[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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               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

                              ----------                              

                               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

                              ----------                              


                       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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \13\ DOE Office of Inspector General, Audit Report: Department of 
Energy's Receipt of Royalty Oil, DOE/IG-0786 (Washington, D.C.: Jan. 
2008).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \1\ U.S. Energy Information Administration; historical data from 
the Annual Energy Review on petroleum (crude oil and refined products) 
imports and consumption.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \2\ U.S. Department of Energy Website, Office of Fossil Energy, 
Facts and Questions related to the Strategic Petroleum Reserve.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \3\ ``US Might Tap SPR if Half Imports Stop--Cheney'', Reuter's 
Report, Washington, D.C., August 25, 2004.
---------------------------------------------------------------------------
    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).*
---------------------------------------------------------------------------
    * All figures have been retained in committee files.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \4\ ``US Government, Senate Democrats on SPR Collision Course,'' 
Reuters report by T. Doggett and C. Baltimore, February 6, 2008.
---------------------------------------------------------------------------
    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.

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