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Order from Chaos

Seven fat years: The importance of preserving the U.S. Strategic Petroleum Reserve

David L. Goldwyn and Robert McNally

Proposals to sell some portion of the United States’ 693.7 million-barrel Strategic Petroleum Reserve (SPR) to fund expenditures unrelated to energy security are misguided. While carefully assessing the size and role of the SPR is in order, the case for preemptively reducing our stockpile has not been made. While current oil prices and oil imports are low, threats to America’s energy security are not. Spare capacity from the Organization of the Petroleum Exporting Countries (OPEC) is very small, and disruptions can transmit oil price shocks to our economy abound. 

The SPR is a critical element of U.S. foreign policy. The world is watching to see if the United States will remain engaged in the Middle East, if it will stand firm against Russian aggression in Europe, and if it will continue to lead on global economic management. Retaining the ability to deter energy threats and to help replace significant supply disruptions is a key element of American strategy and diplomacy.

Recognizing this, Senator Lisa Murkowski made a public appeal last week against selling off the SPR, describing the reserve as “our insurance policy out there and you don’t sell the insurance policy for a one-term shot in the arm. That’s just using it as an ATM. That’s not what it’s designed for.” If, after careful analysis, a drawdown is warranted, any revenues available should be devoted to strengthening U.S. energy defenses.

A buffer against disruption

The SPR has effectively deterred embargoes and enabled the United States to replace disrupted supplies of oil for nearly 40 years. The International Energy Program Agreement that founded the International Energy Agency (IEA) required member nations store at least 90 days of imports, in both commercial and strategic stocks, to redress oil supply disruptions. In the ensuing years, with the expansion of global trade in oil, the advent of spot markets, a mature oil futures market, and other instruments, the primary threat of an oil supply disruption arises less from physical shortage and more from the economic impact of disruptions. An oil disruption anywhere will hit consumers and businesses with price shocks everywhere, including in the United States. Disruptions can be ameliorated by supply replacements from strategic stocks if commercial supplies and spare capacity are not sufficient.

Despite current low nominal oil prices, the risk of a severe economic impact from a major supply disruption remains high. History shows that oil price shocks are quickly followed by major economic downturns and recessions. Geopolitical risks abound, from instability across the Middle East to internal unrest in key producing countries in Africa and Latin America.

The Energy Information Administration (EIA) estimates that global unplanned supply disruptions rose to 3.4 million barrels per day (bpd) in May and June. Meanwhile, EIA-estimated OPEC spare capacity, held almost entirely in Saudi Arabia, is half that amount: 1.7 million bpd. As Riyadh produces close to its maximum capacity in a battle for market share, its ability to provide adequate spare capacity in a 93-million-bpd (and growing) market shrinks. Low spare capacity and high disruption risk require us to give careful thought before lowering U.S. strategic defenses to pay for domestic spending unrelated to energy security.

As Secretary of Energy Ernest Moniz noted recently, a modern conception of the SPR should consider the size, duration and likelihood of a supply disruption to determine if the U.S. reserve is larger than needed. But whatever its size, the SPR will only be useful if the storage caverns are stable, and if there is pipeline and delivery capacity to move it to market. 

Beware a prodigal policy

As a component of prudent, broad, and bipartisan energy security strategy, SPR policy should include at least three steps. First, we need an analysis of the right size and configuration of the SPR. A risk analysis should consider the size and duration of likely disruptions and their economic impacts on our economy, as well as adequacy of spare capacity and commercial storage. It should also assess the utility of SPR infrastructure outside of the Gulf Coast and other impediments to quickly supply oil to the market, as well as the role that product reserves might play.

Second, if the analysis finds that the SPR should be reduced in size, the Department of Energy should look at options that allow IEA members with little or no reserves to buy those excess barrels, store them in the SPR, and utilize them under IEA rules. This would monetize the excess stocks but enable others to share the burden of carrying them.

Third, any funds available from reducing the SPR should be used to first to fund necessary SPR maintenance and modernization. In the Quadrennial Energy Review released this spring, the administration estimated that $1.5 to $2 billion would be needed to increase the incremental distribution capacity of the SPR and maximize its effectiveness. These investments would potentially include a dedicated marine loading dock for the SPR in the Gulf Coast and an SPR-component life extension program. It is also vital that annual budgets for maintenance and upkeep of the SPR are preserved.

Forty years ago, U.S. leaders had the foresight and wisdom to build an effective deterrent for supply disruptions, preventing another oil embargo. While its vulnerabilities have evolved, the nation’s need for defense against supply disruptions and their economic impacts has not. The SPR remains a major asset of national power; we should not squander it.

Authors

R

Robert McNally

Founder and President, Rapidan Group. Mr. McNally served in the George W. Bush Administration as the top international and domestic energy adviser on the White House staff, holding the posts of Special Assistant to the President on the National Economic Council and Senior Director for International Energy on the National Security Council. Mr. McNally was an oil market, policy, and geopolitical analyst with Energy Security Analysis, Inc. and Tudor Investment Corporation.

Check out our other foreign policy blog, Markaz, on politics in and policy towards the Middle East. Read all the Order from Chaos content »

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