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NS4960 Spring Term 2018 Strategic Petroleum Reserve

NS4960 Spring Term 2018 Strategic Petroleum Reserve. Overview. Jason Bordoff, Senate Testimony on the U.S. Strategic Petroleum Reserve, October 6, 2015 Main Points

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NS4960 Spring Term 2018 Strategic Petroleum Reserve

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  1. NS4960 Spring Term 2018Strategic Petroleum Reserve

  2. Overview • Jason Bordoff, Senate Testimony on the U.S. Strategic Petroleum Reserve, October 6, 2015 • Main Points • First, the SPR created during the 1970s crisis remains an important national security asset – even though there has been a steep rise in U.S. oil production and a fall in imports • Second It is prudent to study whether the size, composition, location or use of the SPR should be modified to reflect changes in the global oil market since the 1970s – security concerns rather than budget problems should frame this discussion • Third there is a need to modernize the SPR’s existing infrastructure to ensure it can remain effective

  3. Background I Background • As member of the IEA the U.S. is required to hold stocks of crude oil and/or petroleum products equivalent to 90 days of net imports for use in emergency situations. • Stocks can be held either in private inventories or directly by the government • Currently the SPR contains about 142 days of net petroleum import cover in 4 salt domes in Texas and Louisiana • In addition to the SPR, the U.S. government maintains in the Northwest emergency reserves of • one million barrels of heating oil, and • one million barrels of gasoline,

  4. Background II • The Energy Policy and Conservation Act (EPCA) of 1975 defines the circumstances under which the SPR may be used: • Full drawdown: President can order a full drawdown of the reserve to counter a “severe energy supply interruption.” • Limited drawdown: Up to 30 million barrels if the President finds there is “a domestic or international energy supply shortage of significant scope or duration.” • Test sale or exchange: The Secretary of Energy is authorized to carry out test drawdowns and distribution of crude from the SPR not to exceed 5 million barrels.

  5. Background III • To date present only three drawdowns: • 1991 during Operation Desert Storm • 2005 during Hurricane Katrina and • 2011 during the Libyan civil war • There have also been a dozen exchanges for various reasons, including the creation of the Northeast Home Heating Oil Reserve to help respon to natural disasters and outages. • There have also been three test sales to check to infrastructure and maintenance issues.

  6. Problems • Recently several members of Congress have proposed selling crude oil from the SPR to raise revenue for other programs • Infrastructure needs – selling 101 million barrels of oil between 2018 and 2015 • While need for infrastructure, SPR still plays critical role in domestic energy security • Would be short-sighted and unwise way to raise needed funding.

  7. Changing Environment I • SPR remains an important national security asset • SPR has created a deterrent against oil exporting countries threatening oil embargoes • Provided a tool to respond to global oil supply disruptions, and • Served to prompt OPEC to release spare capacity • Several arguments put forth on why SPR is less necessary today including • Change in oil markets over last 40 years mean that the risk of actual physical shortages of oil is far lower • The U.S. is less vulnerable to supply shortages today following the surge in domestic oil production • The dramatic collapse in oil prices since mid-2014 has consequently decreased he potential economic harm from a supply disruption, and • Improvements in technology and the growth of climate policy mean the U.S. will soon be able to get off oil.

  8. Changing Environment II • Today’s oil market is different than the oil market in the 1970s • In 1970s oil price controls existed in the U.S. and most internationally traded oil was sold under long term contracts. • A disruption in contracted shipments could result in physical shortage for buyer because of • Lack of strategic and commercial stockpiles, or A large spot market where buyers could easily access alternative sources of supply • In intervening years oil market has become the most largest and liquid commodity market on earth with vibrant futures market • Vast majority of globally traded oil bought and sold for a price indexed to benchmarked crude prices including Europe (Brent), The United States (WTI) and Middle East (Dubai)

  9. Changing Environment III • Given changes in oil markets – consequence of a supply disruption anywhere is a price increase everywhere • Hence risk against which the SPR needs to guard today is a global disruption to crude supply that causes domestic prices to spike regardless of whether U.S. refineries import from the disrupted countries • Oil price spices have an adverse effect on the economy • Generally a $10 per barrel increase in oil price would cause a 0.7% slower economic growth in the U.S. four quarters after the oil price rise • All but one of the 12 post war oil price shocks were accompanied by U.S. recessions • Increasingly important role for SPR may also be to manage market expectations • 2012 oil price tempered following sanctions on Iran because of the perception U.S. and allies would release oil from stockpiles

  10. Changing Environment IV Surge in oil production makes U.S. less vulnerable • Net imports are only one channel by which the economy is vulnerable to oil price spikes • Since 2008 oil production in U.S. has risen 80 percent or four million barrels per day • With decline in domestic demand, this has led to a decline in oil imports from 60 to 20% of U.S. consumption • Currently the volume of oil the U.S is projected to import in 2025 is 14 million b/d lower than projections made less than a decade ago • Reduced oil imports and increased domestic production should lessen the impact on the domestic economy of global oil price swings.

  11. Changing Environment V • Reduced impact does not mean there would be no impact. Several reasons that the SPR remains critical despite reduced import dependence • First, any supply disruption would still have significant distributional impacts • Gasoline price increase reduce motorists spending for other goods and services • Energy price increases also regressive given lower-income consumers spend a higher percentage of their income on energy than high income consumers • In theory other ways of addressing such distributional concerns – however doing so is unlikely

  12. Changing Environment VI • Second it is far from clear U.S. oil import dependence will remain this low forever • The reduction in import dependence has been driven by both increased domestic supply and reduced demand – great uncertainty about the outlook for both. • On the supply side shale oil has shown ability to increase productivity, but unclear current rates of improvement can be maintained • Still limited experience with tight oil production, so all projections should be taken with a grain of salt • On demand side 2015 much greater increase in demand than anticipated from oil price declines

  13. Changing Environment VII • The oil market is entering uncharted territory • While oil prices have fallen history teaches we should not expect them to stay there • Indeed oil prices may be even more volatile than in the past. • OPEC countries have for the time being given up their historic role as market stabilizer • Right now OPEC countries have a very narrow margin of spare capacity • In world of narrow spare capacity any disruption to global supply can have an outsized impact on price because thee is little buffer in the event of supply disruptions • With low oil prices higher political risks and thus possibility of supply shortfalls

  14. Changing Environment VIII • The U.S. economy will remain heavily dependent on petroleum • Many advances in energy efficiency, together with increased attention to climate change should result in reduced fossil fuel consumption • Still very likely oil will remain the dominant transportation fuel for decades in the U.S. and globally • IEA is predicting oil consumption will increase form the current 92 million b/d to 104 million b/d by 2040

  15. SPR Future I SPR should not be used as an ATM • Given evolving role of SPR in today’s changing oil markets good reasons to undertake an analysis of whether and how the SPR should be reformed • If the primary risk against which it projects is not a shortage of oil imports but a global price spike with disruptions • Should the size of the SPR be increased or deceased? • Given the changing patterns of US. Oil output and trade • Should the composition of light versus heavy oil be changed? • How should the concept of “severe energy supply disruption” be understood today? and • What does that mean about the frequency with which government officials should considser releasing or filling the SPR?

  16. SPR Future II Some generalizations • Given the nature of today’s oil market, the level of stocks should no longer be based solely on import dependence. • Instead an analysis would need to assess • the impact on the macro-economy of oil price spikes • The likelihood of supply disruptions and associated price spikes, and • The impact of SPR volumes to mitigate those spikes • Compare those potential benefits to the carrying and opportunity costs of maintaining crude oil in strategic reserves • Need to rebuild country’s infrastructure, but depleting the SPR is a short-sighted way to raise those funds • Besides, prudent management buys low and sell high – not the case today

  17. SPR Future III SPR revenue should be used for SPR modernization • SPR’s outdated infrastructure needs to be modernized • to ensure it can remain effective in the event of an emergency by delivering additional and incremental barrels to the market • Historically oil and refined petroleum products flowed from south to north to inland refineries • With increase in oil production in North Dakota these patterns are being reversed • To accommodate these changes in geography of U.S. crude oil supply and transportation • Have been pipeline additions and • Reversals as well • Analysis and heavy investments in infrastructure will have to take place before SPR is effective in quickly getting oil to refineries

  18. Recommendations I • To ensure SPR crude oil can be effectively assessed in a future supply disruption the Quadrennial Energy Review estimated that $1.5 to $2 billion was needed to make the SPR effective • Conclusions • SPR has served as a critical piece of country’s energy security strategy since the 1970s oil crisis • Our ability to tap the SPR has been severely limited by recent changes in the U.S. oil outlook and infrastructure • Addressing these constraints should be a key priority to ensure the SPR can remain effective in an emergency

  19. Recommendations II • Dramatic changes in the global oil market over the past four decades and • Changed nature of the risks against which the SPR guards mean • Mean that Congress working with the U.S. Department of Energy need to consider whether to modify the SPR’s • Size • Composition • Location, or • Use • That analysis should determine whether we sell off SPR crude, not immediate budget needs for priorities unrelated to energy security

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