Monday, June 23, 2008

A Strategic Petroleum Reserve Primer

Written by Kenneth D'Amica, AIER, Wednesday, 11 June 2008 10:15

The United States’ Strategic Petroleum Reserve (SPR) is the largest reserve of its kind, with 700 million barrels of unrefined crude oil housed in man-made, underground facilities in Texas and Louisiana. That is about as much oil as the entire world consumes in nine days. By 2015, total SPR capacity will have been increased from 730 million to one billion barrels.

There have been numerous calls for the President to sell off some of the SPR reserves in order to mitigate the steep upward movement of crude oil prices. On May 13, 2008, deliveries to the SPR were halted by Congressional action. Since 1975, when it was created, the SPR has made only three major sales of its reserves.

The first sale was authorized during Saddam Hussein’s occupation of Kuwait and the American invasion that ensued, when 21 million barrels were sold. Distribution, however, began in February 1991, by which time prices had decreased by more than a third from their October 1990 highs. The second instance was in 1996, when President Clinton authorized the sale of 28 million barrels and used the revenue to make up for part of the federal spending deficit. Finally, in September 2005, after Hurricanes Katrina and Rita caused major damage to refineries and pipelines in the region, the SPR sold 11 million barrels of its reserves, which ensured that the remaining refineries could continue to operate near capacity.

If a sustained sale were implemented, SPR facilities would be capable of supplying up to 4.4 million barrels of oil per day -- about half the daily production of Saudi Arabia (the world’s largest producer) and more than that of Iran (the fourth largest).

An additional supply of 4.4 million barrels per day could be sustained for 90 days, decreasing thereafter as the facilities emptied and less could be pumped. This would increase the global supply of crude oil by 5.5 percent. If it were sold exclusively to domestic buyers, would reduce imports by one third. If the focus were mainly on replacing OPEC imports, total imports from OPEC nations would be reduced by 75 percent during this period.

However, the SPR consists entirely of crude oil, which must be refined before it can be used. The rate of U.S. refinery utilization as of May 2, 2008 was 85 percent. Given that total U.S. production is about eight million barrels per day, this implies that there is refining capacity for only another 1.4 million barrels per day. At this pace, the release of refined SPR reserves into the market could be sustained for one and a half years and could replace about 12 percent of total imports.

It is difficult to predict what the short-term effect on oil prices would be if SPR crude were released. All else equal, one could expect prices to drop, though by how much is anyone’s guess. However, other factors could dampen the effect. For instance, a sudden influx of crude could put pressure on already strained refineries, leading to higher refining costs. Also, oil-producing nations, many already reluctant to increase supply, could be further disinclined to do so.

Though short-term price fluctuations are unpredictable, any sale of SPR crude of significant magnitude cannot be sustained for long, making it unlikely to have any effect on oil prices after the reserve has been exhausted.

American Institute for Economic Research (AIER)

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