 2007.
Memorandum for John D. Shages, Deputy Assistant Secretary, Office of
Petroleum Reserves
Through: Lynnette Le Mat, Director, Office of Operations and Readiness
From: Nancy Marland, Industrial Specialist; Jeremy Cusimano, Economist;
and Jordon Grimm, Economist
Subject: Assessment of prevailing market conditions prior to the
continuation of Strategic Petroleum Reserve fill
BACKGROUND
The Procedures for the Acquisition of Petroleum for the Strategic
Petroleum Reserve (10 CFR Part 626) establishes the rules and
procedures for acquiring Strategic Petroleum Reserve (SPR) crude oil.
This rule stipulates that prior to the resumption of SPR fill, ``DOE
will consider various factors that may be affecting market
fundamentals, current and projected SPR and commercial receipt
capabilities, and the geopolitical climate.'' In April of 2007 the
Department of Energy resumed activities to acquire approximately 37
million barrels of crude oil to fill the SPR to its current capacity of
727 million barrels. These activities included resumption of the
Royalty-inKind (RIK) Exchange Program with the Department of the
Interior and two unsuccessful solicitations for direct market
purchases. Presently, the first round of RIK exchanges is nearing
completion and the Department of Energy wishes to issue a solicitation
for a second round of exchanges. Therefore, as prescribed by the rule,
DOE must make an assessment of the impact of these acquisition
activities.
ASSESSMENT
To assess the potential impact on markets of DOE's acquisition of
crude oil for the Strategic Petroleum Reserve, the SPR office reviewed
current and future prices, a wide variety of industry assessments and
expert opinions as contained in studies, trade publications and news
reports, and official outlooks published by the Energy Information
Administration and International Energy Agency. The factors considered
are not limited to those being enumerated below
(1) The current inventory of the SPR
The current inventory of the SPR is approximately 692.1 million
barrels. The peak inventory of 700.8 million barrels was achieved in
August 2005 before the sale of 11 million barrels as a result of
Hurricane Katrina. On April 25, 2006 President George W. Bush directed
the Department of Energy to defer filling the SPR for a short period of
time in response to prevailing market conditions.
The fill of the SPR was resumed through the RIK program with the
Department of the Interior. A solicitation for the first round of RIK
was issued in April 2007 and the first exchange barrels have begun to
arrive at SPR sites. Approximately 8.5 million barrels of exchange oil
that will be delivered to the SPR by January 2008 in the first round of
RIK. The Department seeks to acquire an additional 28.5 million barrels
to complete the fill of the Reserve to its near term capacity. Filling
to the current capacity is consistent with the Energy Policy Act of
2005 (P.L. 10958, Sec. 301 (e)) direction to fill as expeditiously as
practicable to the authorized one billion barrels capacity. The volume
of crude oil that is sought to fill the SPR represents less than one-
third of total global daily production. The fill rate for the second
round of RIK will increase slightly from 50,000 barrels per day to
70,000 barrels per day. The total quantity of oil to be offered for
exchanged will be roughly 12.6 million barrels. At these rates it would
take more than a year to fill the SPR to the 727 million barrel
capacity.
(2) The current level of private inventories
As of September 12, 2007, the Energy Information Administration
(EIA) reported total petroleum stocks (excluding the SPR) of 1019.1
million barrels. This level is above the upper half of the 5-year range
for this time of year, and in general inventories in 2007 have been in
or above the average range.
Crude oil (excluding the SPR) stocks accounted for 322.6 million
barrels of total private stocks. While declining from peak levels in
the July of 2007, crude oil stocks are nonetheless also above the upper
end of the 5-year average for this time of year.
The crude oil futures market is currently backwardated. This is a
market condition where near-term prices are higher than future prices.
This market condition typically discourages the building and holding of
private stocks and is likely a driving force behind the observed
decline in private stocks. Although privately held stocks are
declining, they are still relatively high when compared to this time of
year over the past decade. Additionally, given the very modest SPR fill
rate from RIK exchanges it is highly unlikely that the diversion of an
additional 12.6 million barrels of crude oil will negatively impact
industry stock levels. Private inventory levels are more influenced by
market forces that would not be significantly impacted by the quantity
of oil being added to the SPR.
(3) Days of net import protection
As a member nation of the International Energy Agency, the United
States is committed to maintaining stocks of crude and products in
reserves equivalent to 90 days of net petroleum imports. Computations
of member stockpile requirements are based on both public and privately
held stocks.
The SPR crude oil inventory of 692.1 million barrels is equivalent
to approximately 58 days of import protection. Together with all usable
private petroleum stocks, the total days of import protection is
approximately 139 days. Filling to the 727 million barrels of SPR
capacity would add an additional 3 days of import protection at current
import levels.
While currently healthy, the days of import protection afforded by
the current stock levels will decline as the import rate goes up and
especially if the futures market remains backwardated over time,
discouraging private stockholding. Based on ETA's Annual Energy Outlook
import projections, days of net import protection provided by the SPR
will decline to 57 days by 2010 and to 53 days by 2015. However, the
three extra days in SPR storage would help to reduce reliance on
private stocks to meet IEA compliance standards.
(4) Current price levels for crude oil and related commodities
Recent crude oil prices have varied between $63 and $80 per barrel.
Compared to prices from one year before, crude oil in late August 2007
was valued nearly 8% higher. Product prices were higher in June than in
the previous year, but cooled for the remainder of the summer as
refinery utilization improved. Refiner margins decreased through the
summer due to a tightening global crude oil market. Enough slack
remains in the oil market that any short-term price spikes or supply
issues should be addressed by the petroleum stocks held by industry.
While the end of summer generally signals a decrease in crude oil
prices, worries over an active hurricane season in the Atlantic helped
increase fuel prices to record levels. Barring a hurricane-related
disaster for producers, though, these fears should ease after the peak
of hurricane season in mid-September. Although it can not be said with
certainty, rising demand from global economic growth, especially in
developing countries, producer (OPEC)-managed supply, investment funds
moving in and out of commodities to balance their portfolios, and the
risk of market volatility driven by geopolitical events would suggest
that if the SPR were filled at a later date it could be done at a
higher cost.
(5) The outlook for international and domestic production levels
According to the Energy Information Administration (EIA) September
11, 2007 Short-Term Energy Outlook, domestic oil production in 2007 is
estimated at 5.2 million barrels per day. In 2008, domestic crude oil
production is projected to average 5.36 million barrels per day.
Fueling these increases is new production from deepwater platforms.
On September 11, 2007, OPEC agreed to increase production by
500,000 barrels per day. EIA projects non-OPEC production to rise by 1
million barrels per day for 2008, an increase over the expected 600,000
barrel per day growth projected for 2007. Most of this increase will
come from the United States, Brazil and the former Soviet Union. These
increases will offset declines in mature fields such as those in
Mexico, and add additional crude oil supply to the global market.
The dedication of 70,000 barrels per day into strategic storage
represents approximately 0.09 percent of world crude oil production.
Given the positive near-term supply picture the daily removal of that
quantity of crude oil from the world market will have a negligible
impact crude oil prices.
(6) Existing or potential disruptions in supply
Many petroleum market analysts attribute a significant portion of
recent crude oil price increases to changes in either perceived or real
global supply risk. The political climate in several major oil
producing regions (e.g. Nigeria, Venezuela, and the Middle East) has
created concern within the market over short-term and long-term supply.
By continuing to rely on these regions for imported crude oil, the
United States is highly vulnerable, both strategically and
economically, to disruptions in supply. The 2005 Energy Modeling Forum
assessment of crude oil market risk identified an increasing likelihood
of crude oil supply disruptions within these regions.
As long as the United States relies on imported oil from unstable
regions, the Strategic Petroleum Reserve provides the first line of
defense from supply disruptions. With the share of U.S. crude oil
demand that is supplied through imports projected to rise significantly
over the coming years, it is prudent to increase the level of
protection supplied by the SPR. Filling the SPR to its capacity will
provide additional protection of over three days worth of net imports.
Prior to engaging in SPR fill activities, the Department of Energy
should consider the potential for large crude oil supply disruptions
that would affect fill activities as well as the potential for SPR fill
activities to increase the likelihood of supply curtailments. In recent
years there have been a number of relatively small (up to 2 million
barrels per day) crude oil supply disruptions and the current
production from a number of less stable regions can fluctuate daily;
however, the market is not currently considered to be `disrupted' in
any way. There is no readily available evidence that would lead us to
expect a crude oil supply disruption in the coming months that would be
of sufficient size to interfere with the fill of the SPR. Additionally,
given the rates at which the SPR will be filled it is highly unlikely
that this fill activity will adversely impact the level of global crude
oil production.
(7) Existing refining capability
Refinery utilization rates can act as an indicator of petroleum
market tightness. High utilization rates (well in excess of 90%)
suggest an elevated demand for petroleum products and therefore crude
oil. As discussed herein, during periods of market tightness small
changes in supply or demand will have an amplified market impact. With
the exception of normal autumn and spring turnarounds to adjust for
seasonal product slates, and some planned downtime in the spring of
2006, domestic refineries have by and large recovered from the 2005
hurricane impacts and have been running between 87 and 92 percent
utilization, lower than in recent years but adequate to supply demand
for and maintain stocks of all major products. The September 11, 2007
EIA Short Term Energy Outlook projects distillate inventories to be
within the five-year average range and motor gasoline stocks to be
slightly lower than at the five-year average. Refining margins have
retreated from earlier elevated levels, and the current level of
refinery utilization reflects that sufficiency of supply. The recent
periods of high refinery utilization and handsome refining margins have
lead many U.S. and international refiners to plan significant capacity
expansions. Virtually all U.S. expansions are designed to increase the
refineries capability to process the cheaper heavy sour crudes as
feedstock. The numbers of refinery expansions that are planned lead us
to believe that refinery utilization rates should remain at a
comfortable level in the near term.
The current backwardation condition in crude oil futures markets
leads refiners to reduce their crude oil stocks. Despite this, stocks
are relatively high and refiners maintain some slack in utilization.
Because of these facts, filling the SPR at the proposed rate should not
cause any disturbance in oil markets.
(8) Futures market price differentials for crude oil and related
commodities
The contango market structure that seemed entrenched in early 2007
had flipped to a backwardation structure by the end of summer. This
represents a market perception that oil prices in the future will be
lower than they are today. Backwardation provides a disincentive for
holding crude oil stocks. At the beginning of September, the WTI
futures price curve was decreasing from the current month price of $75
per barrel to $68--$70 per barrel 18-22 months out. However, the NYMEX
WTI contract has previously remained backwardated while prices
consistently climbed for several consecutive years. This highlights the
fact that the WTI forward curve is not in anyway a forecast of market
prices. While prices may be relatively high at the moment, we have no
reason to believe that they will be going down anytime soon.
Additionally, while industry reduces the amount of crude oil held in
their operational reserves, our domestic industry becomes more
vulnerable to shocks. This is because they have a reduced ability to
absorb `bumps in the road' when holding smaller operational stocks.
Extended periods of market backwardation highlight the inherently
governmental nature of strategic stock building. Thus, continuing fill
of the SPR now will increase the total amount of stocks held in the
U.S. during a period where they would not otherwise be stored by
industry.
(9) Any other factor the consideration of which the Secretary deems to
be necessary or appropriate
China has recently completed fill of the 33 million barrel first
phase of its strategic reserve. The presence of the United States into
the market may introduce competition with China to pick up the marginal
barrels for filling respective reserves.
Recent reports indicate China may fill its reserve at 150,000
barrels per day through the end of 2007. The actual pattern of those
future acquisitions, in terms of both volume and timing, is unclear,
and this uncertainty may result in periodic market forays having a
marked impact. In contrast, DOE would follow past practice of acquiring
stocks at a low, steady rate under term contracts or continuous open
spot closings until the advertised goal is reached. The transparency
inherent in this process allows market participants to factor it into
their planning. The anticipated 70,000 barrels per day anticipated
combined purchase and royalty transfer rate would be expected to be
accommodated in the same way, and is a mere fraction of OPEC's
discretionary production.
As China has opened up the facilities for Sinopec and other
international entities' stocks, despite pubic statements that it will
be used only in instances of supply shortage, it is at yet unclear what
the use policies will be, i.e., in response to price signals or for
supply security. While there is some `freerider' benefit to the U.S.
from other countries developing strategic stockpiles, the uncertainty
over the development of the Chinese reserve actually will be and their
future use policy brings these benefits into question. To ensure the
energy security of the United States it is recommended that the SPR be
filled with this incremental volume rather than relying on others to
develop the reserves.
RECOMMENDATION
Based on the considerations described herein, we recommend the
Department of Energy issue a public solicitation for the second round
of RIK exchanges to acquire an additional 12 million barrels of crude
oil in support of the goal of filling the SPR to its capacity of 727
million barrels. The fill rate during this next round of exchanges will
be roughly 70,000 barrels per day. As highlighted in the above
discussion, market conditions are less than ideal for crude oil
acquisition; however, the method of acquisition and the quantity of oil
being diverted to the SPR provide the necessary assurances that these
activities will not exacerbate current market conditions. It is
determined that, the market impact of transferring these 12 million
barrels to the SPR should be negligible and the potential benefits
derived from incrementally increasing the size of the SPR outweigh and
exposure to market price risk.
Handwritten notation follows:
The recommendation to proceed with acquisition of
approximately 12 million barrels of crude oil at a rate of
70,000 barrels per day beginning January 1, 2008, is approved.
John D. Shages,
Deputy Assistant Secretary,
Petroleum Reserves,
September 22, 2007.
______
Department of Energy,
Washington, DC, October 15, 2007.
Memorandum for the File
From: David F. Johnson, Director, Planning and Engineering Office,
Petroleum Reserves
Subject: Continuation of Strategic Petroleum Reserve (SPR) Fill Through
Royalty-In-Kind (RIK) Exchange
BACKGROUND
The Energy Policy Act of 2005 (EPAct 2005) directs the Secretary of
Energy, ``as expeditiously as practicable, without incurring excessive
cost or appeiably increasing the price of petroleum products to
consumers, acquire petroleum in quantities sufficient to fill the
Strategic Petroleum Reserve to the 1,000,000,000 barrel capacity
authorized under section 154(a) of the Energy Policy and Conservation
Act.''
EPAct 2005 also required the Department to issue procedures for oil
acquisition. Those procedures were finalized as regulations and
prescribe the issues that must be acillressed either before the
Department enters the market or every six months for continual of
ongoing acquisition activity.
In January 2007, after a post-hurricane Katrina hiatus, the SPR
conducted the analysis required by the acquisition procedures and
initiated activities to resume fill to the current 727 million barrel
capacity. While direct purchase solicitations in spring 2007 were
unsuccessful due to unacceptably high offers, the RIK exchange program
with the Department of the Interior was successfully resumed in July
2007. Transfer of royalty oil under the current six-month contract ends
December 31, 2007.
ISSUE
Is it appropriate to continue the RIK exchange program for another
six-month contract cycle?
DISCUSSION
The attached report authored by the staff of the Strategic
Petroleum Reserve addresses the areas required by the regulations to be
considered for the continuance of acquisition activities. The report
indicates it is appropriate to issue a public solicitation for the
second round of RIK exchanges to acquire an additional 12 million
barrels of crude oil (70,000 barrels per day over a six-month period)
in support of the goal of filling the SPR to its capacity of 727
million barrels.
FINDING
I find that the attached analysis satisfies the codified procedures
for acquisition. I also agree with the substance of the analysis and
its conclusions. Further, despite ongoing uncertainty in demand, supply
and economic growth, the markets have accommodated current prices
levels, and the marginal impact of the quantity diverted to the SPR
should be negligible. As market backwardation has continued, inhibiting
the build of commercial stocks, there is no benefit in ceasing
acquisitions to build the strategic reserve at this time. Accordingly,
I am directing the SPR staff to take the necessary actions to initiate
the next round of RIK exchange contracting activities.
Ms. Fredriksen. Yes, sir. I think much of that has been
transferred up for Senator Levin, but we'll be happy to share
with you.
Senator Dorgan. Just a quick question. Are there better
investments we can make than the investment of $100 a barrel
oil underground for 70,000 barrels a day in order to reduce our
dependence and increase our energy security?
Ms. Kenderdine. I believe, obviously the Members of
Congress and the Administration have a lot of issues, energy
issues that they have to balance and weigh the relative value.
I personally believe that at this point in our--the energy
situation in the world that we need to be investing heavily in
technologies to reduce dependence on oil, sequester carbon so
that we can use the coal that's in many of your states.
Dramatically increase our investments in energy efficiency, the
energy efficiency programs and at DOE have been fairly
decimated over the last several years and that's our, the
biggest bang for our buck is to invest in efficiency right now.
I think that we are at a critical juncture in our history.
The geo-politics of energy are not good right now for us or for
anyone. I think there are wiser investments then pulling $100
oil off the market and gaining a very incremental amount of oil
into the SPR right now.
Senator Dorgan. Mr. Chairman, I've exceeded my time. Maybe
if you have another round, I will ask.
The Chairman. Alright.
Senator Craig.
Senator Craig. Let me pick up where Senator Dorgan just
left off. So, if Senator Dorgan is chairman of the Energy
Appropriations Subcommittee, so Ms. Fredriksen, he's in charge
of your budget. So if he cuts you off and keeps the money
inside his committee and it goes to some of those technology
programs and he gives me $10 million to begin to survey oil
reserves in the outer continental, some of you happen to agree
with that apparently.
All politics aside if America knew where all of its oil was
and how much there was, would that be as valuable as having a
SPR? We'll start with Ms. Kenderdine.
Ms. Kenderdine. I actually have worked for many years to
get, not a survey of the OCS, but a R and D program in both
unconventional on shore oil and gas as well as ultra deep water
off shore. There are enormous resources in both those provinces
and DOE's forecasts say that on shore, natural gas, for
example, unconventional is going to play an enormous role in
meeting our natural gas demand.
So, I have not specifically looked at the value of
surveying the OCS, but I do believe that there's significant
resource in those provinces that need to be exploited.
Senator Craig. Mr. Verrastro.
Mr. Verrastro. Senator, I just echo the sentiments,
exactly. The last thing I did in the private sector, we worked
on the Treasure Island block which is a reserve, maybe the size
of Alaska. It's subsalt. It's shallow water, but the target
depth is still 30,000 feet. So these are $200 million wells.
Senator Craig. Yes.
Mr. Verrastro. You can't afford to have too many that miss.
So, but I think the resource potential is huge. That we ought
to do more and an inventory is a great idea.
Senator Craig. Our success in deep water in the Gulf is
beginning to prove itself substantially beyond where we thought
we could drill.
Mr. Verrastro. Where we thought we were, absolutely.
Senator Craig. So if we were to do that. But more
importantly, let me ask this question. Have any of you looked
at the figures if we just pulled the 70,000 barrels a day and
left it in the market?
Would it change the value of the price of crude in the
market today? Have any of you looked at that? Yes? I'm kind of
generically asking the question, anyone who wants to respond.
Ms. Kenderdine. I mean, it's very, very difficult to
measure the impact of 70,000 barrels a day as Mr. Verrastro
brought up. The refinery goes down. We lose 70,000 barrels of
refined product the price goes over 100.
Senator Craig. Yes.
Ms. Kenderdine. There are enormous prorogations in the
market all the time. What I--I would go back to the--a couple
points. The price of oil is set at the margin and so the
impacts of the time exchange that we did in 2000. We announced
the exchange. The oil hadn't moved into the marketplace and the
price of oil dropped $7 a barrel.
Senator Craig. Yes.
Ms. Kenderdine. Ok. So that illustrates a couple of points.
One, the price of oil set in the margin. Two, when the U.S.
indicates that it's willing to act or not act, as Frank pointed
out, the world pays attention.
Ok. We have enormous--because our demand is so huge, we
have just the President saying he might do something has
enormous impact on the market. Then the market psychology is
and the speculation in the marketplace is, as Senator Dorgan
pointed out, I think that it is very significant going on right
now. It is a major issue that needs further examination.
The market fundamentals do not suggest that we should have
$100 oil. There are other things going on in this marketplace.
When there's a lot of speculation in the market, making small
changes, or announcing that the government is willing to act,
has a big impact because that speculative bubble is fairly easy
to burst.
I will tell you just one circumstance. In 2000 as we were
trying to figure out how to get enough heating oil to the
Northeast and New England that year. OPEC announced, or
actually did, increase production by almost three million
barrels a day that year.
The last announcement right before we did the exchange,
they announced they were going to increase production by
$800,000--800,000 barrels a day and the price of oil went up.
Ok. That was the market's judgment that they didn't have the
capacity to do that. It turns out when we actually did the
exchange the price of oil dropped dramatically. It did go back
up at the bombing of the coal, ok. But that was a momentary
blip.
Senator Craig. Sure.
Ms. Kenderdine. By the end of the year, prices had gone
dramatically down. So there are lots of other anecdotes I could
give you. It's a difficult thing to pinpoint. Those are factors
that affect the price of oil and in small amounts.
Senator Craig. Were you preparing to make----
Mr. Verrastro. Senator, may I?
Senator Craig. Yes, please.
Mr. Verrastro. Yes, I would just add that, I guess, three
points. I don't think any of us are disagreeing with the notion
that the SPR is a cornerstone of our energy policy.
Senator Craig. It's a matter of security. It's an issue of
security in relation to shocks. We understand that.
Mr. Verrastro. Yes, so there's no question. It's the timing
and the volume and I think the drawdown rate is another thing
that you have to pay attention to when we talk about days
forward cover if you can only drawdown 4.4 million barrels a
day, that's hours of daily consumption.
Senator Craig. Yes.
Mr. Verrastro. So you can't displace whatever the total
disruption is if you lose all your imports. So that's one
factor. The second factor is I think it's directional
consistency at a time when the President of the United States
or the Secretary of Energy goes to the Middle East and says, we
think the market is tight. It would be good if OPEC would put
additional oil on the market. The response from other producers
is why are you taking oil off the market, whether it's a big
volume or a small volume.
Just to add to that the plans for the spring are for
125,000 barrels a day, some from royalty in kind and some from
direct purchase. But that actually is more light, sweet crude
which at a time of gasoline supply absolutely makes no sense.
So I understand the direction of building the Reserve but you
just have to be smart about the way you do it.
Senator Craig. Ok. My time is up.
The Chairman. Senator Corker.
Senator Corker.I think that last statement is actually a
great summary. It seems to me that this is a great hearing that
everybody on the panel agrees with the significance of having
reserves. Basically we're talking about some management issues
as to how to do it.
You know it's really interesting to me. This is a really
great populist issue, talking about the fact that we're taking
oil off the market and driving up prices at the pump. But some
of the very same people that are making an issue out of that
wouldn't consider opening up ANWR or other reserves.
That actually--matter of fact, we talk about 70,000 barrels
a day. What would ANWR produce at full capacity a day? Does
anybody--I know the number is much larger than that.
Mr. Verrastro. At its peak, Senator, people talk about
800,000 to a million barrels a day. It would supply about 20
percent of U.S. domestic supply for 20 years or more. It's
considerable.
Senator Corker. Yes. So if this, I think, 12 to 14 times a
day coming out of ANWR. So if people truly are concerned about
the price of gasoline at the pump, this is not the issue for
them to be pursuing. It would really be maybe an issue, but an
even bigger issue would be to open up our capacity in our own
country in an environmentally safe way to other reserves. Is
that correct?
Ms. Kenderdine. If I could say something, Senator. The--it,
ANWR, could produce up to a million barrels a day. There's a
range of barrels, the estimates.
But the, from my perspective, and I was an oil and gas and
coal person in the Clinton Administration. The--and so I spent
a lot of time looking at ANWR, looking at the Naval Petroleum
Reserve in Alaska, NPRA, etc. etc. met with an environmentalist
not long----
Senator Corker. Please hurry. I have other questions.
Ms. Kenderdine. Yes. Major, major environmental
organization discussed ANWR. Her response to me is if we needed
that oil we wouldn't oppose it, but how do you expect me to go
to my members and say open ANWR when our cars are getting 20
miles to the gallon. I think that's a very fair point. It goes
back to the other things that you can do.
Senator Corker. We've done a lot of those. I think that's
been pointed out. I think most of us on this committee
supported the more aggressive standard on CAFE. But I do think
it's ironic that we're having this hearing, this populist
hearing and yet doing nothing whatsoever, really, to increase
production.
I would like to say that right behind this, cap and trade
legislation is going to be discussed. We're actually looking at
that and open to it. But that's also going to drive up,
ultimately, the price of gasoline at the pump.
So I would just like to express that in the sphere of
discussion, this is very minute. I assume, are we using futures
in our buying process today? I mean we talked a little bit
about the price of oil a year from now. We're utilizing the
futures market to buy our oil today. Is that correct for the
Reserves?
Ms. Fredriksen. It's a factor we look at during a market
assessment process that we conduct, the market analysis
process. We look at the future.
Senator Corker. If we began buying today on the futures
market, and we know that it is lesser than today, would that
not automatically, potentially automatically accrue some
savings to us in the future?
Ms. Fredriksen. Potentially, sir. The current value of the
barrels in our Strategic Reserve right now are roughly around
$27 a barrel. So you can see that that long-term strategy has
reduced the average dollar per barrel. So it's a very big
national asset that we have.
Senator Corker. So in essence a lot of people when
investing they continue to buy over time whether it's the stock
market and whatever the price is they just continue to buy. So
what you're saying by virtue of the fact that we continue to
buy oil over time is that what we have in the ground is
actually worth three times what we paid for it?
I'd just like to say in general that I usually ask
questions and don't make statements, but I really think this
issue, personally, is being more driven by populism. I think
everybody on this panel sees the need to have Strategic
Reserves. I would actually say at this point in time in the
world, we really need them more than ever with the driving
demand and the lack of supply.
I do think there are some management issues that have been
brought out today that are intelligent. I hope the Department
will look at that. But I hope that we as a body will not do
anything to try to keep our country from having Strategic
Reserves, but would hope instead that the Department itself
will make necessary steps to manage this in the best way for
our taxpayers. I thank all of you for your testimony.
The Chairman. Senator Dorgan is next. Let me just ask one
question by way of clarification. Ms. Fredriksen, my
understanding is, we the Federal Government, are not buying in
the futures market. We are buying in the spot market; and even
though the price of oil in the futures market is lower than the
price of oil today in the spot market, we are buying a
predetermined amount in the spot market at the higher price. Am
I right?
Ms. Fredriksen. Correct, sir. I meant that we do take into
consideration the future of production, both current and future
estimations on production, etc. all of those things that factor
into it. So we do look at it in a future way, but we do not buy
on the futures market.
The Chairman. Right. So we don't do what Southwest Airlines
does, and go in and buy in the futures market and in that way
keep the price of tickets down.
Ms. Fredriksen. Correct, sir. We have a fill policy that's
in accordance with EPACT '05 that outlines very clearly what
those parameters would be and we follow those.
The Chairman. Does EPACT '05, in your view, prohibit us
buying us in the futures market?
Ms. Fredriksen. I actually don't know the answer to that,
sir, exactly. But I'd be happy to respond to you at another
time in writing.
[The information referred to follows:]
Section 160 of the Energy Policy and Conservation ACT (EPCA), as
amended by the Energy Policy Act of 2005, allows the Secretary to
acquire petroleum products ``by purchase, exchange, or otherwise'' for
the SPR (Section 160(a)). Although the current language seems to give
the Secretary wide discretion in how oil is acquired by the SPR, the
Department in earlier direct acquisitions was unable to explore the
possibility of purchasing oil or contract options from the New York
Mercantile Exchange (NYMEX) because Federal agencies, under Executive
Order 12778 (1991), were prohibited from entering into binding
arbitration. NYMEX rules require that all entities conducting
transactions through the NYMEX submit to binding arbitration to settle
disputes.
The Alternative Dispute Resolution Act of 1996 authorizes a Federal
agency to enter into binding arbitration if the agency, in consultation
with the Attorney General, has issued guidance on the appropriate use
of binding arbitration, and the circumstances under which the agency
may use the authority. DOE has not issued such guidance to date. The
Department may seek legislation to give the Secretary clear authority
to enter into binding arbitration for the purpose of acquiring oil for
the SPR on the NYMEX.
The Chairman. Senator Dorgan.
Senator Dorgan. Mr. Chairman, Senator Corker used the word
populist about seven times and I'm--I don't know the exact
definition. Somebody once said it means putting the jam on the
lower shelf so everybody can reach it. This is not a populist
hearing. This is a hearing about a significant economic policy.
But I do want to respond to something Senator Corker said.
He asked the question about well, what about those people that
come with this populist idea on SPR about increasing
production? Before you were on the committee, Senator Corker,
Senator Bingaman, myself, Senator Domenici and one other
Senator began to push to produce and lease 181 in the Gulf of
Mexico.
The reason that we did that is the following. The greatest
potential additional production off shore is ranked in the
following way: first, in the Gulf of Mexico, second, off the
West Coast and third, finally, in Alaska. What we did is we put
together a piece of legislation that says let's open up lease
181.
That's the greatest potential of additional production.
Bipartisan, four of us fought very hard to get that done. We
got it done. It's not as much as I would like.
I want more, but we got it done. So I just want to make the
point that this notion that those of us who also want some
fairness and some effectiveness in public policy on these
issues are not always opposing production. In fact, some of us
have been out pushing for additional production and doing so
successfully.
Let me make a point about this issue of SPR. The question
is if you're taking $100 a barrel oil and sticking it
underground when prices are at their maximum is it having an
impact, upwards in fact, on price? The answer is clearly, yes.
Now one might disagree. Mr. Berger sits in front of us and says
because it's sweet, light crude, he thinks it's increased the
price of oil by $10 a barrel.
I mean, Senator Corker you may disagree with that. I find
it pretty persuasive. When I look at what hedge funds and
investment bankers are doing with this carnival of speculation
in the futures market, I'm damn concerned about that. I think
there's something fundamentally broken here. We ought to fix
it. That's not populist. That's demanding on behalf of economic
security for this country that we get this done right.
There are reasons perhaps to oppose my piece of legislation
that would say let's stop filling SPR at this moment. What I
would suggest is we stop filling SPR right now, take a pause. I
assume that would have upward pressure, excuse me. That would
have upward pressure on inventory and downward pressure on
prices. I think people would immediately then respond to that
in a positive way in the marketplace.
To me it just makes no sense at a time when we have all
this speculation going on to take supply down, stick it
underground and say, you know, we're going to do this no matter
what. It doesn't matter. We're just going to do it no matter
what. Timing is irrelevant. We're just going to do it.
The question is if you had converted that to the money, to
the cash and had an opportunity to invest in other things. Let
me give you an example. Ultra deep and unconventional research,
you do that, Ms. Fredriksen, in your area, right? Is that
productive? I would think it's enormously productive, ultra
deep and unconventional drilling because we're trying to figure
out what's down there and how do you get to it.
Guess what, the President zeros that out. Guess what, I
stuck it back in the appropriations process because I believe
it ought to be a priority. Now I'm not involved in it. I'm just
saying I think that short changes the future in terms of what
we ought to be investing in.
So I just want to say it's not about populism. This is
about hard nosed economic issues with respect to whether we
ought to put $100 a barrel oil underground and what it does to
price. I just hope, I hope we can find a way to pass this
legislation. I'm certainly willing to modify the legislation. I
don't think what I write is in stone. Some have suggested I
think maybe the price point on my legislation should be
adjusted. I'm willing to do that.
But I do think we ought to take a pause. That pause ought
to give us the opportunity to use what otherwise would come in
as revenue from royalty in kind and invest in things that we're
not investing in at the moment. We're not investing enough
money in energy efficiency, in the biofuels and renewables and
unconventional oil programs. A whole range of things that I
think will also contribute to this country's energy security.
So, I want to make that point. I'm a big admirer of Senator
Corker. You couldn't tell that from my statement and response
to what--how he described this hearing. But I do hope we can
work together, Senator Corker and try to find a way through
this because I think this is an important issue.
Senator Corker. Mr. Chairman, since my----
The Chairman. Senator Corker.
Senator Corker [continuing]. In Presidential debates I
noticed when someone's name was evoked they get to respond.
First of all I have enjoyed working with you too on numbers of
issues. This one has felt a little odd. But just because we're
talking with each other and basically leaving our panelists
out.
[Laughter.]
Senator Corker. Your legislation would stop the purchase of
this until what time? The money instead would be used for what?
Senator Dorgan. My legislation is a 1-year pause. So it,
you know, I don't suggest we pause beyond that. I might at some
point if the timing existed beyond that and oil were $150 a
barrel and I thought that was a result of speculation I might
want to come back in. But so it would be a 1-year pause. It has
a $50 price point in it.
Senator Corker. I would just respond by saying I don't
think any of us know what the price of oil is going to be in
the future. It just seems to me like we are in semi-perilous
times. Even though--but I look forward to talking with you more
about it in the future.
I hope my comments were not--we are doing other things that
cause the price of oil to be more than it is today. Some of our
other policies affect it far more than SPR. But I certainly
look forward to talking to you. It sounds like to me you've
been a--I see a halo developing actually around your head as it
relates to, you know, additional supplies. Apparently you've
tried to pursue both courses of action. I thank you for that.
Senator Dorgan. Mr. Chairman, thanks for being patient
here. There's a bar that had a bumper sticker once, a bar named
Oats Willie's. It had a bumper sticker that says onward through
the fog. The one thing that united all of us is none of us know
what's going to happen with respect to the price of oil. But we
all have a sense of what we ought to be doing in order to deal
with prices now and our economic and energy security issues.
The Chairman. We've had a good discussion and a lot of good
testimony. Thank you all for being here. That will conclude the
hearing.
[Whereupon, at 12:22 p.m. the hearing was adjourned.]
APPENDIX
Responses to Additional Questions
----------
Responses of Frank Rusco to Questions From Senator Domenici
Question 1a. In your testimony you state that in order to improve
the efficiency and reduce fill costs of the SPR, DOE should acquire 10%
heavier crude oil for the SPR. It is my understanding that the type of
oil in the SPR reflects the U.S. refining capacity in the event of an
emergency drawdown. Is there assurance that during an emergency
drawdown there will be sufficient refining capacity to handle larger
volumes of heavier crude oil?
Answer. The type of crude oil that refineries can process into
specific refined products is determined by the type of equipment that
the refinery has installed. Crude distillation--the simplest and most
basic type of refining process--can be accomplished on a variety of
crude oils. However, refineries in recent years have moved to
significantly enhance their capabilities for refining heavier crude
oils by installing other equipment such as coking units; indeed, a GAO
analysis found that 40% of the crude oils that refineries typically
process is heavier than what is contained in the SPR, and DOE has noted
that ``virtually all U.S. (refinery) expansions are designed to
increase the refineries capability to process the cheaper heavy sour
crudes as feedstocks.'' Since U.S. refineries have the capability to
process the heavier, and cheaper, crude oils, it is appropriate that
the expanded SPR contain at least 10 percent heavy crude oils, and that
DOE conduct a new crude oil compatibility study to determine the
maximum amount of heavier crude oils that the expanded reserve should
contain.
Question 1b. Can we run our refineries on heavier, more sour grades
of oil without having negative health impacts?
Answer. Yes. Refineries are required to comply with various
environmental health standards. The EPA enforces regulations that
implement environmental laws including the Clean Air Act, the Clean
Water Act, and the Oil Pollution Act, which aim to control the
discharge of pollutants into the environment by refiners and other
industries. Refiners would be expected to consider the trade-off in
increased equipment/environmental mitigation costs when they decide
whether to install the equipment to refine heavier crude oils. Thus,
refiners' decisions to install the expensive processing equipment to
refine heavier crude oils indicates that refiners believe the savings
to the refinery by running a heavier, cheaper crude slate--which
incidentally is the type of crude oil that the world will increasingly
produce in the future--justifies the cost of the complex processing
equipment. Moreover, since any heavy crude oil in the reserve would
only be used in an emergency and since approximately 40% of the crude
oils that refineries typically process is heavier than what is
contained in the SPR, filling the SPR with heavier crude oils, such as
refiners typically run, would not require the installation of
additional refining equipment and would not have any associated
negative health impacts. Moreover, the SPR would be more effective
because it could release a slate of crude oils closer to what U.S.
refineries can use most efficiently.
Question 2a. In your testimony you mention the ``dollar-cost-
averaging purchasing strategy''--please explain this method of
acquiring crude oil for the SPR?
Answer. Under a dollar-cost averaging purchasing strategy, DOE
would acquire a steady value of oil per time period, e.g. month. During
periods of high prices, the government would buy less crude oil.
However, during periods of low prices, the government would buy more
crude oil. For example, in a simplified example, if the government
committed to buying $10 million of crude oil per month it would
purchase 100,000 barrels of crude oil when prices were $100/barrel; but
purchase 200,000 barrels when prices were $50/barrel. This approach
would likely reduce fill costs over a range of plausible paths of
future crude oil prices, and the likely savings would be greater if
price volatility is greater. In addition, it may provide benefits to
the market by taking fewer barrels of crude oil off the market when
prices are high.
Question 2b. Isn't the point of ``dollar-cost-averaging'' that
greatest economic security comes through regular investment, and that
timing the markets is unwise?
Answer. Not necessarily. Our work has shown the government can save
money filling the SPR using dollar cost averaging, relative to
purchasing a steady volume of oil over time. However, dollar cost
averaging and broad determinations about when it is appropriate to fill
the reserve are not mutually exclusive. For example, DOE could first
make an overall assessment about whether it was an appropriate time to
buy oil, and, if it was, use dollar cost averaging to reduce fill
costs. However, the extent to which DOE should time the market depends
on how well it can estimate future price movements and we have not
evaluated this.
Question 3. Which has a greater impact on the markets: the SPR
fill, or the myriad of disruptions we've experienced over the past
several years? Is the 70,000 barrel per day fill significant when
compared to the disruptions in Nigeria, Venezuela, and the Gulf of
Mexico?
Answer. A large supply disruption can have a dramatic impact on
crude oil prices. It is also reasonable to say that the potential
impact of any event depends on the overall conditions in the market at
the time of the event. For example, taking 70,000 barrels of crude oil
off the market when potential supplies exceed market demand would
likely have a negligible impact on prices. However, taking the same
amount of crude oil off the market when oil supplies are tighter might
have a greater impact on price. Overall, GAO has not analyzed the
effects of SPR fill decisions on prices over time, although we are
aware that there are differences of opinion as to such effects.
Responses of Frank Rusco to Questions From Senator Dorgan
Question 1. Has there been extensive analysis done on the long-term
costs of filling the SPR to 1 billion barrels as authorized in EPACT
2005? How about analysis on the Administration goal of filling the SPR
to 1.5 billion barrels?
Answer. In June 2007 DOE published a study entitled ``Strategic
Petroleum Reserve Plan: Expansion To 1 Billion Barrels,'' which named
three sites for the expanded fill, and estimated costs for the
expansion to 1 billion barrels at approximately $3.67 billion. The cost
of operating and maintaining expansion facilities following
construction was estimated at $35 to $40 million per year. The
projected cost of crude oil to fill the SPR from 700 million barrels to
1 billion barrels was $18.125 billion based on forecasted crude oil
prices of $56.20 to $65.10 per barrel. GAO has not evaluated this study
so we cannot speak to its completeness or accuracy.
In its August 2006 written comments to our report on the subject of
expanding the SPR, DOE agreed that it should study how to reduce costs
when filling the SPR, and noted SPR crude oil acquisition must be in
accordance with rules and procedures set forth in Energy Policy Act of
2005 (EPACT05). DOE earlier this month told us they believe they have
adequately studied how to reduce costs of the future fill, through
DOE's November 8, 2006 publication of the rulemaking ``Procedures for
Acquisition of Petroleum for the Strategic Petroleum Reserve.'' DOE
noted these new crude oil acquisition procedures include ``provisions
to consider a wide array of factors when acquiring crude oil, including
fill rate, present and future oil prices, and expert opinions. The
Department will review these factors prior to commencing crude oil
acquisition and will review the appropriate rate of crude oil
acquisition each time an open market solicitation has been suspended
for more than three months, and six months in the case of ongoing or
suspended royalty-in-kind transfers. Additionally, [DOE] will provide
for deferrals of contractually scheduled deliveries in the event that
the market is distorted by a disruption to supply or other factors.''
However, we note that the publication of this new rule, a mere 3 months
after our August 2006 report, does not reference any new DOE study, nor
does it appear to include any extensive analysis to support these new
rulemaking procedures--in fact, the Federal Register notice outlining
the new rules notes they are ``substantially the same as those
proposed'' on April 24, 2006, which preceded our August 2006 report.
Moreover, the new rule itself does not include results from a formal
study of acquiring steady dollar value of crude oil for SPR over the
long term, as we recommended in our report and to which DOE agreed; nor
does the new rulemaking procedure include formal procedures or a
mechanism for providing such flexibility in acquiring crude oil to fill
the reserve.
Question 2. In your view, has the government fully considered the
macro level market impact it has by taking oil off the market
regardless of its price?
Answer. GAO has not conducted any formal analysis to determine
whether filling the SPR, at a volume of 70,000 barrels per day, has any
impact on crude oil prices. However, if DOE acquired a steady dollar
value--rather than a steady volume--of oil over time, this ``dollar-
cost-averaging'' approach would allow DOE to acquire more oil when
prices are low and less when prices are high. Implementing dollar-cost-
averaging means that DOE would put less oil in the SPR during times of
tight supply and demand.
Question 3. Does the Energy Policy Act or any other legislation
require that the Department of Energy to continuously fill the SPR
regardless of circumstances or must it consider the economic and
consumer impacts of such decisions?
Answer. The legislation governing the Department of Energy's
responsibility to fill the SPR does not mandate that it continuously
fill the SPR regardless of circumstances. The general statement of
intent in section Sec. 301(e)(1) of the Energy Policy Act of 2005
(EPACT 2005) requires the Secretary of Energy to fill the reserve as
expeditiously as ``practicable,'' without incurring excessive cost or
appreciably affecting the price of petroleum products to consumers. The
Act also specifically directs the Secretary to develop procedures to
acquire petroleum for the SPR that, among other things, take into
account the need to minimize costs to the Department of Interior and
the Department of Energy in acquiring petroleum products (including
foregone revenues from the royaltyin-kind program) as well as the need
to maximize overall domestic supply of crude oil and to protect
national security. Sec. 301(e)(2)(A).
Question 4. Are there not certain conditions in the Energy Policy
Act of 2005 that would require a suspension of the fill?
Answer. Yes. The Energy Policy Act of 2005 requires that the
Secretary not fill the SPR if he determines that doing so would incur
``excessive'' cost to the government or would ``appreciably'' affect
the price of petroleum products to consumers. Sec. 301(e). However,
this language vests discretion in the Secretary to determine the
meaning of these terms.
______
Responses of Frank A. Verrastro to Questions From Senator Domenici
Question 1. Given that the proposed increased fill rates of the SPR
account for between one quarter and one third of one percent of U.S.
demand for oil, and between one sixteenth and one ninth percent of
world demand for oil, would any change in fill policy have a small
effect on price?
Some have argued that there is a very small amount of relatively
light, sweet oil that is not under contract and therefore freely traded
on the global markets--and as a result, the impact of our small
purchase is magnified. Seems that this argument either exaggerates the
scarcity of this oil, or it assumes that the markets will not account
for our very transparent, stable, and relatively small acquisition
plans. Your thoughts?
Answer. As indicated in my testimony, while I understand the
arithmetic of calculations that attempt to derive a particular price
impact by simply dividing the volume of oil being used to fill the
reserve by the total number of barrels imported or consumed by the US,
or globally, I don't believe that is an accurate gauge of impact. The
price of oil in an open market is set on the margin, and if there are
more buyers than sellers, prices will be bid up, regardless of the size
of global demand.
A more accurate assessment would have to consider the SPR volumes
in terms of global balances. If the market is deemed to be
undersupplied--as the administration continues to maintain--then
removing barrels will necessarily cause prices to rise, since price is
ultimately the final allocator. Recent analysis presented by the Energy
Information Administration (EIA) concurs with this judgment, although
their calculation suggests the impact is only a few dollars per barrel,
while I believe the impact to be greater.
In terms of rationale for this approach, I would suggest that when
oil is released from the reserve, we tend to both determine the size of
the release as well as measure the ``relief'' it provides by comparing
that volume to the perceived size of the global shortfall (i.e., the
marginal barrels deemed to be missing) rather than total global
consumption. Consequently, whether oil is being added to the market or
taken away, the correct reference point should be the amount of the
``gap'' rather than total global supply or demand.
With respect to your second question on volumes of light, sweet
crude, I would reiterate my earlier points about supply and demand for
the incremental barrels on the margin and conclude that if the buyers
outnumber the sellers, then yes, the magnitude of the price impact
could well be exaggerated. I also agree that the markets will account
for this imbalance, and that the reaction will be an adjustment in
price.
Question 2. Given that most observers feel that high oil prices are
likely to persist, and with some suggesting that the world has entered
into a new age of high prices, is it likely that there will be a better
time to fill the SPR in the near term? When might such time occur?
Answer. Senator Domenici, as you correctly pointed out in your
remarks at the hearing, price forecasts and forecasters are frequently
wrong, so I answer this question with both humility and some
trepidation. Having said that, however, in an attempt to be responsive,
I do believe that there are more than ``fundamentals'' at work with
respect to the current price run up. With the economy and dollar
decline, investors are increasingly looking to commodities as a better
place to park their money. And, again, as indicated in my remarks, I
believe the administration's steadfast determination to continue to
withdraw oil from the (admittedly tight) market (and give no indication
of considering putting SPR oil into the market) is in fact emboldening
investors to push prices higher.
I do believe, however, that reduced seasonal demand in the second
quarter, coupled with rising global inventories may provide some price
relief over the next few weeks/months--assuming OPEC does not act to
restrict production in the face of growing stock levels. There is also
data to suggest that if additional supplies come on as scheduled later
this year and demand is dampened by sustained high prices, we could
very well see a small surplus and lower prices in 2009. This would
allow global spare capacity to grow and serve as a price buffer for
geopolitical concerns or supply interruptions.
Question 3. In your opinion, to what extent and what rate will the
increased automobile economy standard and other provisions of the
Energy Impendence and Security Act of 2007 reduce oil consumption and
will this eliminate the need for an expanded SPR?
Answer. The most recent revision of EIA's Annual Energy Outlook
(AEO2008) forecasts both a reduction in the growth of U.S. net liquids
demand and an increase in domestic supply. The reduction is tied to
higher prices, alternative fuels availability and efficiency
improvements. That same analysis suggests that U.S import dependence
will decline from some 60% today to just over 50% by 2022, then rising
to 54% by 2030.
Plans are already in place to expand the reserve from 700 million
barrels to 1 billion barrels. The question, I believe, is whether that
expansion should grow to 1.5 billion barrels. Given the limitations on
drawdown volumes and considerations about the expansion of domestic
refining capacity and the changing fuel mix (due to mandates for
alternatives and the prospects for adopting carbon constraints), I
believe that a reassessment of the role, size, composition and use of
the strategic reserve is in order.
Question 4. In your opinion is the U.S. dependence on foreign oil
increasing? If so, how can the U.S. increase its energy security needs
without increasing the size of the SPR?
Answer. As indicated above, the most recent projections prepared by
the EIA forecast a reduction in oil import dependence over time. There
are, however, a number of ways for the U.S. to enhance its energy
security and these include: reducing oil demand through conservation
and improved fuel efficiency; diversifying our fuel choices and
suppliers; enhancing infrastructure; promoting technology improvements,
including accelerating deployment of promising technologies; and better
managing global geopolitics in an interdependent world.
The SPR is a cornerstone of that security strategy and will
continue to serve that vital purpose. But in a changing world, we
should constantly look for additional and better ways to improve that
security. When one looks at the projected expenditures needed to
acquire an additional 800 million barrels of oil (to bring the SPR
volumes up to 1.5 billion barrels), we should consider how those monies
might be better spent (e.g., on alternative fuels, infrastructure
support, technology development, pilot programs, efficiency
initiatives, etc.,) to enhance our security.
Question 5. Are there any benefits to having a refined product
reserve? If so, would it be more or less expensive to manage then the
SPR?
Answer. The original EPCA provisions governing the creation of the
SPR addressed both crude oil and refined product requirements. Studies
conducted at the time concluded that, among other things, given the
robust state of the domestic refining industry and the small volume of
product imports, it was more prudent and cost effective to develop a
centrally located crude reserve rather than multiple product storage
sites.
I am not an advocate for a government operated refined product
reserve, but as indicated above, believe that a reassessment of reserve
needs should be undertaken. Factors such as the level of product
imports, available refining capacity, the changing fuel mix and
prospects for more frequent and high intensity storms entering the gulf
coast and disrupting process operations and supply lines should all be
factored in that assessment.
I would also note that prior to the introduction of ``just in
time'' inventory practices, U.S. refiners maintained larger product
inventories to ensure consumers were adequately supplied. In the
absence of significant refinery expansion in the US, an alternative to
a refined product reserve might be to incentivize refiners and terminal
operators to hold nominally larger stocks (1%) in proportion to their
particular fuel mix. They would control these inventories and turn them
over consistent with normal stock management practices.
It is worth noting that in the aftermath of hurricanes Katrina and
Rita in 2005, the significant loss of domestic refinery capacity in the
gulf coast somewhat negated the value of a crude only reserve and that
the greatest source of relief came from the release of global product
stocks.
Responses of Frank A. Verrastro to Questions From Senator Dorgan
Question 1. Does the Energy Policy Act or any other legislation
require that the Department of Energy to continuously fill the SPR
regardless of circumstances or must it consider the economic and
consumer impacts of such decisions?
Answer. The Energy Policy Act of 2005, in section 301 (e)(1),
states that . . . ``the Secretary shall, as expeditiously as
practicable, without incurring excessive cost or appreciably affecting
the price of petroleum products to consumers, acquire petroleum in
quantities sufficient to fill the SPR to the 1 billion barrel capacity
authorized under section 154(a) of EPCA . . .'' The language in this
section of the Energy Policy Act explicitly directs the Department of
Energy to consider economic and consumer impacts of filling the SPR.
Question 2. Are there not certain conditions in the Energy Policy
Act of 2005 that would require a suspension of the fill?
Answer. Other than the conditional language of section 301,
referenced above, which directs the Secretary to expeditiously fill the
SPR ``. . . without incurring or excessive cost or appreciably
affecting the price of petroleum products to consumers . . .'' I am
unaware of any other provisions that would require suspension of such
activity. The Secretary is required to consider the economic and
consumer impacts of filling the SPR, but if he completes such an
analysis and concludes that the impacts and costs are not ``excessive''
or that the fill is not ``appreciably'' affecting oil prices, it would
appear that he has the discretion to continue.
______
Responses of Melanie A. Kenderdine to Questions From Senator Domenici
Question 1. In your testimony you indicate that IEA countries can
rely on privately owned stocks and government controlled stocks to meet
their 90 day import protection requirement. The U.S. has 57 days of
protection with government stocks and 118 days with government and
commercial stock. Over the past several months, commercial stocks of
crude oil and petroleum products have declined. Given that commercial
stocks will respond to market signals and inventory management
strategies, is it possible, or even likely, that these stocks might be
low in times of a disruption?
Answer. Private stocks may increase or decrease in times of
disruption, depending on whether the market is backwardated or in
contango when the disruption occurs. Regardless, the US is an IEA
signatory nation and is in compliance with IEA's 90 day import
protection requirement based on the IEA definition.
Further, it should be noted that DOE cites the IEA 90 day
requirement as a justification for continuing to fill the SPR with RIK
oil at the same time it apparently rejects the IEA definition that
allows countries to count public and private inventories, in effect
``cherry-picking'' the 90 day requirement. If the USG believes that
private stocks are unreliable measures of import protection, it should
approach the IEA about changing the definition. As near as I know, the
USG has not done so and continues to participate in the IEA under these
conditions. Unless and until the US indicates we need to re-visit this
requirement, the US is in compliance and in fact substantially exceeds
the 90 day requirement.
Finally, as noted in my written testimony, the drawdown capacity of
the SPR of 4.4 million barrels per day is a boundary condition that
physically limits as well as extends the amount of import protection of
the Reserve. This suggests that we need a much more sophisticated
approach to SPR policy than a reliance on a simple measure of ``days of
import protection'' that does not accommodate the infrastructure and
product mix limitations and capacity of the SPR.
Question 2. As imports rise faster than the SPR fill rate, isn't it
inevitable that the number of days of import replacement that the SPR
can provide will decline?
Answer. As I understand it, fill rate is not the denominator in
this equation; total capacity over total daily consumption of imports
is the calculation for days of import protection. Further, the
remaining 27 million barrels of capacity in the SPR would supply
roughly two days of total import protection at today's rate of
consumption. Total capacity and drawdown rate are more important
indicators for determining the import insurance provided by the
Reserve.
Question 3. Would there be an advantage to having a refined product
Strategic Petroleum Reserve? If so how?
Answer. As I noted in my testimony, given the increase in product
imports, the increasing reliance of US markets on this imported
product, and the amount of time it takes to move refined product to
high demand areas where there is a shortage (10 days to two weeks), we
should re-visit the issue of refined product reserves. Without benefit
of a sophisticated analysis of need, I would expect that there would
need to be several regional locations.
Question 4. During the next 25 years, can government actions to
reduce oil consumption feasibly eliminate the need for a larger SPR and
still meet the nation's IEA stockpile commitment?
Answer. The most effective way to increase the days of import
protection provided by the SPR is to dramatically increase the mpg of
the US vehicle fleet and shift away from petroleum based transportation
fuels. Congress made progress in that regard recently but there are
much greater efficiencies to be gained in this arena. Corn ethanol
displaces some oil imports but its energy balance is fairly marginal
and legal mandates are already forcing competition between fuel and
food and could place pressure on available arable land and conservation
areas. Cellulosic ethanol offers another avenue for reducing oil demand
but the DOE roadmap for research in this arena has roughly a 25 year
time window for large-scale market penetration.
Responses of Melanie A. Kenderdine to Questions From Senator Dorgan
Question 1. I am interested in the market signal sent by filling
the SPR. Is there historical evidence that suggests an announcement or
implementation of a sale of oil from the SPR has caused the market
price of oil to decline, even if only on a short-term basis?
Answer. This question is answered by the following graph* which
plots significant SPR actions--two sales and one exchange--against
nominal oil prices over time. As demonstrated in this graph, the use of
the SPR had an impact on price although it is difficult to isolate use
of the SPR as the sole reason for such declines. There is however a
substantial correlation between price declines and decisions to use the
SPR.
---------------------------------------------------------------------------
* Graph has been retained in committee files.
---------------------------------------------------------------------------
Question 2. Based on your knowledge and experience with the SPR
program, what would happen today if we decided to suspend filling the
SPR during this time of high prices and tight world markets?
Answer. Depending on the timing of such an announcement, there
could be a noticeable impact on price. The psychological impacts on
prices when the USG sends a signal to the marketplace that it is
prepared to act can be substantial, particularly when oil prices such
as those we see today are not reflective of market fundamentals. The
impact would be greater if the action was not telegraphed in advance
but was instead timed to have maximum impact based on market
conditions.
Question 3. Is filling the SPR with $90 or $100 dollar barrel of
oil the best use of taxpayer dollars to reduce dependence on foreign
oil? Are there other ways that would be a better investment at this
point in time in order to improve our long-term economic and national
security circumstances of the U.S.?
Answer. There is virtually no upside to filling the SPR with oil at
these prices and considerable downside. The energy security
implications are negligible and again, bounded by the drawdown rate of
the SPR, not its total capacity.
The value of the oil to fill the remaining capacity of the SPR is
around $3 billion. As I noted in my testimony, GAO indicates that in
real dollars, DOE energy research investment has declined by 85% over
the last twenty years. This trajectory is deeply disturbing in view of
the enormous energy challenges we are facing today. Given the extremely
marginal security value of filling the SPR to capacity, a better
investment of scarce resources might be in developing technologies that
would ultimately diminish or eliminate the need for an SPR, including:
highly efficient vehicles such as plug-in hybrids; unconventional
natural gas and carbon capture and sequestration technologies that
would enable us to generate carbon-light electricity to enable
widespread use of cleaner plug-in hybrids while mitigating climate
change; cellulosic ethanol and other sustainable fuels, and; other
clean or carbon-free sources of energy for power generation.
Question 4. Does the Energy Policy Act or any other legislation
require that the Department of Energy to continuously fill the SPR
regardless of circumstances or must it consider the economic and
consumer impacts of such decisions?
Answer. The Energy Policy Act provides DOE with significant
latitude as to when and how it decides to fill the remaining capacity
in the SPR, including consideration of market conditions and price
impacts. Former Secretaries of Energy, both Republicans and Democrats,
have suspended the RIK program out of concern such actions might place
pressure on oil prices in tight markets. Apparently, the current SOE
disagrees with the conclusions of Secretaries Abraham and Richardson.
Question 5. Are there not certain conditions in the Energy Policy
Act of 2005 that would require a suspension of the fill?
Answer. According to EPACT 2005, these are the factors DOE is
supposed to consider as it develops the ways and means to fill the SPR
to capacity and expand it to one billion barrels. I have inserted
comments after the legal factors articulated in EPACT 2005 as follow:
(1) maximize overall domestic supply of crude oil (including
quantities stored in private sector inventories)
Filling the SPR to capacity at this time could affect
private sector inventories and discourage their holding.
(2) avoid incurring excessive cost or appreciably affecting
the price of petroleum products to consumers'
As noted, other Secretaries of Energy have had concerns
about the appreciable impacts on price from filling the SPR
with RIK oil and suspended the program accordingly based on a
review of market conditions.
(3) minimize the costs to the Department of the Interior and
the Department of Energy in acquiring such petroleum products
(including foregone revenues to the Treasury when petroleum
products for the Reserve are obtained through the royalty-in-
kind program)
At today's prices, the foregone revenues to the Treasury
from continuing the RIK program are substantial.
Also, GAO has indicated that the current ``steady volume
approach of the RIK program'' has effectively cost the taxpayer
an additional $590 million for the same amount of oil.
(4) protect national security
As I have noted, the national security impacts of filling
the existing SPR to its full capacity are highly negligible
(5) avoid adversely affecting current and futures prices,
supplies, and inventories of oil
Putting small amounts of oil onto the market, for example
when the Clinton Administration exchanged 30 million barrels of
oil (in a 3 B barrel annual market), spot prices dropped almost
20%, from $37.22 to $30.26 a week later. Prices stayed down
until the bombing of the Cole on October 12. Further, this
action ultimately netted over 35 million barrels of oil
returned to the Reserve, a clear and positive impact on
inventories of oil. Consideration of market conditions, unlike
today's policy of filling without such consideration, enables
the converse of this factor; positive impacts on current and
future prices, supplies and inventories of oil.
(6) address other factors that the Secretary determines to be
appropriate.
I cannot comment on what other factors have been deemed
appropriate by the SOE.
______
Responses of Katharine Fredriksen to Questions From Senator Bingaman
Question 1. Could you tell us how the 4.4 million barrel per day
maximum drawdown rate will increase as a result of the 1-billion-barrel
expansion?
Answer. The SPR Expansion to 1.0 billion barrels will increase the
maximum drawdown rate from 4.4 million barrels per day to approximately
6.0 million barrels per day. The expansion sites will increase the
drawdown rate by 485,000 barrels per day and the new site will increase
the drawdown rate by 1,000,000 barrels per day.
----------------------------------------------------------------------------------------------------------------
Current 700 million Expansion to 1 Billion
------------------------------------------------
Distribution system Storage Facility Storage Drawdown Storage Downtown
(MMB) (MB/D) (MMB) (MB/D)
----------------------------------------------------------------------------------------------------------------
Seaway Bryan Mound 254 1,500 254 1,500
----------------------------------------------------------------------------------------------------------------
Texoma West Hackberry 227 1,300 227 1,300
--------------------------------------------------------------------------
Big HUI 170 1,100 250 1,500
----------------------------------------------------------------------------------------------------------------
Capline Bayou Choctaw 76 616 109 600
--------------------------------------------------------------------------
Richton (Hew) -- -- 160 1,000
----------------------------------------------------------------------------------------------------------------
Total Program 727 4,415 1,000 5,000
----------------------------------------------------------------------------------------------------------------
Question 2. EPAct directs DOE to: ``as expeditiously as possible,
without incurring excessive cost or appreciably affecting the price of
petroleum products to consumers, acquire petroleum in quantities
sufficient to fill the Strategic Petroleum Reserve to the 1 billion
barrel capacity.'' Is it DOE's interpretation that this EPAct direction
legally obligates the Department to fill the SPR? Is this the reason
that they are currently filling the SPR?
Answer. DOE does not interpret EPAct as directing obligatory fill
of the Strategic Petroleum Reserve without regard to price. Rather DOE
seeks to conduct a petroleum acquisition program that complies with the
guidelines enumerated in EPAct Section 301(c) to: (1) maximize overall
domestic supply of crude oil; (2) avoid incurring excessive cost or
appreciably affecting the price of petroleum products to consumers; (3)
minimize the costs to the Department of the Interior and DOE in
acquiring such petroleum products; (4) protect national security; (5)
avoid adversely affecting current and futures prices, supplies, and
inventories of oil; and, (6) address other factors that the Secretary
determines to be appropriate. The published Procedures for the
Acquisition of Petroleum for the SPR (71 FR 65376, 11/8/06) are
consistent with these objectives.
The current royalty-in-kind program, which is fully in compliance
with these guidelines, was initiated pursuant to the Administration's
policy set forth in the President's January 2007 State of the Union
message to Congress to fill and expand the Reserve to 1.5 billion
barrels.
Question 3a. In its latest Emergency Response Review of the United
States, the IEA recommends that the U.S. take several steps to enhance
its energy security and ability to respond to emergency situations. The
Administration clearly would like to increase the amount of crude oil
that we hold in the SPR, but has any thought been given to the other
IEA recommendations, including:
Developing demand restraint measures;
Establishing product reserves; or
Requiring private industry to meet minimum inventory
requirements.
Answer. Demand Restraint Measures--The U.S. has considered demand
restraint measures in the past and decided against using them as an oil
disruption response measure. During disruptions, the key concern will
be economic damage. The U.S. has long maintained that the best response
to a severe supply disruption is to add supply through drawdown of the
SPR and cooperation with the IEA. Working within the market by adding
supply, and allowing prices to provide important market signals,
minimizes the impact on the economy. Administrative demand restraint
measures entail government interference in the market and can
themselves result in adverse economic impacts. The U.S. will use
additional stockdraw, if necessary, during an IEA response action,
rather than impose administrative demand restraint on an already-
suffering economy.
Product Reserves--The U.S. has considered product reserves in the
past, each time deciding that the best response measure for the U.S.
would be crude oil stored near refining centers. We have informed the
IEA of our views on this issue at various times over the years.
Private Industry Requirements--As to private industry inventory
requirements, again, the U.S. believes that a government-owned,
government-controlled crude oil reserve provides the best option for
mitigating the economic impacts of an oil supply interruption. Imposing
a stocks requirement on industry would increase industry costs,
increasing costs to the American consumer--without the sort of
certainty of stock use in an emergency that is provided by the SPR.
Question 3b. This Administration has departed from the standing SPR
policy that, in the case of a supply disruption, SPR oil should be
drawn down early and in large volumes. Could you explain to us why the
Administration decided to change this policy? And could you explain the
criteria that the Administration uses when determining its SPR fill and
drawdown policies? For instance, what circumstance might prompt the
Administration to stop its current fill? And, what circumstance might
prompt a drawdown? Is the policy different depending on whether the
disruption is weather-related or geopolitically-based?
Answer. The Administration has consistently followed relevant
provisions of law to manage the SPR in a manner that limits use to
cases of severe physical disruption to oil supply. The Administration
has also consistently resisted calls to use the SPR to impose short-
term effects on a normally-operating global oil market, as 1) any
effects would be transient, expiring once an SPR draw down were halted;
and 2) any reduction in long-term energy and economic security as the
result of a non-emergency draw down would run against the very purpose
of maintaining the SPR, and the intent of policymakers over the past 30
years who established this important national security asset.
The Energy Policy Act of 2005 (EPAct 2005 requires acquisition of
petroleum to fill the Strategic Petroleum Reserve to its authorized one
billion barrel capacity ``as expeditiously as practical without
incurring excessive costs or appreciably affecting the price of
petroleum products to consumers''; and directs the Secretary of Energy
to promulgate procedures for the acquisition of petroleum for the
Reserve.
Section 301(c) of EPAct 2005 directs that the acquisition
procedures:
1. Maximize overall domestic supply of crude oil;
2. Avoid incurring excessive cost or appreciably affecting
the price of petroleum products to consumers;
3. Minimize the costs to the Department of the Interior and
the Department of Energy in acquiring such petroleum products;
4. Protect national security;
5. Avoid adversely affecting current and future prices,
supplies, and inventories of oil; and,
6. Address other factors the Secretary determines to be
appropriate.
After consideration of public comments, the Department of Energy
promulgated Procedures for the Acquisition of Petroleum for the
Strategic Petroleum Reserve (10 CFR 626), effective December 8, 2006.
The Procedures establish the rules and procedures for acquisition
of SPR crude oil by direct purchase or royalty-in-kind (RIK) transfer.
The Procedures require a complete market analysis be performed prior to
any oil fill activities to ensure that Strategic Petroleum Reserve
acquisition activities will not unduly affect current market conditions
adversely. Since the beginning of 2007, three separate market
assessments have been performed prior to initiating activities to
attempt acquisition by direct purchase and for the two RIK exchange
cycles.
Question 4. Other witnesses testified that the Administration's
current SPR fill is affecting market psychology, which is pushing
prices upward in a manner that cannot be captured by modeling or
economic analysis. I understand that DOE believes that the current SPR
fill is too small to affect world oil prices in a manner than can be
modeled. However, I would like you to comment on the relationship
between current SPR policy and market psychology, and whether the
Department has taken these non-quantitative variables into account in
its decision-making on this issue.
Answer. Market psychology is indeed an important factor in short-
term crude oil price movements. However, price movements driven by, or
perhaps more accurately exaggerated by, the psychology of market
participants are very short lived if not associated with significant
impacts on market fundamentals. When it is made public that the
Department of Energy may acquire crude oil for the SPR, it is possible,
all else equal, that there will be a notable market response. However,
as we have seen in the past, any market reaction is very short lived (1
or 2 days). The transparency of the fill program, small quantity
involved, and deliberate pace of crude acquisition by the Department of
Energy allows the world crude oil market ample time to adjust.
Ultimately any price impact is proportionate to the net quantity of oil
that is being removed from world markets, following adjustments by both
consumers and producers. Considerations such as these are part of the
market assessment that is conducted by the Department of Energy prior
to engaging in acquisition activities.
Responses of Katharine Fredriksen to Questions From Senator Domenici
Question 1. With the U.S. consumption of oil increasing, domestic
production falling, and net imports rising to over 12 million barrels
per day in 2007, is it fair to say that U.S. dependence on the world
petroleum market in relation to our own domestic supply is growing?
Answer. Total consumption of liquid fuels is projected to grow from
20.7 million barrels per day in 2006 to 22.8 million barrels per day in
2030. While U.S. crude oil production increases from 5.1 million
barrels per day in 2006 to 5.6 million barrels per day in 2030, total
domestic U.S. liquids supply, including crude oil, natural gas plant
liquids, refinery processing gains, and other refinery inputs (e.g.,
ethanol, biodiesel, biomass to liquids, and liquids from coal) grows
from 8.3 million barrels per day in 2006 to 10.4 million barrels per
day in 2030.
The difference between consumption and production is made up by
imports. Total liquid net imports are projected to remain roughly
constant at 12.4 million barrels per day between 2006 and 2030 in the
AEO2008 reference case, so the net import share of total liquids
supplied, including crude oil and refined products, drops from 60
percent in 2006 to less than 51 percent in 2022, and then increases to
54 percent in 2030--lower than today's share.
Question 2. In light of threats to oil supply from Nigeria, Iran,
Venezuela and other countries, physical limits to surging world oil in
response to a disruption, and a variety of other factors, what level of
import protection can the SPR can offer us currently? What is a
reasonable level that we should expect?
Answer. The current SPR inventory of 701 million barrels affords
the Nation 56 days of net import protection. The SPR plans to increase
its inventory to 727 million barrels, providing 63 days of protection
in 2009.
The SPR has a maximum drawdown capability of 4.4 million barrels
per day which can replace approximately 45% of current crude oil
imports for a 90-day period, and the entire Reserve can be drawn in 180
days in response to a severe energy supply interruption. The drawdown
can be sustained at lower rates for a much longer period.
However, it is unlikely that a severe energy supply interruption
will result in a 100% cutoff of imports. In addition, through our
membership in the International Energy Agency, we participate in
coordinated response measures to global supply disruptions.
The Administration strongly believes, in light of the significant
U.S. petroleum consumption, and a doubling of imports over the past 30
years, it is vital to expand the SPR to 1.5 billion barrels.
Question 3a. In the case of a physical disruption to supply because
of a storm, or a conflict in a major producer, or a terrorist attack on
infrastructure--what are our real options for protecting our economy?
Answer. The Strategic Petroleum Reserve (SPR) was established by
the Energy Policy and Conservation Act to specifically address
potential physical interruptions to petroleum supplies. The U.S. SPR
and the petroleum stockpiles of the other IEA member countries provide
important insurance policies against possible energy supply
interruptions.
Question 3b. In the case of a physical disruption to supply because
of a storm, or a conflict in a major producer, or a terrorist attack on
infrastructure--is there realistically any extra oil in the market to
offset a significant disruption, other than the SPR?
Answer. The oil market's ability to respond to a supply disruption
will depend upon the size of the disruption. Disruptions that are
short-lived or small are generally met by stock draws. Oil inventories
have been building, and U.S. stocks of crude oil and petroleum products
are now back in the middle of their average range. Petroleum
inventories in the other Organization for Economic Cooperation and
Development countries as a group have not built as much, but are
projected to reach their 5-year average by the end of 2008.
Larger oil market disruptions could be offset to some extent by the
use of surplus production capacity, which is held primarily in Saudi
Arabia. Global surplus capacity is currently low by historical
standards at an estimated 1.5 million barrels per day for the first
quarter of 2008. This surplus capacity is projected to increase to 2.2
million barrels per day by the end of 2008, and rise further to an
average of 3.6 million barrels per day in 2009 because of increases in
capacity in Saudi Arabia and other OPEC countries, as well as a large
increase in non-OPEC production in 2009.
Question 4. What is the United States obligation as a Member
Country of the IEA? How does the U.S. fulfill its obligation?
Answer. The United States, under the 1974 Agreement on an
International Energy Program (the Charter of the IEA), is required to:
hold emergency oil stocks equivalent to at least 90 days of
net oil imports;
Release stocks, restrain demand, and switch to other fuels,
increase domestic production, or share available oil, if
necessary, in the event of a major supply disruption.
The IEA Agreement carries the commitment and status of a U.S.
Treaty.
The United States currently satisfies its IEA obligations to
provide 90 days of net import coverage through a combination of SPR and
commercial stocks. The SPR currently provides 56 days of import
protection and the remaining portion is satisfied through industry
stocks.
Question 5. How does the United States compare to other LEA Member
countries' stockholding requirements?
Answer. All members of the IEA are required to maintain stocks
equivalent to 90 days of net petroleum imports. The IEA members can
meet their obligations through reserves held by government or industry.
The U.S. obligation of maintaining 90 days of oil import protection
does not differ from other IEA members; however unlike many IEA
members, the U.S. does not impose a stockholding requirement on
industry.
As of July 2007, there were no IEA member countries below the 90-
day minimum stockholding requirement. IEA members utilize three methods
for holding stocks: placing a stockholding requirement on industry (20
countries); government-owned stocks (7 countries); and agency stocks
(11 countries). Agency stockholding entities can take various forms,
some being government-sponsored, some being industry-created, but all
under some form of government control during emergencies. Many
countries opt for a combination of these stockholding methods. For
example, two countries, Japan and Korea, which are nearly 100%
dependent on petroleum imports, maintain stocks far in excess of the
90-day requirement by utilizing both government stocks and mandatory
requirements on industry. Japan has a Government reserve of 77 days and
requires its industry to hold an additional 70 days, and Korea has a
Government reserve of 70 days and requires its industry to hold an
additional 40 days.
Question 6. Import protection is essential for our energy security.
Since there is not a mandatory requirement on industry to hold a
minimum number of days of commercial stock, what is its incentive to
continue to hold surplus inventories during times of high crude oil
prices? How will this effect our obligation to the IEA and import
protection during an energy supply disruption?
Answer. Trends in commercial inventories are driven almost entirely
by the economics of holding stocks. This often has less to do with the
absolute price of crude and is more associated with forward prices on
futures markets. When futures prices are in `contango', the prices on
the futures markets are increasing into the out months. This pricing
structure creates an economic incentive to hold physical stocks. A
refining company can buy and hold the physical stocks and sell futures
contracts to lock in a profit. Conversely, when futures prices are in
`backwardation', the prices on futures market are decreasing into the
out months. This pricing structure creates an economic disincentive to
hold physical stocks. Under these conditions, a refining company can
sell physical stocks on hand and buy futures contracts at a lower price
to lock in a price and profit.
The West Texas Intermediate (WTI) contract on the NYMEX flipped
from a contango market to a backwardated market in early 2007. The
shape of the forward price curve is primarily determined by global
crude oil market fundamentals. In this most recent case, it was
successive OPEC production cuts aimed at reducing OECD stock levels
that caused the price curve to flip. When the market changes occur and
our domestic refining industry changes its stock holding patterns, the
change in commercial stock levels in the U.S. can change substantially.
Over a period of prolonged backwardation, the number of days of import
protection provided by our commercial stocks can decline by as much as
five or six days compared to inventory holdings when contango patters
prevail.
Question 7. To what extent and at what rate will the increased
automobile fuel economy standard and other provisions of the Energy
Independence and Security Act of 2007 reduce U.S. growth in projected
oil imports?
Answer. The specific EISA2007 provisions that are modeled in the
Annual Energy Outlook 2008 include the renewable fuel standard (RFS),
the new corporate average fuel economy (CAFE) standard for new light-
duty vehicles, new appliance energy efficiency standards, new lighting
energy efficiency standards, provisions to reduce energy consumption in
Federal buildings, and new industrial electric motor efficiency
standards. Compared to the projections contained in the Annual Energy
Outlook 2007 (AE02007), the combined effect of the EISA2007 provisions
is a 11.6 percent reduction in total U.S. delivered energy demand by
2030, a reduction of 11.2 quads. The majority of the petroleum savings
realized from EISA2007 are due to increased CAFE standards for light
duty vehicles and the RFS. The combined effect of the RFS and CAFE is a
15.4 percent reduction in petroleum demand by 2030, which equates to a
reduction of 4.1 million barrels per day compared with AE02007. The
reduction in petroleum consumption translates into lower imports; the
decline in net imports (including crude oil and petroleum products) 4.0
million barrels per day, or 24.7 percent, resulting in imports of 12.3
million barrels per day by 2030.
Question 8. What is the most effective way of acquiring oil for the
SPR? And, why?
Answer. We feel that the key to minimizing our impact on markets
and on consumers is to fill steadily and at modest predictable rates.
This fill policy allows industry to have clear expectations of our fill
activities and it allows our fill plans to be built into mid-range
market fundaments, thus avoiding surprises that could shock the market.
Responses of Katharine Fredriksen to Questions From Senator Dorgan
Question 1. The Energy Policy Act of 2005 provides guidance to
expand the Strategic Petroleum Reserve (SPR) to the level of 1 billion
barrels but only ``without incurring excessive cost or appreciably
affecting the price of petroleum products to consumers.'' The
Department of Energy has said it conducts economic analysis on whether
filling the SPR would impact the price of petroleum and did so before
the recent RIK contracts.
Can you provide more detail about how the Department
performs this market analysis?
Was the analysis peer-reviewed?
Is the analysis available to the public, such as the web
site or other means?
Have you made this available to policy makers and other
parties?
Answer. Prior to engaging in activities to acquire crude oil for
the Strategic Petroleum Reserve, the Office of Petroleum Reserves
conducts an assessment of market conditions to evaluate the potential
for impacts on crude oil markets. Several market indicators are
examined in these assessments including stock levels, spot and futures
prices, market fundaments, and energy security policy. The most recent
market assessment was conducted in February 2008 and is currently being
reviewed by Department officials, having been informally peer reviewed
by staff at the Energy Information Administration. However, EIA was not
asked to comment on or evaluate the policy recommendations contained
within the document. These assessments are not published on the
internet, but they have been transmitted to the Congress.
Question 2. Secretary Bodman stated to me and other Senators in a
letter dated Jan. 8, 2008, that one of the reasons to increase the
capacity of the SPR is that it only contains 57 days of import
protection. However, your own web site said that the U.S. has 118 days
of public and private strategic stocks for import protection. The
requirement to meet U.S. treaty obligations with the International
Energy Agency (IEA) is for 90 days of import protection. Why is the
Department telling U.S. policy makers that we need to fill the SPR for
import protection and telling the international community that we are
currently meeting our treaty obligations for import protection? How can
you justify the juxtaposition?
Answer. Under the International Energy Program, member countries
are permitted to meet their stockholding obligations for 90 days of net
petroleum imports through the combination of both Government and
private stocks. Since 1988, the U.S. has relied on commercial industry
stocks. (Currently, the U.S. relies on industry stocks to make up more
than one-third of its obligation.)
While private inventories help satisfy the U.S. obligation to the
IEA, such commercial stocks are not under government control; it is the
position of this Administration that the nation's long-term energy and
economic security requires a gradual expansion of the SPR, in order to
ensure that government-controlled inventories are adequate in light of
a doubling of imports over the past 30 years.
Question 3. The Administration has asked Congress for funding in FY
09 to expand the SPR to the 1.5 billion level. In my estimate, it could
cost more than $80 billion at today's oil prices to build the
facilities and fill to that level. This will require a national
commitment through 2029 to get to that level under the Bush
Administration's plan. At the same time, even with the passage of the
2005 and 2007 Energy Bills, there has been no major increase in funding
requests for the energy programs. How does the Administration respond
to its policy efforts to put the SPR fill on autopilot without
consideration of cost and at the same time, it will not make the same
commitment for energy programs?
Answer. The Administration strongly believes that SPR expansion,
although costly, is necessary to protect the economic and energy
security of the Nation, given the increased risk of disruption in the
global oil market. The SPR is our only guaranteed source of additional
oil in the case of a severe energy supply disruption.
The Administration has proposed strong energy programs to reduce
dependence on imported oil, including the Twenty in Ten proposal to
reduce future gasoline demand, substantially enacted in the EISA07, tax
credit support for renewable and alternative fuels to displace imported
oil, and the Advanced Energy Initiative to foster development of
replacement energy forms and technologies to make America less
dependent on fuel imports.
Question 4. On December 11, 2007, Dr. Philip Verleger testified
before a joint Energy and Homeland-Government Affairs Subcommittee
hearing that filling the SPR, especially with light sweet crude, is
putting upward pressure on the price of a barrel of petroleum. In fact,
he stated that removing even small supplies of this highly-valuable
crude oil could have raised the overall price of oil as much as $10 per
barrel.
Explain to me how and why your analysis differs from Dr.
Verleger's?
Does the Department's analysis show a price threshold for a
barrel of oil that would stop you from filling because it is
impacting the economy?
Answer. The Department of Energy strongly rejects the assumptions
and conclusions set forth in Dr. Verleger's December 11, 2007,
testimony. His analysis was closely examined by DOE and it was found to
not be supported by observed market data or by traditional economic
theory. A lengthy briefing was given to several Energy and Natural
Resources Committee staff in January 2008 detailing the position of the
Department of Energy on this matter. We would be happy to provide these
briefing materials to you for your review.
The market assessments conducted by the Office of Petroleum
Reserves do not set price thresholds for the termination or subsequent
resumption of fill.
Question 5. I am also concerned about contracts for Royalty-in-Kind
oil to fill the SPR. Three were recently issued to BP North America,
Sunoco Logistics, and Shell Trading Company.
Does the Department have the ability to suspend these or any
future RIK oil contracts if circumstances or policy decisions
change? (Yes, they do.)
What might be the geopolitical or national circumstances
where the Department would consider suspending these contracts?
Answer. The Procedures for the Acquisition of Petroleum for the
Strategic Petroleum Reserve (10 CFR 626), specifically address
deferrals of contractually scheduled deliveries. ``Deferral'' is
defined as rescheduling delivery outside the original contract period.
Section 626.8 provides that, in the event the market is distorted by
disruption to supply or other factors, DOE may defer deliveries or
entertain contractor deferral requests. Deferral requests may be
granted only if DOE can receive a premium for the deferral paid in the
form of additional barrels of oil. Conditions to grant a deferral
request must be such that the deferral will reduce the oil acquisition
cost per barrel or a supply shortage situation exists or may be
imminent.
The Acquisition Procedures stipulate that DOE shall only grant a
deferral request if it determines that DOE can receive a premium for
the deferral paid in additional barrels of oil and, based on DOE's
deferral analysis, that at least one of the following conditions
exists:
(1) DOE can reduce the cost of its oil acquisition per barrel
and increase the volume of oil being delivered to the SPR by
means of the premium barrels required by the deferral process.
(2) DOE anticipates private inventories are approaching a
point where unscheduled outages may occur.
(3) There is evidence that refineries are reducing their run
rates for lack of feedstock.
(4) There is an unanticipated disruption to crude oil supply.
The Procedures require that a deferral request is granted only if
the negotiation results in an agreement to give the Government a fair
and reasonable share of the market value.
Question 6. Does the Energy Policy Act or any other legislation
require that the Department of Energy to continuously fill the SPR
regardless of circumstances or must it consider the economic and
consumer impacts of such decisions?
Answer. DOE does not interpret EPAct as directing obligatory fill
of the Strategic Petroleum Reserve. Rather DOE seeks to conduct a
petroleum acquisition program that complies with the guidelines
enumerated in EPAct to Section 301(c) to: (1) maximize overall domestic
supply of crude oil; (2) avoid incurring excessive cost or appreciably
affecting the price of petroleum products to consumers; (3) minimize
the costs to the Department of the Interior and DOE in acquiring such
petroleum products; (4) protect national security; (5) avoid adversely
affecting current and futures prices, supplies, and inventories of oil;
and, (6) address other factors that the Secretary determines to be
appropriate. The published Procedures for the Acquisition of Petroleum
for the SPR (71 FR 65376, 11/8/06) are consistent with these
objectives.
The current royalty-in-kind program, which is fully in compliance
with these guidelines, was initiated pursuant to the Administration's
policy set forth in the President's January 2007 State of the Union
address to Congress to fill and expand the Reserve to 1.5 billion
barrels.
Question 7. Are there not certain conditions in the Energy Policy
Act of 2005 that would require a suspension of the fill?
Answer. DOE does not interpret EPAct as directing obligatory fill
of the Strategic Petroleum Reserve without regard to price. Rather DOE
seeks to conduct a petroleum acquisition program that complies with the
guidelines enumerated in EPAct Section 301(c) to: (1) maximize overall
domestic supply of crude oil; (2) avoid incurring excessive cost or
appreciably affecting the price of petroleum products to consumers; (3)
minimize the costs to the Department of the Interior and DOE in
acquiring such petroleum products; (4) protect national security; (5)
avoid adversely affecting current and futures prices, supplies, and
inventories of oil; and, (6) address other factors that the Secretary
determines to be appropriate.
When acquiring petroleum, whether by purchase or royalty transfer,
DOE will seek to balance the objectives of assuring adequate security
and minimizing impact to the petroleum market. To this end, DOE will
consider various factors that may be affecting market fundamentals and
the geopolitical climate. DOE decisions on crude oil acquisition will
take into consideration the current level of inventories, import
dependency, the international and domestic production levels, oil
acquisition by other stockpiling entities, the security value of
additional storage, incipient disruptions of supply or refining
capability, market volatility, the demand and supply elasticity,
petroleum logistics, and any other considerations that may be
pertinent, Monetary policy, the rate of economic growth, specific
domestic market segments, and foreign policy considerations will also
be considered. The timing of DOE entry into the market, its sustained
presence, and the quantities sought will all be sensitive to these
factors and their impact on U.S. energy security.
Responses of Katharine Fredriksen to Questions From Senator Murkowski
Question 1a. I am a supporter of adding oil to SPR as quickly as
economically possible. When we face threats of a supply disruption from
the Venezuelan President, it only makes sense that we increase the size
of our stockpile. But there is something to be said for not driving the
price of oil higher at a time of record oil costs. So my questions are
what are the contractual and logistical issues concerning the U.S.
royalty oil with which you are filling the reserve?
Answer. The Department of the Interior (DOI) and DOE award six-
month term concurrent contracts for the delivery of royalty-in-kind oil
by DOI contractors to market centers and the market center receipt of
those volumes by DOE contractors. Premature termination of these
arrangements to ultimately deliver oil to the SPR is very complex and
costly because of the number of parties involved and contracts in
place, both government and contractor, including contractors' physical
acquisition and market hedging contracts.
Question 1b. How much notice do you need to give to stop taking
royalty oil to place in the reserve?
Answer. All DOE royalty-in-kind contracts have provisions for
termination for the convenience of the Government, for which an
effective date of termination can be specified by the government.
However, the impact on the contractors can be significant, depending on
current and future market conditions. DOE contractors may incur costs
with respect to prior market hedging of their exchange liability at
time of award which would have to be terminated as well as any physical
barrels purchased for future delivery. Contractors may incur costs for
canceling long term charter contracts (if applicable). DOE contractors
may also have claims related to having to sell royalty barrels received
at the market in lieu of delivery to SPR.
Question 1c. Can you switch to selling the government's 70,000
barrels from Gulf royalties relatively quickly to put slight downward
pressure on prices or do you have longer notice requirements for
changing from in-kind to advertising for sale of the government's oil?
Answer. The Department of the Interior would require a 45-day lead
time to make changes to the status of royalties-in-kind, either to
convert to royalty paid in value or to conduct outright sales of those
volumes.
Question 1d. Is it the Administration's position that 70,000
barrels per day of oil has absolutely no ability to affect prices being
paid to fill the SPR?
Answer. No. The basic supply and demand principles of economics
require there to be some impact on prices if you affect supply
regardless of the amount of oil. However, it is the Administration's
position that the quantity of oil being transferred to the SPR through
the RIK program is not having an impact on markets that is
disproportionate to the quantity being removed. There are several
compounding market factors that could affect the relative magnitude of
removing this quantity of oil from world markets; however, it is still
our position that this impact is relatively small.
Question 1e. Does the Department see any need for changes to the
SPR provisions that Congress approved two years ago in the Energy
Policy Act of 2005?
Answer. Not at this time. The Energy Policy Act of 2005 directed
the Department of Energy to expand the SPR to its authorized capacity
of 1 billion barrels as expeditiously as practicable. The
Administration is acting on this legislation and is fully complying
with the law and the procedures for acquisition of crude oil for the
SPR. It is the policy of this Administration to fill the SPR to its
current capacity of 727 million barrels by the end of 2008 and then to
expand and fill the Reserve to 1 billion barrels.