Strategic Petroleum Reserve (Energy Policies, Politics and Prices)

ENERGY POLICIES, POLITICS AND PRICES SERIES

STRATEGIC PETROLEUM RESERVE

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Natural Gas Markets and Lessons Learned E. K. Cho (Editor) 2010. ISBN: 978-1-61668-429-7 (Online Book) Strategic Petroleum Reserve Albert L. Strait (Editor) 2010. ISBN: 978-1-60692-290-3 Solar Energy Technologies: From Research to Deployment Liam G. White (Editor) 2010. ISBN: 978-1-60741-323-3 Federal Energy Management and Government Efficiency Goals Amelia R. Williams (Editor) 2010. ISBN: 978-1-60692-985-8 Federal Energy Management and Government Efficiency Goals Amelia R. Williams (Editor) 2010. ISBN: 978-1-61668-538-6 (Online Book) U.S. Energy: Overview of the Trends, Statistics, Supply and Consumption Gregor E. Peake (Editor) 2010. ISBN: 978-1-60876-041-1 Rational Use and Energy Planning: A Thermodynamic and Geographical Approach Giuseppe Grazzini, Carla Balocco and Giovan Battista Andreani 2010. ISBN: 978-1-60741-350-9 World Biofuels Production Potential Thomas E. Rommer (Editor) 2010. ISBN: 978-1-61668-663-5 World Biofuels Production Potential Thomas E. Rommer (Editor) 2010. ISBN: 978-1-61668-425-9

Transition to Hydrogen Fuel Cell Vehicles Selim Koca (Editor) 2010. ISBN: 978-1-60741-806-1 Employment Effects of Transition to a Hydrogen Economy in the U.S. Michele Auriemma (Editor) 2010. ISBN: 978-1-60741-808-5 The Role of Auctions in Emission Allowance Allocations for Greenhouse Gases Aubrey D. O'Connor (Editor) 2010. ISBN: 978-1-60741-699-9 The Role of Auctions in Emission Allowance Allocations for Greenhouse Gases Aubrey D. O'Connor (Editor) 2010. ISBN: 978-1-61668-652-9 (Online Book) Reducing Greenhouse Gas Emissions Joseph G. Levitt (Editor) 2010. ISBN: 978-1-60741-890-0 Reducing Greenhouse Gas Emissions Joseph G. Levitt (Editor) 2010. ISBN: 978-1-61668-730-4 (Online Book) Energy Efficiency through Combined Heat and Power or Cogeneration David H. Thomas (Editor) 2010. ISBN: 978-1-61668-341-2 Energy Efficiency through Combined Heat and Power or Cogeneration David H. Thomas (Editor) 2010. ISBN: 978-1-61668-432-7 (Online Book) U.S. Energy and the Environment: An Overview and Comparative Analysis Roland H. Terrison (Editor) 2010. ISBN: 978-1-61668-017-6

U.S. Energy and the Environment: An Overview and Comparative Analysis Roland H. Terrison (Editor) 2010. ISBN: 978-1-61668-641-3 (Online Book) The Smart Grid and Electric Power Transmission Caitlin G. Elsworth (Editor) 2010. ISBN: 978-1-61668-223-1 Combined Heat and Power - Analysis of Various Markets Jordan A. Cory 2010. ISBN: 978-1-60741-269-4 Combined Heat and Power - Analysis of Various Markets Jordan A. Cory 2010. ISBN: 978-1-61668-377-1 (Online Book) Worldwide Biomass Potential: Technology Characterizations R. L. Bain 2010. ISBN: 978-1-60741-267-0 The Completion of the Oil Era: The Economic Impact Carlos A. Rossi 2010. ISBN: 978-1-60741-340-0

ENERGY POLICIES, POLITICS AND PRICES SERIES

STRATEGIC PETROLEUM RESERVE

ALBERT L. STRAIT EDITOR

Nova Science Publishers, Inc. New York

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CONTENTS Preface Chapter 1

Chapter 2

Chapter 3

xi The Strategic Petroleum Reserve: History, Perspectives, and Issues Robert Bamberger Strategic Petroleum Reserve: Improving the CostEffectiveness of Filling the Reserve Frank Rusco Strategic Petroleum Reserve: Available Oil Can Provide Significant Benefits, but Many Factors Should Influence Future Decisions about Fill, Use, and Expansion Government Accountability Office

1

19

33

Chapter 4

Expansion of the Strategic Petroleum Reserve U.S. Department of Energy

97

Chapter 5

Strategic Petroleum Reserve - Quick Facts and Frequently Asked Questions U.S. Department of Energy

105

Expanding the Nation's Strategic Petroleum Reserve U.S. Department of Energy

115

Chapter 6

Chapter Sources

121

Index

123

PREFACE The Strategic Petroleum Reserve (SPR) was created in 1975 to help protect the U.S. economy from oil supply disruptions and it currently holds about 700 million barrels of crude oil. The Energy Policy Act of 2005 required the Department of Energy to expand the Strategic Petroleum Reserve's maximum storage capacity to 1 billion barrels of crude oil. As the Department of Energy (DOE) begins to expand the SPR, past experiences can help inform future efforts to fill the reserve in the most cost-effective manner. Thus, this book will focus on the factors that experts recommend be considered when filling and using the SPR, to what extent the SPR can protect the U.S. economy from damage during oil supply disruptions and under what circumstances would an SPR larger than its current size be warranted. As part of this book, GAO developed oil supply disruption scenarios, used models to estimate potential economic harm, and convened 13 experts in conjunction with the National Academy of Sciences. Chapter 1 - Congress authorized the Strategic Petroleum Reserve (SPR) in the Energy Policy and Conservation Act (EPCA, P.L. 94-163) to help prevent a repetition of the economic dislocation caused by the 1973-1974 Arab oil embargo. The program is managed by the Department of Energy (DOE). The capacity of the SPR is 727 million barrels, and it currently holds around 704 million barrels of crude oil. In addition, a Northeast Heating Oil Reserve (NHOR) holds 2 million barrels of heating oil in above-ground storage. At issue in recent years has been whether SPR capacity should be expanded and whether the reserve should continue to be filled. During the period FY1999-FY2007, roughly 139 million barrels of royalty-inkind (RIK) oil were added to the SPR. An estimated 19.1 million barrels was to be acquired during FY2008. RIK oil is turned over to the U.S.

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government in lieu of cash royalties on offshore oil production from federal leases that would otherwise be paid to the Treasury. The Energy Policy Act of 2005 (EPACT, P.L. 109-58) permanently authorized the SPR and permits fill only if it can be established that adding to the SPR is not placing upward pressure on prices. However, the Bush Administration continued RIK fill. With gasoline prices exceeding, on average, $3.60/gallon, and approaching $4.00/gallon in some regions, some policymakers proposed that Congress take action to halt RIK deliveries. On May 13, the House and Senate passed H.R. 6022, suspending RIK fill. President Bush signed the legislation into law (P.L. 110-232) on May 19. However, a few days earlier, on May 16, DOE announced it would not accept bids for an additional 13 million barrels of RIK oil that had been intended for delivery during the second half of 2008. An energy bill (H.R. 3044) scheduled to reach the Senate floor during the week of June 9 includes language requiring suspension; presumably, this title will be dropped. The SPR comprises five underground storage facilities, hollowed out from naturally occurring salt domes in Texas and Louisiana. EPCA authorized drawdown of the Reserve upon a finding by the President that there is a ―severe energy supply interruption.‖ Congress enacted additional authority in 1990 (Energy Policy and Conservation Act Amendments of 1990, P.L. 101383), to permit use of the SPR for short periods to resolve supply interruptions stemming from situations internal to the United States. The meaning of a ―severe energy supply interruption‖ has been controversial. However, the statute intends use of the SPR only to ameliorate discernible physical shortages of crude oil. The sharp and sustained increase in crude prices during 2008 is attributed to a ―tight‖ market that has added new complexities to decision making on when to fill and to use the SPR. The Energy Policy Act of 2005 (EPACT) required expansion of the SPR to its authorized maximum of 1 billion barrels. Congress approved $25 million in the FY2008 budget for land acquisition for a site in Richton, Mississippi, that would add 160 million barrels of capacity, but rejected spending for other expansion work. In FY2009, the Administration is again seeking funds for this purpose, for which there still appears to be limited support. The FY2008 request was $331.6 million; Congress approved spending of $186.8 million. The FY2009 request is $346.9 million. Chapter 2 - The Strategic Petroleum Reserve (SPR) was created in 1975 to help protect 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

Preface

xiii

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-in-kind 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 we incorporated where appropriate. To view the full product, including the scope and methodology, click on GAO-08-726T. For more information, contact Frank Rusco at (202) 512-3841 or [email protected]. Chapter 3 - Congress authorized the Strategic Petroleum Reserve (SPR), operated by the Department of Energy (DOE), to release oil to the market during supply disruptions and protect the U.S. economy from damage. The reserve can store up to 727 million barrels of crude oil, and currently contains enough oil to offset 59 days of U.S. oil imports. GAO answered the following questions: (1) What factors do experts recommend be considered when filling and using the SPR? (2) To what extent can the SPR protect the U.S. economy from damage during oil supply disruptions? (3) Under what circumstances would an SPR larger than its current size be warranted? As part of this study, GAO developed oil supply disruption scenarios, used models to estimate potential economic harm, and convened 13 experts in conjunction with the National Academy of Sciences. Chapter 4 - The Energy Policy Act of 2005 required the Department of Energy to expand the Strategic Petroleum Reserve's (Reserve) maximum storage capacity to 1 billion barrels of crude oil. The Department stores the oil in large underground caverns, which have been created in salt domes. After evaluating various alternatives, the Department decided to develop a new 160 million barrel storage facility at Richton, Mississippi, and to expand the storage capacity at two existing Reserve facilities. As part of the evaluation, the Department eliminated a salt dome in Bruinsburg, Mississippi, from

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consideration as a potential expansion site. According to Department officials, the Bruinsburg site was not selected because (1) the salt dome was too small to meet storage needs, and (2) the site presented significant technical risks since thc Department would have to use deep injection wells to dispose of nearly 1.2 million barrels per day of brine used to excavate the caverns. Subsequent to the announcement of the Richton site as the preferred expansion alternative, public and congressional entities raised serious concerns about the procedurcs uscd by the Department in eliminating Bruinsburg as an expansion location. For example, a member of Congress raised concerns to the Department on several occasions that in determining the size of the Bruinsburg salt dome, the Department had not (1) considered existing well data, (2) resolved questions about data reliability concerning the location of wells, and (3)used existing seismic data. Additionally, four private-sector geologists concluded that thc Bruinsburg salt dome was large enough to meet the Dcpartment's storage requirements for 160 million barrels of oil. Finally, the Congressman was concerned that the Department's planned approach at the Richton site to use a 100-mile long pipeline to the Gulf of Mexico to dispose of brine produced during the creation of the storage caverns could cause environmental damage due to pipeline leaks. We initiated this review to evaluate the above concerns. Chapter 5 - The Strategic Petroleum Reserve is a U.S. Government complex of four sites with deep underground storage caverns created in salt domes along the Texas and Louisiana Gulf Coast that store emergency supplies of crude oil. Chapter 6 - The Energy Policy Act of 2005 (EPAct) directs the Secretary of Energy to fill the Strategic Petroleum Reserve (SPR) to its authorized one billion barrel capacity and to select sites necessary to enable acquisition by the Secretary of the full authorized volume. The current physical capacity of the SPR is 727 million barrels. Following passage of the EPAct in August 2005, the Department of Energy (DOE) began proceedings to select sites necessary to expand the SPR to one billion barrels. Thus far, DOE has issued the following: Expansion Plan (2007) to fill the SPR beyond 700 million barrels Environmental Impact Statement (2006) and Record of Decision (2007) for selection of a new site Supplemental Environmental Impact Statement (2008) to address newly identified issues

In: Strategic Petroleum Reserve Editors: Albert L. Strait

ISBN: 978-1-60692-290-3 © 2010 Nova Science Publishers, Inc.

Chapter 1

THE STRATEGIC PETROLEUM RESERVE: HISTORY, PERSPECTIVES, AND ISSUES Robert Bamberger SUMMARY Congress authorized the Strategic Petroleum Reserve (SPR) in the Energy Policy and Conservation Act (EPCA, P.L. 94-163) to help prevent a repetition of the economic dislocation caused by the 1973-1974 Arab oil embargo. The program is managed by the Department of Energy (DOE). The capacity of the SPR is 727 million barrels, and it currently holds around 704 million barrels of crude oil. In addition, a Northeast Heating Oil Reserve (NHOR) holds 2 million barrels of heating oil in above-ground storage. At issue in recent years has been whether SPR capacity should be expanded and whether the reserve should continue to be filled. During the period FY1999-FY2007, roughly 139 million barrels of royalty-inkind (RIK) oil were added to the SPR. An estimated 19.1 million barrels was to be acquired during FY2008. RIK oil is turned over to the U.S. government in lieu of cash royalties on offshore oil production from federal leases that would otherwise be paid to the Treasury. The Energy Policy Act of 2005 (EPACT, P.L. 109-58) permanently authorized the SPR and permits fill only if it can be established that adding to the SPR is not placing upward

2

Robert Bamberger

pressure on prices. However, the Bush Administration continued RIK fill. With gasoline prices exceeding, on average, $3.60/gallon, and approaching $4.00/gallon in some regions, some policymakers proposed that Congress take action to halt RIK deliveries. On May 13, the House and Senate passed H.R. 6022, suspending RIK fill. President Bush signed the legislation into law (P.L. 110-232) on May 19. However, a few days earlier, on May 16, DOE announced it would not accept bids for an additional 13 million barrels of RIK oil that had been intended for delivery during the second half of 2008. An energy bill (H.R. 3044) scheduled to reach the Senate floor during the week of June 9 includes language requiring suspension; presumably, this title will be dropped. The SPR comprises five underground storage facilities, hollowed out from naturally occurring salt domes in Texas and Louisiana. EPCA authorized drawdown of the Reserve upon a finding by the President that there is a ―severe energy supply interruption.‖ Congress enacted additional authority in 1990 (Energy Policy and Conservation Act Amendments of 1990, P.L. 101383), to permit use of the SPR for short periods to resolve supply interruptions stemming from situations internal to the United States. The meaning of a ―severe energy supply interruption‖ has been controversial. However, the statute intends use of the SPR only to ameliorate discernible physical shortages of crude oil. The sharp and sustained increase in crude prices during 2008 is attributed to a ―tight‖ market that has added new complexities to decision making on when to fill and to use the SPR. The Energy Policy Act of 2005 (EPACT) required expansion of the SPR to its authorized maximum of 1 billion barrels. Congress approved $25 million in the FY2008 budget for land acquisition for a site in Richton, Mississippi, that would add 160 million barrels of capacity, but rejected spending for other expansion work. In FY2009, the Administration is again seeking funds for this purpose, for which there still appears to be limited support. The FY2008 request was $331.6 million; Congress approved spending of $186.8 million. The FY2009 request is $346.9 million.

HISTORY OF THE SPR Establishment of the SPR From the mid-1970s until 2007, world markets have had to absorb roughly five significant spikes in the price of crude oil and petroleum products.1

The Strategic Petroleum Reserve: History, Perspectives, and Issues

3

Whether driven by disruptions in the physical supply of crude or refined fuels, or by uncertainties owing to international conflicts and instabilities, these price increases have consequences for the United States. Elevated petroleum prices affect the balance of trade and, owing to the relative inelasticity of demand for gasoline at prices less than $4.00 per gallon, siphon away disposable income that might be spent to support spending, investment, or savings. The origin of the U.S. Strategic Petroleum Reserve (SPR) stems from the 1973 Arab-Israeli War. In response to the United States‘ support for Israel, the Organization of Arab Exporting Countries (OAPEC) imposed an oil embargo on the United States, the Netherlands, and Canada, and reduced production. While some Arab crude did reach the United States, the price of imported crude oil rose from roughly $4/barrel (bbl) during the last quarter of 1973 to an average price of $12.50/bbl in 1974. While no amount of strategic stocks can insulate any oil-consuming nation from paying the market price for oil in a supply emergency, the availability of strategic stocks can help blunt the magnitude of the market‘s reaction to a crisis. One of the original perceptions of the value of a strategic stockpile was also that its very existence would discourage the use of oil as a political weapon. The embargo imposed by the Arab producers was just that, and intended to create a very discernible physical disruption. This explains, in part, why the genesis of the SPR was focused especially on deliberate and dramatic physical disruptions of oil flow, and on blunting the significant economic impacts of a shortage stemming from international events. In response to the experience of the embargo, Congress authorized the Strategic Petroleum Reserve in the Energy Policy and Conservation Act (EPCA, P.L. 94-163) to help prevent a repetition of the economic dislocation caused by the Arab oil embargo. In the event of an interruption, introduction into the market of oil from the Reserve was expected to help calm markets, mitigate sharp price spikes, and reduce the economic dislocation that had accompanied the 1973 disruption. In so doing, the Reserve would also buy time — time for the crisis to sort itself out or for diplomacy to seek some resolution before a potentially severe oil shortage escalated the crisis beyond diplomacy. The SPR was to contain enough crude oil to replace imports for 90 days, with a goal initially of 500 million barrels in storage. In May 1978, plans for a 750-million-barrel Reserve were implemented. The SPR is currently authorized for expansion to 1 billion barrels, and the Bush Administration has been unsuccessful to date in persuading Congress to raise the authorized size further to 1.5 billion barrels.

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The program is managed by the Department of Energy (DOE). Physically, the SPR comprises five underground storage facilities, hollowed out from naturally occurring salt domes, located in Texas and Louisiana. The caverns were finished by injecting water and removing the brine. Similarly, oil is removed by displacing it with water injection. For this reason, crude stored in the SPR remains undisturbed, except in the event of a sale or exchange. Multiple injections of water, over time, will compromise the structural integrity of the caverns.2 By 2005, the capacity of the SPR reached 727 million barrels. Its inventory reached nearly 700 million barrels before Hurricanes Katrina and Rita in 2005. Following the storms, some crude was loaned and some was sold. The loan of SPR oil was ―paid‖ by the return of larger amounts of oil than were borrowed. By June 2008, the SPR held roughly 704 million barrels.3 SPR oil is sold competitively. A Notice of Sale is issued, including the volume, characteristics, and location of the petroleum for sale; delivery dates and procedures for submitting offers; as well as measures for assuring performance and financial responsibility. Bids are reviewed by DOE and awards offered. The Department of Energy estimates that oil could enter the market roughly two weeks after the appearance of a notice of sale.4 The Arab oil embargo also fostered the establishment of the International Energy Agency (IEA) to develop plans and measures for emergency responses to energy crises. Strategic stocks are one of the policies included in the agency‘s International Energy Program (IEP). Signatories to the IEA5 are committed to maintaining emergency reserves representing 90 days of net imports, developing programs for demand restraint in the event of emergencies, and agreeing to participate in allocation of oil deliveries among the signatory nations to balance a shortage among IEA members. The calculation of net imports for measuring compliance with the IEA requirement includes private stocks. By that measure, the United States has more than 100 days‘ cushion. However, it is likely that less than 20% of the privately held stocks would technically be available in an emergency, because most of that inventory supports movement of product through the delivery infrastructure. The Administration‘s advocacy for expansion of the SPR is partly based on this argument that the SPR will need to be larger if the United States is to be able to maintain stocks equivalent to 90 days of net imports. Some IEA nations require a level of stocks to be held by the private sector or by both the public and private sectors. Including the U.S. SPR, roughly twothirds of IEA stocks are held by the oil industry, whereas one-third is held by governments and supervisory agencies.6

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The Energy Policy Act of 2005 (EPACT) requires, ―as expeditiously as practicable,‖ expansion of the SPR to its authorized maximum of 1 billion barrels. Congress approved $25 million in the FY2008 budget for land acquisition for a site in Richton, Mississippi, that would add 160 million barrels of capacity, but rejected spending for any other expansion work. In FY2009, the Administration is again seeking funds for this purpose, for which there still appears to be limited support. The FY2008 request was $331.6 million; Congress approved spending of $186.8 million. The FY2009 request is $346.9 million. The Administration has requested $9.8 million for the Northeast Heating Oil Reserve in FY2009, a reduction of $2.5 million from the FY2008 enactment, principally due to a reduction in the need for funds for repurchasing heating oil that was sold during FY2007 to finance new storage contracts.

ACQUISITION OF CRUDE OIL FOR THE SPR By the end of 1978, the SPR was supposed to contain 250 million barrels, but it contained only 69 million barrels. When the Iranian revolution cut supplies in the spring of 1979, purchases were suspended to reduce the upward pressure on world oil prices. Filling of the Reserve was resumed in September 1980 following enactment of the Energy Security Act (P.L. 96-294), which established a minimum fill rate of 100,000 barrels per day (b/d). The Reagan Administration accelerated the fill rate to 292,000 b/d in FY1981, but the rate steadily declined to a low of 34,000 b/d in FY1990. Filling of the SPR was suspended during 1990-1992 after the Iraqi invasion of Kuwait, but it resumed thereafter at a modest rate. Fill declined to 16,500 b/d during FY1994 before being suspended at the end of that fiscal year; by then the SPR held 592 million barrels. Owing to sales of SPR oil during 1996, the level in the Reserve had fallen to 563.5 million barrels by the early spring of 1997. From 1995 until the latter part of 1998, sales of SPR oil, not acquisition, were at the center of debate. However, the subsequent reduction and brief elimination of the annual federal budget deficit — as well as a precipitous drop in crude oil prices into early 1999 — generated new interest in replenishing the SPR, either to further energy security objectives or as a means of providing price support to domestic producers who were struggling to keep higher-cost, marginal production in service. As an initiative to help domestic

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producers, Secretary of Energy Bill Richardson requested that the Office of Management and Budget (OMB) include $100 million in the FY2000 budget request for oil purchases. The proposal was rejected.

Royalty-in-Kind Acquisition As an alternative to appropriations for the purchase of SPR oil, DOE proposed that a portion of the royalties paid to the government from oil leases in the Gulf of Mexico be accepted ―in kind‖ (in the form of oil) rather than as revenues. The Department of the Interior (DOI) was reported to be unfavorably disposed to the royalty-in-kind (RIK) proposal, but a plan to proceed with such an arrangement was announced on February 11, 1999. (Legislation had also been introduced [H.R. 498] in the 106th Congress to direct the Minerals Management Service to accept royalty-inkind oil.) Producers were supportive, maintaining that the system for valuation of oil at the wellhead is complex and flawed. While acquiring oil for the SPR by RIK avoids the necessity for Congress to make outlays to finance direct purchase of oil, it also means a loss of revenues in so far as the royalties are settled in wet barrels rather than paid to the U.S. Treasury in cash. Final details were worked out during the late winter of 1999. In mid-November of 2001, President Bush ordered fill of the SPR to 700 million barrels, principally through oil acquired as royalty-in-kind (RIK). At its inception, the RIK plan was generally greeted as a well-intended first step toward filling the SPR to its capacity of 727 million barrels.7 However, it became controversial when crude prices began to rise sharply in 2002. Some policymakers and studies asserted that diverting RIK oil to the SPR instead of selling it in the open market was putting additional pressure on crude prices. Deposit of 40 million barrels into the SPR during 2002 was criticized in a report released on March 5, 2003, by Senator Levin, representing the minority on the Permanent Subcommittee on Investigations of the Senate Committee on Governmental Affairs.8 The study argued that this increment of fill had been a major contributor to oil price increases during that year. A number of industry analysts quickly dismissed the study, arguing that the quantity of SPR fill was not enough to have driven the market. One of the most vocal critics of RIK fill, Philip K. Verleger, Jr., argued that SPR fill is one of two reasons that crude oil prices were exceeding $90/barrel during the latter part of 2007. In a commentary released in January 2008, Verleger estimated that, were the Administration to cease depositing sweet crude into the SPR, ―crude prices

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7

would ease dramatically were this to happen, possibly to $70 per barrel.‖9 The Administration has strongly disagreed with claims that RIK fill bears responsibility for the continuing spike in prices, arguing in part that market fluctuations both take and restore crude supply to world markets without affecting prices at the scale that would be implied by Verleger‘s assumptions. Legislative attempts to suspend RIK fill began in 2004, during the 108th Congress. An amendment to the FY2005 Interior Appropriations Bill (H.R. 4568) to suspend RIK deliveries and cap the SPR at 647 million barrels was defeated on the House floor (152-267) on June 17, 2004. Another effort to suspend RIK deliveries to the SPR occurred on September 14, 2004, during debate on H.R. 4567, the FY2005 Department of Homeland Security Appropriations Bill. Senator Byrd proposed suspension of RIK fill in order to provide $470 million in additional funding for homeland security purposes. The amendment was set aside. Despite the continued opposition to RIK fill of some policy makers, the Administration continued with it until August 2005, when the SPR held virtually 700 million barrels. Deliveries of RIK oil were suspended in August 2005 after Hurricanes Rita and Katrina. The Administration had suspended RIK oil on other occasions in the past. In light of tightness in world oil markets and increasing prices, the Bush Administration agreed to delay deliveries scheduled for late 2002 and the first months of 2003. The Administration had intended to boost deliveries to the SPR to 130,000 barrels per day during April 2003, a total of 3.9 million barrels. But, on March 4, 2003, DOE delayed delivery of all but 15,000 b/d of RIK oil. With the declared end of the military phase of the war in Iraq and little effect on oil markets, deliveries of RIK oil were resumed, as well as delivery of oil still owed from a ―swap‖ held in 2000 (described in detail below). The Energy Policy Act of 2005 (P.L. 109-58), enacted in the summer of 2005, required the Secretary of Energy to develop and publish for comment procedures for filling the SPR that take into consideration a number of factors. Among these are the loss of revenue to the Treasury from accepting royalties in the form of crude oil, how the resumed fill might affect prices of both crude and products, and whether additional fill would be justified by national security. It is likely that these provisions of P.L. 109-58 were a partial consequence of the debate over the wisdom of RIK fill. On November 8, 2006, DOE issued its final rule, ―Procedures for the Acquisition of Petroleum for the Strategic Petroleum Reserve.‖ The rule essentially indicated that DOE would take into account all the parameters to which P.L. 109-58 insists be weighed in

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any acquisition strategy. DOE rejected tying decisions to acquire oil to any specific, measurable differentials in current and historic oil prices. In the summer of 2007, DOE resumed RIK fill of the SPR, after soliciting and accepting bid for delivery of 8.7 million barrels of oil from Shell at a rate of roughly 50,000 b/d over a six-month period. On October 10, 2007, DOE issued a solicitation for an additional 13 million barrels of RIK oil, and in early November, contracts were awarded for 12.3 million barrels of RIK oil to Shell Trading Company, Sunoco Logistics, and BP North America. Bills to suspend RIK fill (H.R. 5146, S. 2598) were introduced early in the second session of the 110th Congress. Introduction of these bills may have been driven, in part, by dissatisfaction with the November 2006 Administration rule responding to the provisions in EPACT requiring the Administration to specify how it would determine that RIK fill would not affect product prices and markets. In May 2008, with gasoline prices exceeding, on average, $3.60 gallon, and approaching $4.00/gallon in some regions, more policymakers expressed support for halting RIK deliveries. On May 13, the Senate, by a vote of 97-1, approved suspension of RIK fill as an amendment to a flood insurance bill (H.R. 3121) that was subsequently passed (92-6). The amendment would permit resumption of RIK fill if crude oil fell to $75/barrel, on average, for a 90-day period. The House approved a similar proposal (H.R. 6022) that evening by a vote of 385-25. The Senate then approved the House bill by unanimous consent. President Bush indicated that he would not veto the legislation. President Bush signed the legislation into law (P.L. 110-232) on May 19. However, a few days earlier, on May 16, DOE announced it would not accept bids for an additional 13 million barrels of RIK oil that had been intended for delivery during the second half of 2008. An energy bill (H.R. 3044) scheduled to reach the Senate floor during the week of June 9 includes language requiring suspension; presumably, this title will be dropped. At the time of congressional passage of H.R. 6022, deliveries of RIK oil were scheduled through July 2008, and DOE had invited bids for additional fill through December 2008. Through FY2007, royalty-in-kind deliveries to the SPR totaled roughly 140 million barrels and forgone receipts to the Department of Interior an estimated $4.6 billion. DOE had estimated deliveries of 19.1 million barrels of RIK oil during FY2008 and $1.170 billion in forgone revenues.10 Opponents of RIK fill in the 110th Congress are not necessarily opposed to the concept of an SPR. When the price of crude was much less of an issue, objections to RIK full were also ideological. Opponents of RIK fill in principle

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contended that a government-owned strategic stock of petroleum is inappropriate under any circumstance — that it essentially has saddled the public sector with the expense of acquiring and holding stocks, the cost for which might have otherwise been borne by the private sector. The existence of the SPR, this argument goes, has blunted the level of stocks held in the private sector.11 On May 15, new legislation (H.R. 6067) was introduced that would initiate an exchange of SPR crude and direct SPR funds from a prior sale to be used to fund energy research and development programs. It is unclear whether this legislation will get any attention before the end of the 110th Congress.

THE DRAWDOWN AUTHORITIES The Energy Policy and Conservation Act authorizes drawdown of the Reserve upon a finding by the President that there is a ―severe energy supply interruption.‖ This is deemed by the statute to exist if three conditions are joined: If ―(a) an emergency situation exists and there is a significant reduction in supply which is of significant scope and duration; (b) a severe increase in the price of petroleum products has resulted from such emergency situation; and (c) such price increase is likely to cause a major adverse impact on the national economy.‖ The SPR could be drawn down initially at a rate of roughly 4.3 mbd for up to 90 days; thereafter, the rate would begin to decline. Although fears were expressed periodically during the 1980s about whether the facilities for withdrawing oil from the Reserve were in proper readiness, the absence of problems during the first real drawdown in early 1991 (the Persian Gulf War) appeared to allay much of that concern. However, some SPR facilities and infrastructure were beginning to reach the end of their operational life. A Life Extension Program, initiated in 1993, upgraded or replaced all major systems to ensure the SPR‘s readiness to 2025. Congress enacted additional drawdown authority in 1990 (Energy Policy and Conservation Act Amendments of 1990, P.L. 101-383) after the Exxon Valdez oil spill, which interrupted the shipment of Alaskan oil, triggering spot shortages and price increases. The intention was to provide for an SPR drawdown under a less rigorous finding than that mandated by EPCA. This section, 42 U.S.C. § 6241(h), allows the President to use the SPR for a short period without having to declare the existence of a ―severe energy supply

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interruption‖ or the need to meet obligations of the United States under the international energy program. As noted previously, the Energy Policy Act of 2005 made the SPR authorities permanent. These authorities also provide for U.S. participation in emergency-sharing activities of the International Energy Agency without risking violation of antitrust law and regulation. Under the additional authorities authorized in P.L. 101-383, a drawdown may be initiated in the event of a circumstance that ―constitutes, or is likely to become, a domestic or international energy supply shortage of significant scope or duration‖ and where ―action taken ... would assist directly and significantly in preventing or reducing the adverse impact of such shortage.‖ This authority allows for a limited use of the SPR. No more than 30 million barrels may be sold over a maximum period of 60 days, and this limited authority may not be exercised at all if the level of the SPR is below 500 million barrels. This was the authority behind the Bush Administration‘s offer of 30 million barrels of SPR oil on September 2, 2005, which was part of the coordinated drawdown called for by the International Energy Agency. The same authority may have been the model for a swap ordered by President Clinton on September 22, 2000 (see below).

THE SPR AND HURRICANES IVAN, KATRINA, AND RITA (2004-2005) The additional drawdown authorities enacted in P.L. 101-383 were also the basis for using SPR resources during the hurricanes of 2004-2005. Crude oil prices exceeded $50/barrel during October 2004, accompanied by declines in crude and product inventories. A major factor was Hurricane Ivan, which rampaged through the Gulf Coast in mid-September and temporarily interrupted more than 70% of offshore crude production, affecting crude oil deliveries to refineries. On September 23, 2004, the Administration agreed to a request placed to the Department of Energy from a couple of refineries seeking to borrow crude oil from the SPR, to be replaced within a short period of time. Subsequent requests raised the amount of borrowed crude to roughly 5.4 million barrels. The volume of oil returned was greater than the volume borrowed, in keeping with the mechanics of a ―swap‖ of oil conducted in 2002 under comparable circumstances. Critics claimed that it was a belated and insufficient use of the SPR, and that it even backfired in terms of calming the market. However, because the

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swap was limited and sharply focused, and represented such a tiny volume of oil, it may have been a misinterpretation to see it as intended to do anything more than it did — which was to provide supply to refiners to whom deliveries of crude were temporarily affected by Hurricane Ivan. The Administration argued that the decision to loan oil to these refineries was consistent with its overall SPR policy not to suspend fill or to authorize a broader drawdown for the purpose of reducing high prices. The swap was not characterized as a broader market-calming measure. The fact that the price of oil rose even after the announcement was a reflection of much stronger factors and uncertainties then prevailing in world markets than could be offset by such a limited swap. Hurricanes Katrina and Rita in 2005 shut down oil and gas production from the Outer Continental Shelf in the Gulf of Mexico, the source for 25% of U.S. crude oil production and 20% of natural gas output. Katrina, which made landfall on August 29, 2005, resulted in the shutdown of most crude oil and natural gas production in the Gulf of Mexico, as well as a great deal of refining capacity in Louisiana and Alabama. Offshore oil and gas production was resuming when Hurricane Rita made landfall on September 24, and an additional 4.8 million barrels per day of refining capacity in Texas and nearby Louisiana was closed. Combining the effects of both storms, 1.3 mbd of refining — about 8% of national capability — was shut down, reducing the supply of domestically refined fuels commensurately. Much of the refined product shortfall was made up by imports of refined products, some of which were made available by strategic supplies released by International Energy Agency (IEA) member nations on September 2. As part of the IEA drawdown, 30 million barrels of crude oil were made available from the SPR, which holds only crude. Only 11 million barrels was sold from the SPR, in part because limited refinery capacity reduced the call on crude. Stocks of heating oil proved more than adequate during the winter of 20052006. There were no calls for use of the SPR during that winter. More attention was focused on providing economic relief through the Low Income Home Energy Assistance Program to low-income heating oil consumers.

A Change in the Market Dynamics (2005-2008) The history of the SPR traces differences of opinion over what could be deemed a ―severe energy supply interruption.‖ As has been noted, the original intention of the SPR was to create a reserve of crude oil stocks that could be

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tapped in the event of an interruption in crude supply. However, in the last few years, there have been increases in the price of products independent of crude prices, as well as increases in crude prices that correlate to ―tight‖ markets, but not to measurable shortages in crude supply.12 The increases in gasoline and other petroleum products following Hurricanes Katrina and Rita were not a response to any shortage of crude, but to shortages of products owing to the shutdown of major refining capacity in the United States and to an interruption of product transportation systems. Demand growth that was strapping refinery capacity even before (as well as after) the hurricanes had significantly altered the traditional correlation between crude and product prices. Since mid-2005, owing to pressure on product supplies and continued international tensions, the price of products has been divorced, in part, from its traditional correlation with crude supply and price. The rise in crude prices to levels reaching over $130 a barrel in the spring of 2008 has been attributed to many contributing factors, including increasing international demand, and concern that demand for crude might outstrip world production. Markets are described as ―tight,‖ meaning that there may be little cushion in terms of the capacity to replace any crude lost to the market, or to provide adequate supply of petroleum products. In such a market, refinery outages, whether routine or unexpected, can spur a spike in crude and product prices, as can weekly reports of U.S. crude and petroleum stocks, if the numbers reported are not consistent with expectations. Some argue that market conditions do not support current price levels. One market analyst remarked at the end of October, ―The market at this stage totally ignores any bearish news [that would soften the price of oil], but it tends to exaggerate bullish news.‖13 Overall, recent events show that significant and sustained increases in oil prices may happen in the absence of the sort of ―severe energy supply interruption‖ that remains the basis for use of the SPR. Depending upon future events, the many more factors that can drive oil markets today may complicate reconciling developments in those markets with possible use of the SPR.

WHEN SHOULD THE SPR BE USED?: THE DEBATE OVER THE YEARS As has been noted, oil prices have risen in recent years in the absence of the normal association with the ideas of ―disruption‖ or ―shortage.‖ High

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prices are driven by international factors, little or no spare capacity downstream to refine products from crude, and a general inelasticity in demand for oil products despite high prices. The historic correlation between shortages of crude and high petroleum product prices has been broken. However, it was that correlation — and the assumption that product prices were driven by, and followed, crude prices — that lay behind debates from the 1980s until early this decade over when drawdown of the SPR was warranted Because there have been calls for use of the SPR in recent years, it‘s useful to outline how policymakers and Administrations have framed SPR policy over this time period. A debate during the 1980s over when, and for what purpose, to initiate a drawdown of SPR oil reflected the significant shifts that were taking place in the operation of oil markets after the experiences of the 1970s, and deregulation of oil price and supply. Sales of SPR oil authorized by the 104th Congress — and in committee in the 105th — renewed the debate for a time.14 The intended use of the SPR became an issue again, beginning with the rise in home heating prices during the winter of 1999-2000. The SPR Drawdown Plan, submitted by the Reagan Administration in late 1982, provided for price-competitive sale of SPR oil. The plan rejected the idea of conditioning a decision to distribute SPR oil on any ―trigger‖ or formula. To do so, the Administration argued, would discourage private sector initiatives for preparedness or investment in contingency inventories. Many analysts, in and out of Congress, agreed with the Administration that reliance upon the marketplace during the shortages of 1973 and 1979 would probably have been less disruptive than the price and allocation regulations that were imposed. But many argued that the SPR should be used to moderate the price effects that can be triggered by shortages like those of the 1970s or the tight inventories experienced during the spring of 1996, and lack of confidence in supply availability. Early drawdown of the SPR, some argued, was essential to achieve these objectives. The Reagan Administration revised its position in January 1984, announcing that the SPR would be drawn upon early in a disruption. This new policy was hailed as a significant departure, considerably easing congressional discontent over the Administration‘s preparedness policy, but it also had international implications. Some analysts began to stress the importance of coordinating stock drawdowns worldwide during an emergency lest stocks drawn down by one nation merely transfer into the stocks of another and defeat the price-stabilizing objectives of a stock drawdown. In July 1984, responding to pressure from the United States, the International Energy

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Agency agreed ―in principle‖ to an early drawdown, reserving decisions on ―timing, magnitude, rate and duration of an appropriate stockdraw‖ until a specific situation needed to be addressed.

Use of the SPR in the Persian Gulf War (1990) This debate was revisited in the aftermath of the Iraqi invasion of Kuwait on August 2, 1990. The escalation of gasoline prices and the prospect that there might be a worldwide crude shortfall approaching 4.5-5.0 million barrels daily prompted some to call for drawdown of the SPR. The debate focused on whether SPR oil should be used to moderate anticipated price increases, before oil supply problems had become physically evident. In the days immediately following the Iraqi invasion of Kuwait, the George H. W. Bush Administration indicated that it would not draw down the SPR in the absence of a physical shortage simply to lower prices. On the other hand, some argued that a perceived shortage does as much and more immediate damage than a real one, and that flooding the market with stockpiled oil to calm markets is a desirable end in itself. From this perspective, the best opportunity to use the SPR during the first months of the crisis was squandered. It became clear during the fall of 1990 that in a decontrolled market, physical shortages are less likely to occur. Instead, shortages are likely to be expressed in the form of higher prices, as purchasers are free to bid as high as they wish to secure scarce supply. Within hours of the first air strike against Iraq in January 1991, the White House announced that President Bush was authorizing a drawdown of the SPR, and the IEA activated the plan on January 17. Crude prices plummeted by nearly $10/barrel in the next day‘s trading, falling below $20/bbl for the first time since the original invasion. The price drop was attributed to optimistic reports about the allied forces‘ crippling of Iraqi air power and the diminished likelihood, despite the outbreak of war, of further jeopardy to world oil supply. The IEA plan and the SPR drawdown did not appear to be needed to help settle markets, and there was some criticism of it. Nonetheless, more than 30 million barrels of SPR oil was put out to bid, but DOE accepted bids deemed reasonable for 17.3 million barrels. The oil was sold and delivered in early 1991. The Persian Gulf War was an important learning experience about ways in which the SPR might be deployed to maximize its usefulness in decontrolled markets. As previously noted, legislation enacted by the 101st Congress, P.L.

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101-383, liberalized drawdown authority for the SPR to allow for its use to prevent minor or regional shortages from escalating into larger ones; an example was the shortages on the West Coast and price jump that followed the Alaskan oil spill of March 1989. In the 102nd Congress, omnibus energy legislation (H.R. 776, P.L. 102-486) broadened the drawdown authority further to include instances where a reduction in supply appeared sufficiently severe to bring about an increase in the price of petroleum likely to ―cause a major adverse impact on the national economy.‖ The original EPCA authorities permit ―exchanges‖ of oil for the purpose of acquiring additional oil for the SPR. Under an exchange, a company borrows SPR crude and later replaces it, including an additional quantity of oil as a premium for the loan. There have been seven exchanges from 1996 through 2005, the most recent ones following Hurricanes Katrina and Rita. A new dimension of SPR drawdown and sale was introduced by the Clinton Administration‘s proposal in its FY1996 budget to sell 7 million barrels to help finance the SPR program. While agreeing that a sale of slightly more than 1% of SPR oil was not about to cripple U.S. emergency preparedness, some in the Congress vigorously opposed the idea, in part because it might establish a precedent that would bring about additional sales of SPR oil for purely budgetary reasons, as did indeed occur. There were three sales of SPR oil during FY1996. The first was to pay for the decommissioning of the Weeks Island site. The second was for the purpose of reducing the federal budget deficit, and the third was to offset FY1997 appropriations The total quantity of SPR sold was 28.1 million barrels, and the revenues raised were $544.7 million. Fill of the SPR with RIK oil was initiated in some measure to replace the volume of oil that had been sold during this period.

ESTABLISHMENT OF A REGIONAL HOME HEATING OIL RESERVE Although a number of factors contributed to the virtual doubling in some Northeastern locales of home heating oil prices during the winter of 19992000, one that drew the particular attention of lawmakers was the sharply lower level of middle distillate stocks — from which both home heating oil and diesel fuels are produced — immediately beforehand. It renewed interest in establishment of a regional reserve of home heating oil. EPCA includes authority for the Secretary of Energy to establish regional reserves as part of the broader Strategic Petroleum Reserve. With support from the Clinton

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Administration, Congress moved to specifically authorize and fund a regional heating oil reserve in the Northeast. The FY2001 Interior Appropriations Act (P.L. 106-291) provided $8 million for the Northeast Heating Oil Reserve (NHOR). The regional reserve was filled by the middle of October 2000 at two sites in New Haven, CT, and terminals in Woodbridge, NJ, and Providence, RI. The NHOR would provide roughly 10 days of Northeast home heating oil demand. There was controversy over the language that would govern its use. Opponents of establishing a regional reserve suspected that it might be tapped at times that some consider inappropriate, and that the potential availability of the reserve could be a disincentive for the private sector to maintain inventories as aggressively as it would if there were no reserve. The approach enacted predicated drawdown on a regional supply shortage of ―significant scope and duration,‖ or if — for seven consecutive days — the price differential between crude oil and home heating oil increased by more than 60% over its five-year rolling average. The intention was to make the threshold for use of the regional reserve high enough so that it would not discourage oil marketers and distributors from stockbuilding. The President may also authorize a release of the NHOR in the event that a ―circumstance exists (other than the defined dislocation) that is a regional supply shortage of significant scope and duration,‖ the adverse impacts of which would be ―significantly‖ reduced by use of the NHOR. During mid- and late December 2000, the 60% differential was breached. However, this was due to a sharp decline in crude prices rather than to a rise in home heating oil prices. In fact, home heating oil prices were drifting slightly lower during the same reporting period. As a consequence, while the 60% differential was satisfied, other conditions prerequisite to authorizing a drawdown of the NHOR were not. A general strike in Venezuela that began in late 2002 resulted, for a time, in a loss of as much as 1.5 million barrels of daily crude supply to the United States. With refinery utilization lower than usual owing to less crude reaching the United States, domestic markets for home heating oil had to rely on refined product inventories to meet demand during a particularly cold winter. Prices rose, and there were calls for use of the NHOR; still, the price of heating oil fell significantly short of meeting the guidelines for a drawdown.15 In connection with the FY2004 Interior appropriations, both the House and Senate Appropriations Committees included language in their committee reports directing that DOE advise Congress as to the ―circumstances‖ under which the NHOR might be used. The provision implied that some in Congress

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were not satisfied with the formula currently in place that would permit drawdown of the NHOR. The language was not included in the final FY2004 Interior appropriations bill. As the sharp increases in home heating oil prices during 2005 are averaged into the five-year rolling average, the price differential needed to trigger use of the NHOR will increase further. However, the President can invoke the authorities for an NHOR drawdown even if the price threshold is not met.

End Notes 1

These have included the Arab oil embargo (1973-1974), the deposing of the Shah of Iran, followed by the Iranian revolution (1979-1980), the first Gulf War (1990), and OPEC production cuts and a resurgence in world oil demand (early 1999 into the fall of 2000). Since 2003, crude oil and product prices have risen to new nominal highs — and, very briefly, a new high in real dollars — owing to a blend of many factors, including international tensions and armed conflicts, as well as worldwide demand. Some of the dynamics behind recent and sustained increases in price owe to factors internal to the United States, including seasonal formulations of gasoline to help meet clean air standards, and strains on U.S. refining capacity. Natural events, such as Hurricanes Rita and Katrina, can also create havoc and alarm in domestic and world markets. 2 Oil stored at one SPR site, Weeks Island, was transferred after problems with the structural integrity of the cavern — unrelated to drawdown activity — were discovered in the mid1990s. 3 Details and current levels of SPR inventory are updated regularly at [http://www2.spr. doe.gov/DIR/SilverStream/Pages/pgDailyInventoryReportViewDOE_new.html]. 4 See [http://www.fe.doe.gov/programs/reserves/spr/spr-facts.html]. For more detail on the sales procedure, see U.S. Federal Register, Department of Energy, Price Competitive Sale of Strategic Petroleum Reserve Petroleum; Standard Sales Provisions: Final Rule, July 27, 2005, pp. 39363-39382; available at [http://www.fe.doe.gov/programs/reserves/spr/spr _rule_070705.pdf]. The Department of Energy has a history of SPR drawdowns, sales, and exchanges on the web at [http://www.fe.doe.gov/programs/reserves/spr/sprdrawdown.html]. 5 IEA member countries are Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Japan, Republic of Korea, Luxembourg, The Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, United Kingdom, and the United States. See [http://www.iea.org/ Textbase/about/ membercountries.asp]. 6 See [http://www.iea.org/Textbase/ subjectqueries/keyresult.asp? KEYWORD _ID =4103]. 7 The SPR estimated capacity of 727 million barrels followed a reevaluation of the cavern formations and other work. Water injections into caverns when oil has been moved have added capacity, as did completion of a project to remove excess gas from stored petroleum. 8 U.S. Strategic Petroleum Reserve: Recent policy Has Increased Costs To Consumers But Not Overall U.S. Energy Security; available at [http://hsgac.senate.gov/_files/sprt10818 petro_reserves.pdf]. 9 Prices at this time were in the realm of the mid-$80 per barrel. Verleger commentary available at [http://www.pkverlegerllc.com/ PKV%20Made% 20in%20 the%20USA%20OpEd.pdf]. 10 Owing to suspension of RIK fill after the passage of legislation in May 2008, these figures will be significantly lower. Annual figures for RIK deliveries through FY2006 may be found in

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the Strategic Petroleum Reserve Annual Report for FY2006, p. 39: [http://www.fossil. energy.gov/programs/ reserves/ publications/Pubs-SPR/spr_annual_rpt_06.pdf]. Estimates for FY2008 furnished in a communication from DOE. 11 See, for example, Taylor, Jerry and Van Doren, Peter, ―The Case Against the Strategic Petroleum Reserve,‖ Policy Analysis, No. 555, November 21, 2005. 12 One article in the trade press describes the oil market as driven by ―tight fundamentals.‖ See Little Relief Seen From Tight Fundamentals, Oil Daily, November 1, 2007: p. 1-2. 13 Oil Daily, October 30, 2007. Crude Continues Its Rally as Storm Hits Mexican Crude Exports: p. 3. 14 These were sales ordered by Congress as deficit-reduction measures. For a chronology of these sales, see [http://www.fe.doe.gov/programs/reserves/spr/spr-drawdown.html]. 15 During the heating oil season, DOE updates and posts a weekly table that shows the various inputs that go into the calculation to determine the current differential, [http://www.fe.doe.gov /programs /reserves/heatingoil/ Sales_ Basis_0506.html].

In: Strategic Petroleum Reserve Editors: Albert L. Strait

ISBN: 978-1-60692-290-3 © 2010 Nova Science Publishers, Inc.

Chapter 2

STRATEGIC PETROLEUM RESERVE: IMPROVING THE COST-EFFECTIVENESS OF FILLING THE RESERVE Frank Rusco WHY GAO DID THIS STUDY The Strategic Petroleum Reserve (SPR) was created in 1975 to help protect 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-in-kind program to fill the SPR.

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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 we incorporated where appropriate. To view the full product, including the scope and methodology, click on GAO-08-726T. For more information, contact Frank Rusco at (202) 512-3841 or [email protected].

WHAT GAO FOUND To decrease the cost of filling the reserve 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 volume—of 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 between October 2001 through August 2005, it could 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 recommends 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

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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 April 21, 2008, current inventory of the SPR stood at 701.3 million barrels of oil, which is roughly equivalent to 58 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

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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-inkind 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 were $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 William 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-in-kind 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. 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,

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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 from January to April 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.

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-costaveraging 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 costeffective 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,

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Frank Rusco 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

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SPR with 100 million barrels of heavy oil.9 The savings could be even larger if DOE included more than 10 percent heavier oils in the SPR. Alternatively, DOE could add heavy oil to the SPR by exchanging the light oil in one or more of the caverns for heavier oil. DOE has the legal authority to exchange one type of oil for another and has done so before. For example, in 1998, DOE exchanged 11 million barrels of heavy crude oil stored in the Bryan Mound site for 8.5 million barrels of other higher value light crude oil. 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 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. 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‖

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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 dollar-cost-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 58 days of net imports, we believe there is sufficient inventory for some flexibility in allowing deferrals. 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-costaveraging 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. Unless DOE addresses and adopts these recommendations, it will not be filling the reserve in the most cost-effective manner. 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

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requirements and believe such a study will find that DOE should include more than 10 percent heavier 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 royalty-inkind 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 Interior and DOE 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. 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

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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. 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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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.

CONCLUSIONS 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 $117 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

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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.

End Notes 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 one 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 William Bodman indicated that DOE‘s goal was to have this expansion completed by 2027. 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). 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 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

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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. 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 and are considered heavy oils. 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. 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. 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. 13 DOE Office of Inspector General, Audit Report: Department of Energy’s Receipt of Royalty Oil, DOE/IG-0786 (Washington, D.C.: Jan. 2008). 14 10 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 exchange for. This means that the government could receive the same number of barrels of SPR oil through its exchanges when spots prices are low or high. However, from a broader federal perspective, it would be more costeffective 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. 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.

In: Strategic Petroleum Reserve Editors: Albert L. Strait

ISBN: 978-1-60692-290-3 © 2010 Nova Science Publishers, Inc.

Chapter 3

STRATEGIC PETROLEUM RESERVE: AVAILABLE OIL CAN PROVIDE SIGNIFICANT BENEFITS, BUT MANY FACTORS SHOULD INFLUENCE FUTURE DECISIONS ABOUT FILL, USE, AND EXPANSION Government Accountability Office WHY GAO DID THIS STUDY Congress authorized the Strategic Petroleum Reserve (SPR), operated by the Department of Energy (DOE), to release oil to the market during supply disruptions and protect the U.S. economy from damage. The reserve can store up to 727 million barrels of crude oil, and currently contains enough oil to offset 59 days of U.S. oil imports. GAO answered the following questions: (1) What factors do experts recommend be considered when filling and using the SPR? (2) To what extent can the SPR protect the U.S. economy from damage during oil supply disruptions? (3) Under what circumstances would an SPR larger than its current size be warranted? As part of this study, GAO developed oil supply disruption scenarios, used models to estimate potential economic harm, and convened 13 experts in conjunction with the National Academy of Sciences.

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WHAT GAO RECOMMENDS GAO is recommending that the Secretary of Energy (1) assess the effectiveness of experts‘ proposals to use dollar cost averaging when filling the SPR and allow delays in SPR fill; (2) to better serve users, store some heavy sour oil in the SPR; (3) clarify the difference in assumptions and purposes of two models DOE uses to estimate the impact of using the SPR; and (4) periodically reassess the ideal size of the SPR in light of changing oil market conditions. DOE generally agreed with the report and recommendations.

WHAT GAO FOUND The group of experts recommended a number of factors to be considered when filling and using the SPR. They generally agreed that filling the reserve 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, would ensure that more oil will be acquired when prices are low and less when prices are high. Experts also suggested allowing oil producers to defer delivery of oil to the reserve at times when supply and demand are in tight balance, with oil producers providing additional oil to the SPR to pay for the delay. Regarding use of the SPR, experts described several factors to consider when making future use decisions, including using the reserve without delay when it is needed to minimize economic damage. During oil supply disruptions, releasing oil from the SPR could greatly reduce damage to the U.S. economy, based on our analyses and expert opinions. Particularly when used in conjunction with reserves in other countries, the SPR can replace the oil lost in all but the most catastrophic oil disruption scenarios we considered, lasting from 3 months to 2 years. DOE uses one model to estimate the optimal size of the SPR and another to estimate the economic effects of oil supply disruptions. Both models predict positive effects from using the SPR, but the magnitude of such benefits differ. The substantial differences between the results of these two models could lead DOE to provide inconsistent advice about expanding and using the reserve. Furthermore, factors beyond the SPR‘s ability to replace oil affect the extent to which the SPR can protect the U.S. economy from damage. For example, SPR crude is not compatible with all U.S. refineries. During a disruption of heavy

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 35 sour crude oil, refineries configured to use this type of oil would have to reduce production of some petroleum products when refining the lighter oil in the SPR, decreasing the reserve‘s effectiveness at preventing economic damage. If demand for oil increases as expected, a larger SPR would be necessary to maintain the existing level of protection for the U.S. economy. The Energy Information Administration recently projected increases in U.S. demand for petroleum of approximately 12 percent by 2015 and 24 percent by 2025, compared with the 2005 level. In this regard, a 2005 study prepared for DOE found that the benefits of expanding the reserve to 1.5 billion barrels exceed the costs over a range of future conditions. However, many factors that influence the SPR‘s ideal size are likely to change over time. For example, although projections show increasing oil demand, the level of demand depends on many factors, including rates of economic growth, the price of oil, policy choices related to alternatives to oil, and technology changes. Consequently, periodic reassessments of the SPR‘s size in light of new information could be helpful as part of the nation‘s energy security planning.

ABBREVIATIONS CAFE DOE EIA GDP ORNL SPR

Corporate Average Fuel Economy Department of Energy Energy Information Administration gross domestic product Oak Ridge National Laboratory Strategic Petroleum Reserve

August 24, 2006 The Honorable Susan M. Collins Chairman Committee on Homeland Security and Governmental Affairs United States Senate The Honorable Carl Levin Ranking Minority Member Permanent Subcommittee on Investigations Committee on Homeland Security and Governmental Affairs

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Government Accountability Office United States Senate

Oil is the world‘s most important energy resource. The world consumes approximately 83 million barrels of oil per day, accounting for nearly 40 percent of world energy consumption. In 2004, the most recent year for which data are available, 40 percent of the energy used in the United States and 96 percent of the energy used in the U.S. transportation sector were derived from oil, the majority of which was imported. In 2004, the United States imported 65 percent of its crude oil supply, or approximately 10 million barrels per day. Supply and demand for oil are in tight balance today, with only about 1 million barrels per day of spare oil production capacity, meaning that even small disruptions in supply can cause large increases in prices. Unusually high prices for petroleum products due to a strike at Venezuela‘s national oil company in 2002 to 2003 and Hurricanes Katrina and Rita in 2005 demonstrated this effect. Because of the central role that oil plays in the U.S. economy, sudden increases in its price can cause economic damage. Increases in crude oil price are reflected in the prices of products made from crude oil, such as gasoline, diesel, home heating oil, and petrochemicals such as fertilizer. Furthermore, because petroleum products are an important part of the production of many goods and services, the prices of these goods and services also increase. These price increases can reduce the total amount of goods and services that consumers can afford, thus reducing economic activity. Past studies have shown that oil price shocks can cause hundreds of billions of dollars of damage to the U.S. economy. To help protect the U.S. economy from damage caused by oil supply disruptions, Congress authorized the Strategic Petroleum Reserve (SPR) in 1975, following the Arab oil embargo of 1973 to 1974. The SPR is owned by the federal government and operated by the Department of Energy (DOE). It can store up to 727 million barrels of crude oil in salt caverns located at sites in Texas and Louisiana. Since 1976, the United States has spent about $45.2 billion in 2005 dollars to build, maintain, fill, and manage the SPR. In addition, the United States and 25 other nations that are members of the International Energy Agency have agreed to maintain reserves of oil or petroleum products equaling 90 days of net imports and to release these reserves and reduce demand during oil supply disruptions.1 In June 2006, the SPR contained about 689 million barrels, equal to 59 days of U.S. oil imports. In addition to government reserves, private industry inventory varies over time, but DOE estimates that private inventory contains an amount equal to an

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 37 additional 59 days of U.S. oil imports. Thus, at the current level of oil demand, the SPR combined with private industry holdings contains enough oil to exceed the United States‘ 90-day reserve requirement. Under conditions prescribed by the Energy Policy and Conservation Act, as amended, the President and the Secretary of Energy have discretion to authorize release of the oil in the SPR to minimize significant supply disruptions.2 In the event of an oil supply disruption, the SPR can provide supply to the market—by selling stored crude oil or trading this oil in exchange for a larger amount of oil to be returned later. When oil is released from the SPR, it flows through commercial pipelines or on waterborne vessels to refineries, where it is converted into gasoline and other petroleum products, then transported to distribution centers for sale to the public. Refineries are configured to refine specific types of crude oil. Crude oil is generally classified according to two parameters: density and sulfur content. Less dense crudes are known as ―light,‖ while denser crudes are known as ―heavy.‖3 Crudes with relatively low sulfur content are known as ―sweet,‖ while crudes with higher sulfur content are known as ―sour.‖4 In general, heavier and more sour crudes require more complex and expensive refineries to process the oil into usable products, but are less expensive to purchase than light sweet crudes. Many refiners in the United States have upgraded their facilities in recent years to process heavy sour crude. The SPR contains about 40 percent sweet crude and 60 percent sour crude, stored in separate caverns. Both crude types in the SPR are considered ―light.‖ Oil markets have changed substantially in the 31 years since the establishment of the SPR. At the time of the Arab oil embargo, price controls in the United States prevented the prices of oil and petroleum products from increasing as much as they otherwise might have, contributing to a physical oil shortage that caused long lines at gasoline stations throughout the United States. Now that the oil market is global, the price of oil is determined in the world market primarily on the basis of supply and demand. In the absence of price controls, scarcity is generally expressed in the form of higher prices, as purchasers are free to bid as high as they want to secure oil supply. In a global market, an oil supply disruption anywhere in the world raises prices everywhere. Releasing oil reserves during a disruption provides a global benefit by reducing oil prices in the world market. Use of the SPR during an oil supply disruption mitigates damage to the economy by replacing the oil lost, thereby reducing the price spike and the resulting economic damage. Such damage is typically reflected in a temporary reduction in gross domestic product (GDP), the total market value of all goods

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and services produced in the U.S. economy in a given year, compared with what it would have been without the disruption. The reduction in GDP caused by an oil supply disruption and the resulting price increases depends on several factors, including the size and duration of the disruption; the availability of oil market ―cushions,‖ such as excess oil production capacity and private inventories; and the importance of oil to economic activities. Severe oil supply disruptions in the past, such as the Arab oil embargo, caused sudden spikes in oil prices accompanied by economic losses of billions of dollars in the United States and other major oil-consuming economies. More recent disruptions, such as the Venezuelan strike in 2002 to 2003, have involved smaller quantities of oil for shorter durations and caused less economic damage. Two offices within DOE—the Office of Petroleum Reserves and the Energy Information Administration (EIA)—use models to analyze the effects of oil supply disruptions and SPR use on the economy. The Office of Petroleum Reserves is in charge of the day-to-day operations of the SPR, and it uses a model to calculate the effects of oil supply disruptions and SPR use as part of a study of the net benefits of expanding the reserve. EIA is a statistical agency that uses a separate model to estimate the impact of oil supply disruptions and to advise officials about their potential consequences. From 1977 to 1992, Congress appropriated money to purchase oil from the market to fill the SPR. Since 1999, oil for the SPR has been obtained through the royalty-in-kind program. Through this program, the government receives oil instead of cash for payment of royalties on leases of federal land in the Gulf of Mexico. Because oil produced in the Gulf generally does not meet the specifications to be stored in the SPR, DOE trades this oil with contractors who provide oil that can be stored in the SPR. Recently, the Energy Policy Act of 2005 directed DOE to increase the SPR inventory to 1 billion barrels and required DOE to select sites for the expansion to accommodate the inventory no later than 1 year after enactment, or by August 2006. Historically, DOE has added oil to the SPR in response to specific concerns about oil supply security. For example, when DOE acquired oil for the SPR after the Arab oil embargo of 1973 to 1974 and the Iranian revolution in 1979, the goal was to rapidly create a reserve large enough to be useful in case of a severe oil supply disruption. During the mid- to late-1990s when oil prices were relatively low, there were no significant oil security concerns and little oil was added to the SPR. In contrast, following the terrorist attacks of September 11, 2001, the President directed that oil be added to the SPR, even though it already contained enough oil to meet potential near-term supply disruptions. The stated goal was to maximize long-term protection against oil

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 39 supply disruptions. Some have criticized filling the SPR at that time because they believe doing so increased the price of oil. The President has the primary authority to decide when to use the SPR. Additionally, the Secretary of Energy is authorized to carry out exchanges from the SPR and test drawdowns to evaluate SPR procedures. Presidents have twice ordered that oil be sold from the SPR in response to oil supply disruptions: that is, in response to the 1990-1991 Persian Gulf War and Hurricane Katrina in 2005. Additionally, the SPR has sold or exchanged oil on several other occasions, including providing small quantities of oil to refiners to help them through short-term localized oil shortages. In conducting our review, we answered the following questions: (1) Based on past experience, what factors do experts recommend be considered when filling and using the SPR? (2) To what extent can the SPR protect the U.S. economy from damage during oil supply disruptions? (3) Under what circumstances would an SPR larger than its current size be warranted? In addressing these questions, we developed six hypothetical oil supply disruption scenarios. These scenarios are set in today‘s oil market, with global crude oil demand of approximately 83 million barrels per day and U.S. demand of approximately 21 million barrels per day. The scenarios are as follows: A hurricane in the U.S. Gulf Coast disrupts oil supplies by up to 1.5 million barrels per day for 6 months, similar to the disruptions caused by Hurricanes Katrina and Rita in 2005. A strike among oil workers in Venezuela disrupts oil production by up to 2.2 million barrels per day over 5 months, similar to a strike that occurred in 2002 to 2003.5 Production then remains 0.2 million barrels per day below its prestrike level for an additional 19 months. Iran stops exporting oil for 18 months, removing 2.7 million barrels per day from the market. A terrorism event at an oil facility in Saudi Arabia disrupts up to 6 million barrels per day over 8 months. Closure of the Strait of Hormuz, which is a vital oil shipping lane located at the entrance to the Persian Gulf, disrupts 17 million barrels per day for 1 month. Supply then recovers over the next 2 months. Saudi Arabia stops oil production, removing 10 million barrels per day from the market for 18 months. Production then recovers over the following 6 months.

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We selected these hypothetical scenarios to illustrate the potential benefits of strategic reserves in a wide range of different situations, not because we consider these scenarios likely. To collect expert opinions on the impacts of past SPR fill and use and recommendations for the future, we convened a group of experts in conjunction with the National Academy of Sciences6 and interviewed experts from industry and academia. We convened the group to allow the experts to exchange and challenge ideas, but the group was not designed to reach consensus on the issues discussed. We also reviewed records and reports from DOE and the International Energy Agency and interviewed officials from these agencies and other oil industry experts. To analyze the ability of the SPR to reduce economic damage caused by oil supply disruptions, we reviewed the economic literature on the impact of oil supply disruptions and used two DOE simulation models to estimate the reduction of harm to U.S. GDP that would result from releasing oil from the SPR and international reserves during our oil supply disruption scenarios. These two models estimate the increase in oil prices and the reduction in GDP that are likely to occur during an oil supply disruption of a given size. Although the models provide useful information, they make assumptions and do not include some factors that could influence the reserve‘s operation, such as the compatibility of SPR oil with U.S. refineries. Therefore, we interviewed oil industry experts, members of our group of experts, and representatives from companies that comprise 76 percent of the refining capacity of the United States to learn about issues with SPR operation not included in the models that affect the extent to which the SPR can protect the economy. To learn about the circumstances under which a larger SPR would be warranted, we reviewed U.S. stockholding obligations to the International Energy Agency, estimates of future U.S. oil demand, and a 2005 study performed by a contractor for DOE that analyzed the expected costs and benefits of expanding the SPR.7 We also reviewed studies and interviewed members of our National Academy of Science group of experts and other oil market experts about factors that influence the ideal size of the SPR. Our intent was to present useful information and discussion of key considerations about expanding the SPR, not to make recommendations about whether the SPR should be expanded. We did not independently verify information about security, drawdown rates, or other operational factors reported by the Office of Petroleum Reserves, nor did we analyze or verify strategic reserves held by other countries that belong to the International Energy Agency. A more detailed

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 41 description of our scope and methodology is included in appendix I. We performed our work between March 2005 and July 2006 in accordance with generally accepted government auditing standards.

RESULTS IN BRIEF The group of experts with whom we consulted recommended a number of factors to be considered for filling and using the SPR. With regard to filling the SPR, although recent fill activity during a time of tight supply and demand conditions raised some concerns that filling the SPR was increasing world oil prices, experts generally agreed that the nearly steady acquisitions of oil for the SPR from late 2001 through 2005 caused minimal increase in world oil prices. To reduce the cost of filling the reserve, experts in our group and others recommended acquiring a steady dollar value of oil over time—that is, a dollar-cost-averaging approach—to ensure that more oil is acquired when prices are low and less oil is acquired when prices are high. We estimated that if DOE had followed a dollar-cost-averaging approach when filling the SPR from October 2001 through August 2005, it could have saved approximately $590 million while acquiring the same amount of oil. Simulations we performed of this approach under various potential oil market conditions, including scenarios of rising and falling prices and periods of smaller and larger price volatility, showed that this approach would likely save money in the future as well. Some experts also suggested that DOE should allow oil producers to delay oil delivery to the SPR when supply and demand are in tight balance. Producers could provide additional oil to the SPR to pay for the privilege of delaying delivery. With regard to using the SPR, experts generally supported providing broad discretion about when to use the reserve, although they questioned some past presidential decisions about SPR use. Experts also described several key factors to consider when making future decisions about using the SPR, including using the SPR without delay when it is needed to minimize economic damage. The SPR is an extremely valuable asset, and releasing oil from the reserve during oil supply disruptions could greatly reduce the damage to the U.S. economy, as measured by losses in GDP. According to DOE, the SPR can currently release up to 4.4 million barrels of oil per day—about 44 percent of U.S. daily oil imports—for 90 days, and can release a diminishing amount of oil for an additional 90 days. This level alone is sufficient to completely

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replace oil lost in the Gulf Coast hurricane and Venezuelan strike scenarios we evaluated and, when combined with international reserves, can completely replace the losses from our Iranian embargo and Saudi terrorism scenarios. However, world reserves are inadequate to fully replace the oil lost in our most catastrophic scenarios: that is, the closure of the Strait of Hormuz and the loss of Saudi oil production. DOE uses one model to estimate the net benefits of expanding the SPR and another model to estimate the economic effect of oil supply disruptions. These models rely on different assumptions, particularly about the effect of oil price increases on GDP. Both models show a positive effect from using SPR, although the results are very different in magnitude. For example, for our Gulf Coast hurricane scenario, the Office of Petroleum Reserves and EIA models estimate avoided GDP damage of $7 billion and up to $400 million, respectively; in our Saudi shutdown scenario, the models estimate avoided GDP damage of $170 billion and up to $66 billion, respectively. The substantial differences between the results of these two models could lead offices within DOE to provide inconsistent advice about expanding and using the SPR. Additionally, several factors beyond the SPR‘s ability to replace oil could decrease or increase the economic benefit of the reserve. For example, the crude oil in the SPR is not compatible with all U.S. refineries. During a disruption of heavy crude oil supply, refineries configured to use this type of crude oil would have to reduce production of some petroleum products if they processed the lighter oil stored in the SPR. This decrease in production could raise prices for these products and decrease the SPR‘s effectiveness in reducing economic damage. If demand for oil in the United States increases as expected, a larger SPR would be necessary and desirable to maintain the economy‘s existing level of protection. EIA recently projected increases in U.S. demand for petroleum products of approximately 12 percent by 2015 and 24 percent by 2025, compared with the 2005 level. Using these demand projections, DOE estimates that the United States will drop below its stockholding obligation to the International Energy Agency by 2025. Additionally, a 2005 study prepared for DOE finds that the benefits of expanding the SPR to 1.5 billion barrels exceed the costs over a range of future conditions. However, factors that influence the SPR‘s ideal size are likely to change over time. For example, although projections show increasing oil demand in the United States and world, the level of oil demand depends on many factors, including rates of economic growth, the price of oil, future policy choices related to increasing conservation and availability of alternative energy sources, and technology changes. As the world oil market changes over time, periodic reassessments by

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 43 DOE of the appropriate size of the SPR could be helpful as part of the nation‘s long-term energy security planning. We are making four recommendations to the Secretary of Energy to improve the operation of the SPR and to improve decisions surrounding the SPR‘s use and expansion. Specifically, we are recommending that the Secretary should (1) study how to best implement experts‘ suggestions to fill the SPR more cost-effectively, including acquiring a steady dollar value of oil for the SPR over the long term and providing industry with more flexibility in the royalty-in-kind program to delay oil delivery to the SPR; (2) conduct a new review to examine the maximum amount of heavy oil that should be held in the SPR and ensure that DOE implements its own recommendation to hold at least 10 percent heavy oil in the SPR; (3) clarify the differences in structure and assumptions between the models used by the Office of Petroleum Reserves and EIA and clarify to policymakers how the models are used; and (4) periodically reassess the appropriate size of the SPR in light of changing oil supply and demand in the United States and the world. In commenting on a draft of this report, DOE generally agreed with the report and recommendations.

BACKGROUND Oil is vitally important to the world and U.S. economy, accounting for nearly 40 percent of world primary energy consumption.8 As shown in figure 1, although world oil consumption has increased significantly over the past 20 years, oil‘s share of primary energy consumption has remained fairly constant. EIA projects similar trends for the next 20 years, with total world energy consumption increasing 2 percent annually through 2025 and oil comprising about 38 percent of all energy consumption in 2025.9 Oil is also the largest primary source of energy in the United States, accounting for about 40 percent of all energy consumed in 2004. As shown in figure 2, two-thirds of the oil consumed in the United States is used for transportation. About 96 percent of energy used for transportation in the United States comes from oil. The transportation sector is almost exclusively dependent on oil because there are no significant competitive alternatives. EIA projects that transportation will comprise an even larger part of U.S. oil use in the future, about 72 percent in 2030, because it expects the growth in demand for transportation to far exceed increases in fuel efficiency.10

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Source: GAO analysis of EIA Note: Percentage shares may not add to 100 percent due to rounding. Figure 1. World Primary Energy Consumption

As shown in figure 3, the United States‘ demand for imported crude oil increased rapidly after 1970, when domestic crude oil production peaked. Although the percentage of imported crude oil decreased from about 45 percent in 1977 to about 26 percent in 1985 due to a reduction in demand for oil, imported crude oil increased again to 65 percent by 2004 due to a combination of increases in consumption and decreases in domestic production.

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Source: GAO analysis of EIA data. Figure 2. U.S. Oil Consumption, by Sector, 2004

Source: GAO analysis of EIA data. Figure 3. United States‘ Use of Domestic and Imported Crude Oil

The United States created the SPR because the country‘s reliance on oil imports makes it vulnerable to disruptions in oil supply. Strategic oil reserves like the SPR are particularly important now because oil market cushions, such as excess oil production capacity and private inventories, have decreased in recent years. Although estimates of spare production capacity are uncertain, experts believe that spare production capacity dropped to around 1 million barrels per day in 2004, close to a 20-year low. Additionally, private

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inventories of oil and oil products have been on a long-term declining trend, in part because of a trend toward just-in-time inventory. The absence of these market cushions means that less oil is available in the market to mitigate price spikes during oil supply disruptions. Thus, a supply disruption that takes even a small amount of oil off the market could cause the price of oil to rise dramatically. One factor limiting excess oil production capacity is recent steep increases in world consumption of oil. Together, the United States and Western Europe accounted for 44 percent of the 80 million barrels of oil per day of world oil consumption in 2003.11 The United States is the world‘s largest oil consumer, accounting for about 25 percent of the world‘s oil consumption, despite having only 5 percent of the world‘s population. In addition to the high levels of consumption in the United States and Western Europe, oil consumption has also been rising rapidly in Asia and Oceania, as shown in figure 4. For example, according to a recent study by the International Monetary Fund, China and India accounted for 35 percent of incremental oil consumption between 1993 and 2003, even though they accounted for only 15 percent of world economic output over the period.12 China has overtaken Japan as the second largest oil consumer in the world, second to the United States. Since 1976, the United States has spent about $26.3 billion—$45.2 billion when valued in year 2005 dollars—to build, maintain, fill, and manage the SPR. The largest cost has been the cost of filling the reserve. Since filling began in 1977, $20.0 billion has been spent to obtain oil ($35.1 billion in 2005 dollars).13 This amount includes $15.7 billion of oil purchased with funds appropriated from 1977 through 1992, and $4.3 billion of oil received in lieu of government royalty payments since 1999. Since 1999, oil for the SPR has been obtained through the royalty-in-kind transfer program, in which royalties from government oil leases in the Gulf of Mexico are taken in the form of oil, rather than in cash. The Department of the Interior‘s Minerals Management Service, which collects the royalties, contracts for delivery of the royalty oil to designated market centers. Because the oil delivered to these market centers often does not meet SPR quality specifications and is distant from the SPR storage sites, DOE awards complementary contracts to exchange royalty oil at the market center for SPRquality oil delivered to the SPR facilities. However, the logistics of Gulf of Mexico oil production from federal leases limits the rate at which royalty oil can be economically delivered to the SPR sites.

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Source: GAO analysis of EIA data. Figure 4. World Oil Consumption, by Region

The SPR oil is stored in salt caverns at the following four facilities: Bayou Choctaw and West Hackberry in Louisiana, and Big Hill and Bryan Mound in Texas. These caverns range in size from 6 million to 35 million barrels and were created by solution mining, in which water injected into an underground salt formation dissolves the salt and creates a cavern. According to DOE, salt caverns offer the lowest cost, most environmentally secure way to store crude oil for long periods of time. Storing oil in aboveground tanks generally costs 5 to 10 times as much. Also, because the salt caverns are 2,000 to 4,000 feet below the surface, geologic pressure will seal any crack that develops in the salt formation, ensuring that no crude oil leaks from the cavern. An additional benefit is the natural temperature difference between the top of the caverns and the bottom, which keeps the crude oil continuously circulating in the caverns, ensuring that the oil in the cavern is of consistent quality. Areas near the Gulf of Mexico were a logical choice for locating the SPR. In addition to the more than 500 salt domes concentrated along the Gulf Coast, many U.S. refineries and distribution points for tankers, barges, and pipelines are available. The four SPR storage areas are connected via pipelines to the Gulf Coast and the Midwest refining regions. Oil can be transferred via tanker to the Louisiana Offshore Oil Port, which is a major facility in the Gulf of

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Mexico that is connected via pipeline to over 50 percent of the United States refining capacity. The location of the SPR is less advantageous for distributing oil to or receiving it from the western United States. Past drawdowns of the SPR have occurred for a wide variety of reasons. The SPR has sold oil twice under emergency conditions, 17.3 million barrels in 1991 at the beginning of Operation Desert Storm and 11.0 million barrels in 2005 after Hurricane Katrina. In response to problems ranging from a blocked pipeline to a potential shortage of commercial heating oil stocks, exchanges of crude oil from the SPR with private companies have occurred eight times, ranging in size from 500,000 barrels to 30 million barrels. The largest exchange occurred in the fall of 2000 in response to concerns about low inventories of heating oil in the Northeast. In these exchanges, the borrowing parties returned the amount of oil borrowed plus additional volumes of oil as interest. In two cases, conducted for operational reasons, the SPR exchanged 11.0 million barrels of lower quality oil for 8.5 million barrels of higher quality oil and 2.7 million barrels of crude oil for 2.0 million barrels of heating oil. DOE has also conducted two test sales to demonstrate the readiness of the SPR, in 1985 and 1990. In addition, sales to reduce the federal deficit occurred mainly in 1996.

BASED ON HISTORICAL EXPERIENCE, EXPERTS SUGGESTED ALTERNATIVE PRACTICES FOR SPR FILL AND POINTS TO CONSIDER FOR USE Recent concerns about filling the SPR and long-standing concerns about its use can be addressed in ways that improve SPR effectiveness, according to numerous energy and oil market experts. A number of persons have raised questions because they believe that recent efforts to fill the SPR during tight oil supply conditions put upward pressure on oil prices. Others have expressed concerns that the SPR has not been used in disruptions where its use was warranted and, when used, has not been used early enough after a disruption has occurred. In addressing these concerns, experts with whom we spoke suggested alternative practices to consider when filling the SPR to reduce fill costs, as well as various points to consider when deciding whether to use the SPR.

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Experts Suggested Practices to Reduce the Cost of Filling the SPR While early SPR fill activity focused on establishing an oil reserve large enough to be useful during a supply disruption, more recent fill activity has focused on maximizing long-term protection against disruptions. Although several oil analysts and experts believe that filling the SPR from late 2001 through 2005 during a time of tight supply and demand conditions caused the price of oil to increase by several dollars per barrel, most of the experts with whom we spoke believe that filling the SPR at that time had minimal impact on oil prices because the volume was so small compared with world oil demand. Experts suggested SPR fill practices that could reduce the cost of filling the SPR. They recommended that DOE acquire a fixed dollar value of oil per time period, rather than a fixed volume of oil per time period, and allow industry more flexibility in the timing of oil deliveries to the SPR.

Early Fill Activity Was Generally Focused on Making the SPR Large Enough to Respond to Disruptions Prior to 1984, several pieces of legislation set forth minimum fill rates for the SPR, in an effort to increase the volume of the reserve to a level large enough to be useful during an oil supply disruption. However, the actual rate of fill often fell short of these goals. Several studies completed around this time reported that, given the SPR‘s small size, it should be reserved for severe disruptions since it is a one-time source of crude oil, which must be replenished after a drawdown. They advised that only after the SPR contained a minimum of 250 million to 500 million barrels of oil would it be advisable to use it. In a September 1981 report, we echoed this concern, believing that DOE should not suspend SPR fill, except during severe disruptions, until the SPR reached a minimum threshold size.14 Furthermore, we stated that, given the importance of the SPR, filling it should be considered a part of U.S. base demand and should not be cut back under tight market conditions. Figure 5 shows the progress in filling the SPR since its inception in 1975. Fill was suspended from September 1979 to September 1980 when oil supplies were disrupted following the Iranian Revolution. The SPR reached a volume of about 500 million barrels in 1985, and filling the reserve slowed considerably after that time. SPR fill was again suspended in 1990 after the Iraqi invasion of Kuwait. The size of the SPR did not significantly increase again until after the September 11 terrorist attacks, when the President ordered DOE to fill the SPR to its 700 million barrel capacity to maximize the long-

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term protection against potential oil supply disruptions.15 The President‘s statement accompanying the fill order indicated that, although current strategic inventories in the United States and other countries were sufficient to meet any potential near-term supply disruption, filling the SPR to capacity would strengthen the long-term energy security of the United States. The President directed that the SPR be filled in a deliberate and cost-effective manner, principally through royalty-in-kind transfers. From April 2002 to August 2005, DOE added 138 million barrels to the SPR at a cost of $4.3 billion.16 The SPR received oil from the royalty-in-kind program at average rates varying from about 60,000 to 116,000 barrels per day, although fill was suspended twice during this period, including January to April 2003 in response to the disruption of crude oil supplies from Venezuela.

Experts Generally Agreed That Recent SPR Acquisitions Caused Minimal Increase in Oil Prices, and Suggested Practices to Reduce the Future Cost of SPR Fill The President‘s directive to fill SPR in 2001 became controversial. Several oil analysts and experts believe that filling the reserve at that time caused the world price of oil to increase by several dollars per barrel. Most of the oil experts with whom we spoke, however, believe that filling the SPR had minimal impact on oil prices, because the volume of oil going to the SPR was very small, less than one-quarter of 1 percent of total world demand. To decrease the cost of filling the SPR, many experts recommend changes in SPR practices, including more flexible timing of oil acquisition. Generally, all fill options must balance the cost of adding oil to the SPR now against the benefits that the additional oil will provide in the future. During the initial filling of the SPR, it was clear that the benefits of adding oil outweighed the immediate costs of doing so. However, now that the SPR holds nearly 700 million barrels of oil, there is a greater interest in finding ways to reduce the acquisition costs.

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Source: GAO analysis of EIA data. Note: Congress authorized the SPR in 1975, but filling the reserve did not begin until 1977. Figure 5. SPR Inventory Over Time

Several experts suggested that DOE should use a predictable, transparent long-term process to acquire oil for the SPR. For example, some experts suggested a dollar-cost-averaging approach, where DOE would acquire a steady dollar value of oil per time period (e.g., day or month) instead of a relatively steady volume, as has generally been the case in recent years. A dollar-cost-averaging approach would take advantage of fluctuations in oil prices, since the same dollar amount will purchase more oil when prices are low than when prices are high. To evaluate the effect of a dollar-costaveraging approach on SPR fill cost, we estimated the potential savings of this approach had it been used from October 2001 through August 2005. Our results showed that if DOE had followed a dollar-cost-averaging approach when filling the SPR during that time, it could have saved approximately $590 million while acquiring the same amount of oil. We also ran simulations to estimate potential future cost savings from using a dollar-cost-averaging approach over 5 years. The simulations showed that dollar cost averaging is likely to save money over a range of plausible paths of future oil prices, whether prices are rising or falling and whether price volatility is small or large. The savings due to dollar cost averaging were generally greater when oil prices were more volatile. As an additional measure, some experts suggested that DOE exercise flexibility and react to market conditions when filling the SPR. They said that DOE should not fill the SPR when the oil market is tight or when doing so would significantly tighten the market. DOE officials told us that the department has approved some delivery deferrals that contractors have

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requested, in particular after the oil workers‘ strike in Venezuela, but DOE has also turned down some requests. In return for these deferrals, DOE received additional barrels of oil as a premium. From October 2001 through August 2005, payment for deferrals added 4.6 million barrels of oil to the SPR, with a value of approximately $110 million. Some experts suggested that DOE could expand the use of deferrals by allowing oil producers to delay oil delivery to the SPR when they believe that supply and demand are in tight balance and current prices are higher than expected future prices.17 Under these conditions, it is financially advantageous for oil producers to delay delivery, and producers could provide additional oil to the SPR to pay for the privilege of delaying delivery. Experts noted that there may be considerations beyond the oil market, such as national security concerns, that would necessitate the delivery of oil to the SPR at a particular time, therefore, DOE would want to exercise its authority to disallow deferrals at times when it is in the national interest that oil deliveries not be delayed.

Experts Suggested Several Points to Consider When Deciding on SPR Use The law allows broad presidential discretion and provides only general guidance for the SPR‘s use, making use of the SPR a matter of judgment by the President. SPR use decisions are largely a matter of judgment, and members of our group of experts disagreed about the appropriateness of past use decisions. Past drawdowns have been for widely varying purposes, including emergency responses, test sales, and deficit reduction. In addressing use-related issues, experts suggested several points to consider when deciding whether to use the SPR.

SPR Legislation Allows Broad Presidential Discretion The President has the primary authority to decide when to use the SPR. The Energy Policy and Conservation Act authorizes the President to use the SPR in the event of a severe energy supply disruption or when required to meet the obligations of the United States to the International Energy Agency.18 Amendments to this act in 1990 gave the President additional authority to use the SPR in reaction to a circumstance that constitutes or is likely to become a significant shortage, and where action taken would assist in preventing or reducing the adverse impact and would not impair national security. These

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 53 amendments allow for only limited use of the SPR—no more than 30 million barrels may be sold over 60 days, and no sales may be made if the SPR is below 500 million barrels. In addition to presidential authority, the Secretary of Energy is authorized to carry out test drawdowns and sales or exchanges from the SPR to evaluate the drawdown and sale procedures. The Secretary may not release more than 5 million barrels of oil during such a test. DOE officials pointed out that they follow a series of progressive steps in responding to a disruption. They can (1) identify relevant inventories and evaluate market impacts (with the help of EIA); (2) defer any ongoing deliveries to the SPR, thereby making this oil available to the market; (3) make exchanges in response to requests from individual companies facing problems; and (4) arrange for competitive exchanges, whereby companies bid for oil from the SPR by promising to replace it with a greater volume of oil at a specified date in the future. DOE officials believe that this graduated approach allows them a flexible and measured response appropriate to the size of the disruption. While the President‘s discretion over the release of oil introduces some uncertainty into the market, it also has certain advantages. Members of our group of experts told us that uncertainty around SPR use can be valuable. For example, the President can use the SPR as a bargaining tool in diplomatic negotiations during energy crises, enabling him to encourage behavior by oilproducing nations that could be beneficial to the United States.

Members of our Expert Group Disagreed about Past SPR Use Decisions Members of our group of experts disagreed about the appropriateness of past SPR use decisions. Since the decision about whether the SPR should be used to ameliorate a situation is generally a matter of judgment, experts tend to view past decisions from the perspective of hindsight. For example, several members of our group told us that they believed the oil workers‘ strike in Venezuela in 2002 to 2003 was a clear case in which SPR use was appropriate, although the reserve was not used in response to the strike. However, DOE officials stated that oil from the SPR was not needed during the strike. They noted that other oil-producing nations had agreed to increase production, and that the U.S. government allowed oil companies to delay delivery of oil to the SPR—which together added significant quantities of oil to the market. Members of our group of experts held a range of views about the timeliness of past use, including the SPR‘s first emergency use during the Gulf War in 1991. While some said that reserve use in this instance was timely and showed the market that supply would be available, others contended that the

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United States did not use the SPR soon enough, when it could have dampened oil price increases and prevented the U.S. economy from slipping into a recession. However, these experts acknowledged the difficulty of disentangling the effects of the war from the effects of the SPR release on oil prices. Group members were generally supportive of SPR use in response to Hurricane Katrina in 2005. Several experts agreed that this use of SPR demonstrated that the government understood its role as one of complementing rather than competing with the market.

Experts Suggested Several Points to Consider When Making Decisions about SPR Use Despite the lack of clear consensus regarding previous decisions to use the SPR, experts in our group suggested several points that policymakers should consider when deciding whether to use the SPR: (1) that recent increases in the size of the SPR should result in a greater willingness to use it during a disruption, (2) that more extensive experience with the SPR during oil supply disruptions may enable better understanding of the features of each disruption that determine whether SPR use is warranted, and (3) that using the SPR without delay when it is needed will minimize economic damage. DOE officials told us that, while they do not have a formal checklist, they consider all relevant features when considering SPR use during a disruption, including the features noted by our group of experts. First, experts in our group and in interviews noted that the SPR is much larger today than in the past, and that this change allows the SPR to be used with less concern about keeping enough oil in the reserve for future disruptions. Members of our expert group pointed out that today‘s larger reserve diminishes the value of holding oil back during a disruption as a hedge against possible future disruptions, and they noted greater willingness to use reserves in response to disruptions now than in the past. Second, more extensive experience with the SPR during past disruptions may enable better understanding of the unique features of future oil disruptions that warrant a release of oil from the SPR. In a 1993 report,19 we stated that U.S. policy emphasized initially relying on free market forces in oil supply disruptions. However, the report observed that this policy provides little specific guidance on how long market forces should be allowed to operate before the SPR is used or what conditions should dictate its use. Experts in our group agreed that the SPR should be used to supply oil during disruptions where the market cannot make up for lost supply. Experts also

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 55 identified a variety of specific features of disruptions that could help determine when SPR use is warranted. These features included the volume of oil disrupted, the type of oil disrupted, the availability of spare oil production capacity, the source of the disruption and its distance from the United States, and the time of year that the disruption occurs (with implications for gasoline supplies in the summer and heating oil in the winter). Economic experts have described additional points to consider when making decisions about using the SPR during a disruption. Experts noted that not all oil price increases are equally damaging to the economy. Economic research shows that rapid oil price increases, or price shocks, are much more harmful to the economy than oil price increases along a steady upward path. For example, one expert noted that although average world crude oil prices increased by more than $30 per barrel between 2001 and 2005, there was no price shock, and the U.S. economy remained strong, growing at about 3.5 percent annually during this period. Under some conditions, decision makers could use monetary policy to partially offset economic damage from an oil price shock. The Federal Reserve might be able to prevent some economic damage by allowing a one-time increase in the money supply to stimulate spending and spur GDP growth. However, not all economists agree that monetary policy would be effective, or that monetary policy could offset the impacts of a disruption without having other negative impacts on the economy. Third, avoiding delay in using the SPR when its use is warranted will minimize economic damage. Expert group members encouraged early use of the SPR as a first line of defense against oil supply disruptions, noting that recent changes in the oil industry—including diminished spare crude oil production capacity, refining capacity, and product inventories—have removed sources of supply security that have covered short-term supply losses in the past. Additionally, some experts believe that much of the harm to the U.S. economy occurs in the early phases of a disruption, before the economy has a chance to adjust to higher prices. Avoiding delay in SPR use is also important because even when spare production capacity is available in the world to take the place of disrupted oil supply, this oil will take time to reach the United States. EIA estimates that the majority of the world‘s spare oil production capacity is located in Saudi Arabia

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and takes about 30 to 40 days to reach the United States. For this reason, experts told us that spare capacity would be unlikely to mitigate the early stages of a domestic disruption or a disruption affecting a nearby oil supplier, such as Venezuela, whose oil takes about 5 to 7 days to reach the Gulf Coast of the United States.

SPR USE DURING DISRUPTIONS CAN PROVIDE SUBSTANTIAL BENEFITS, BUT THE MAGNITUDE OF THESE BENEFITS IS UNCERTAIN At their current capacities, the SPR and international reserves can replace the oil lost in all but the most catastrophic disruptions. Doing so protects the economy from significant damage, according to the results of two DOE models, although these models disagree about the magnitude of the avoided damage. Additionally, several factors beyond the SPR‘s ability to replace oil could decrease or increase the economic benefit of the reserve, such as the compatibility of SPR oil with some U.S. refineries.

SPR and International Reserves at Their Current Size Can Replace the Oil Lost in All but the Most Catastrophic Disruptions In June 2006, the SPR contained 689 million barrels of oil that can be released at a maximum initial rate of 4.4 million barrels a day, a rate that can replace about 44 percent of U.S. oil imports. As shown in figure 6, the maximum drawdown rate gradually decreases after 90 days as the storage caverns are emptied. If the SPR is drawn down more slowly, it could release a million barrels of oil per day for nearly 1½ years, or at smaller rates for an even longer period. In addition to the reserves in the United States, members of the International Energy Agency have about 2.7 billion barrels of public and industry reserves, of which about 700 million barrels are governmentcontrolled for emergency purposes.20 These government-controlled reserves can release a maximum of about 8.5 million barrels of oil and petroleum products per day, diminishing quickly to about 4.5 million barrels per day after 30 days, about 3.5 million barrels per day after 60 days, and slightly more than

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 57 1 million barrels per day after 90 days. Reserves of refined petroleum products, such as gasoline or diesel, can be useful during oil supply disruptions, but they are more expensive to store than crude oil.21 We did not independently verify the potential drawdown rates of international reserves.

Source: DOE‘s Office of Petroleum Reserves. Figure 6. SPR Maximum Drawdown Capability

The SPR, either alone or in combination with these international reserves, can replace the oil lost in four of the six hypothetical disruption scenarios that we developed for this review. The six scenarios are (1) a hurricane in the U.S. Gulf Coast, (2) a strike among oil workers in Venezuela, (3) an embargo of Iranian oil supply, (4) a terrorism event at an oil facility in Saudi Arabia, (5) closure of the Strait of Hormuz, and (6) a shutdown of Saudi Arabian oil production. For each scenario, we assume that world excess crude oil production capacity and world fuel-switching capabilities, which together total 850,000 barrels per day, are available immediately to help offset a

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disruption.22 We also assume that private inventories of crude oil are neutral during a disruption—holders of private inventory neither draw down their inventories nor hoard oil. (See app. II for a more detailed description of our scenarios.) Table 1. Ability of the SPR and International Reserves to Replace Barrels in millions

Disruption size

Excess capacity and fuel switching

Can replace oil?

Volume of release

Can replace oil?

Volume of release

Gulf Coast hurricane Venezuelan strike Iran embargo Saudi terrorism Strait of Hormuz closure Saudi shutdown

Disruption Length (months)

Hypothetical oil supply disruption scenario

Release from the Release from the SPR SPR alone and international reserves

6

155

131

Yes

24

Yes

24

5

307

220

Yes

87

Yes

87

18 8 3

1,478 882 882

465 207 78

No No No

684 650 344

Yes Yes No

1,013 675 688

24

6,205

620

No

684

No

1,461

Source: GAO assumptions and analysis of data from Leiby, Paul N. and David W. Bowman, ―Disruption Scenarios and the Avoided Costs Due to SPR Use,‖ Oak Ridge National Laboratory Working Paper (Jan. 19, 2006).

As shown in table 1, the SPR is large enough and has enough drawdown capacity to completely replace the oil lost during our Gulf Coast hurricane and Venezuelan strike scenarios, which reduce world oil supply by 155 million barrels over 6 months and 307 million barrels of oil over 24 months, respectively. The SPR could eliminate these hypothetical disruptions by releasing 24 million and 87 million barrels of oil, respectively, and world spare capacity and fuel switching would make up the remaining 131 million and 220 million barrels. The SPR alone is not large enough to replace all of the oil lost in our Iranian embargo scenario, and it does not have enough drawdown capacity to completely replace the oil lost during our Saudi terrorism scenario. Our Iranian embargo scenario assumes a disruption of almost 1.5 billion barrels of oil over

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 59 18 months. Even if the United States were to release all of the oil in the SPR and if excess production capacity and fuel switching were available in the amount assumed here, there would still be a net disruption of slightly more than 300 million barrels. In our Saudi terrorism scenario, the drawdown capacity of the SPR would be insufficient to replace the oil lost during the 1st month of the disruption. For the SPR to replace the oil during the 1st month with no assistance from international reserves, maximum SPR drawdown capacity would need to be increased by almost 1 million barrels per day, to a total drawdown capacity of approximately 5.2 million barrels per day. In both of these cases, however, a coordinated international response could replace all of the disrupted oil. Even with a coordinated response, the SPR and international oil reserves are not adequate to replace the disrupted oil from our catastrophic Strait of Hormuz closure and Saudi shutdown scenarios. The drawdown capacity of international reserves is inadequate to replace the very large amount of oil that could be disrupted if the Strait of Hormuz were closed. We assume that a closure of the Strait of Hormuz could disrupt 17 million barrels of oil per day during the 1st month—more than 12 million barrels per day beyond what the SPR could release on its own and more than 4 million barrels per day beyond what could be released during a coordinated international response. In contrast, the volume of oil in international reserves is inadequate to replace the oil lost during our Saudi shutdown scenario. Even if all of the oil in the SPR were used in a unilateral response, the net disruption would still be more than 4.9 billion barrels over 2 years, an amount equal to about 16 percent of the crude oil consumed in the world in 2004. Assuming a coordinated international response, the net disruption would still be over 4.1 billion barrels over 2 years, an amount equal to more than 13 percent of the crude oil consumed in the world in 2004.

SPR Use during Disruptions Can Prevent Substantial Economic Damage The SPR can reduce economic damage during oil supply disruptions by replacing some or all of the disrupted oil, moderating the resulting oil price increase and its negative effect on U.S. economic activity, as measured by GDP. As previously noted, DOE uses two different economic models to estimate the impact of oil supply disruptions on oil prices and GDP: one used by the Office of Petroleum Reserves and one used by EIA. We used both of

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these models to estimate the reduction in economic damage (avoided damage) that could result from releasing oil from the SPR and international reserves during our six hypothetical disruption scenarios. (See app. II for additional description of these models and the assumptions used in our analysis.) Table 2 shows the oil price increases that the Office of Petroleum Reserves‘ model estimates for our six disruption scenarios if reserves were not used, if the SPR were used alone, and if the SPR were used as part of a coordinated international response. This model estimates oil prices each month during a disruption and assumes that completely replacing the oil lost in a disruption eliminates the resulting price increase. Thus, this model predicts no price increase in situations where the SPR or international reserves can completely replace the disrupted oil, although experts told us that a price increase would likely occur in this instance due to market psychology. For those scenarios where some, but not all, of the oil can be replaced, the model estimates smaller oil price increases than if reserves were not used. For example, the model estimates that oil prices could rise by up to $47 per barrel during our Saudi terrorism scenario if reserves were not used.23 However, if SPR oil were released into the market, the estimated maximum price increase would be only $7 per barrel. If oil from international reserves were also released into the market, the model estimates there would be no price increase, because the reserve oil would completely replace the disrupted oil. To estimate how much economic damage could be avoided by using the SPR and international reserves during our oil supply disruption scenarios, we first estimated the damage that would occur if no reserves were used. We then estimated the damage to GDP, if any, from the disruptions if the SPR were used, either alone or in conjunction with international reserves. The difference between the estimates with and without reserve use is the avoided damage to GDP resulting from use of the reserve. As shown in table 3, the Office of Petroleum Reserves‘ model estimates that the ability of the SPR alone to curb rising oil prices reduces damage to GDP by a range of $7 billion for our 6month Gulf Coast hurricane scenario to $142 billion for our 8-month Saudi terrorism scenario. In all but the two smallest scenarios, the model shows that a coordinated international response can provide a greater reduction in damage, ranging from $118 billion for the 3-month closure of the Strait of Hormuz to $201 billion for our 18-month Iranian embargo scenario. In our 24month Saudi shutdown scenario, the model shows that economic damage of approximately $62 billion occurs even if international reserves were used in response to the disruption.

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 61 Table 2. Maximum Monthly Increases in Oil Price, According to the Office of Petroleum Reserves’ Model

Dollars per barrel Maximum monthly oil price increase Hypothetical oil supply disruption scenarios Gulf Coast hurricane Venezuelan strike Iranian embargo Saudi terrorism Strait of Hormuz closurea Saudi shutdown

No release

SPR release

$5 11 16 47 175

$0 0 5 7 121

SPR and international release $0 0 0 0 34

89

77

63

Source: GAO analysis of data from Leiby, Paul N. and David W. Bowman, ―Disruption Scenarios and the Avoided Costs Due to SPR Use,‖ Oak Ridge National Laboratory Working Paper (Jan. 19, 2006). Note: For each scenario, we assume that world excess crude oil production capacity and world fuel-switching capabilities, which together total 850,000 barrels per day, are available immediately to help offset a disruption. a This model shows a very large maximum oil price increase in the 1st month of the Strait of Hormuz closure because the disruption volume in this month is the largest of any of the scenarios, even though the volume of the disruption as a whole is smaller.

The damage caused by each disruption and the portion of that damage that can be avoided by releasing reserves depend on the nature of the disruption. For example, the SPR and international reserves cannot eliminate all of the economic damage that could be caused by our Strait of Hormuz closure scenario because, even though the duration is short, it involves a disruption of a very large quantity of oil that the reserves cannot replace. Additionally, the models show that replacement of a portion of the oil lost in the Saudi Arabian shutdown scenario results in less benefit to the economy than completely replacing the oil lost in the smaller Iranian embargo scenario.

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Table 3. Ability of the SPR and International Reserves to Reduce Damage to GDP, According to the Office of Petroleum Reserves’ Model Dollars in billions

Hypothetical oil supply disruption scenarios Gulf Coast hurricane Venezuelan strike Iranian embargo Saudi terrorism Strait of Hormuz closure Saudi shutdown

GDP damage caused by disruption $7

GDP damage that can be eliminated by reserves SPR SPR and alone international reserves $7 $7

23 201 149 146

23 132 142 56

23 201 149 118

832

77

170

Source: GAO analysis of data from Leiby, Paul N. and David W. Bowman, ―Disruption Scenarios and the Avoided Costs Due to SPR Use,‖ Oak Ridge National Laboratory Working Paper (Jan. 19, 2006) Note: For each scenario, we assume that world excess crude oil production capacity and world fuel- switching capabilities, which together total 850,000 barrels per day, are available immediately to help offset a disruption.

The way in which oil is released from the reserves also impacts how effective the reserves are in preventing damage to GDP. In each scenario, the results previously described include the assumption that release begins immediately and occurs at a steady rate for the entire length of the disruption. The results also include the assumption that the rate of release either completely replaces the oil lost or is the maximum sustainable rate for the entire disruption. Delaying the release of reserves in response to a disruption is harmful in every scenario, and the harm is greater the longer release is delayed. This effect is particularly large in scenarios where more oil is lost at the beginning of the disruption, such as the closure of the Strait of Hormuz or the Saudi terrorism scenarios. Replacing the oil lost during the disruption at the maximum rate possible instead of a steady rate gives a different result only in our largest disruption scenario, the Saudi shutdown. The maximum release strategy is advantageous in this scenario because the model assumes that the economic damage from the disruption is worse at the beginning, before the

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 63 economy has had a chance to adjust. Since international reserves are emptied to respond to this scenario, releasing more oil at the beginning provides more benefit than releasing at a steady rate. Table 4. Maximum Quarterly Increases in Oil Price, According to the EIA Model Dollars per barrel Hypothetical oil supply disruption scenarios Gulf Coast hurricane Venezuelan strike Iranian embargo Saudi terrorism Strait of Hormuz closure Saudi shutdown

Maximum quarterly oil price increase No release SPR SPR and release international release $1 - $2 $0 $0 9 - 13 19 - 28 39 - 67 54 - 82

0-2 11 - 17 18 - 39 32 - 52

0-2 6 - 11 15 - 35 11 - 24

66 - 104

60 - 96

54 - 87

Source: GAO analysis using the EIA model. Note: For each scenario, we assume that world excess crude oil production capacity and world fuel-switching capabilities, which together total 850,000 barrels per day, are available immediately to help offset a disruption. Oil price increases are modeled for each quarter of the disruption, rather than each month as in the previous model, meaning that the price increases are not directly comparable.

Table 4 shows the oil price increases that the EIA model estimates for our six oil supply disruption scenarios for the same three circumstances described for the Office of Petroleum Reserves‘ model: if reserves were not used, if the SPR were used alone, and if the SPR were used as part of a coordinated international response. The EIA model estimates a range of price impacts for each quarter of the disruption, rather than a single value for each month as in the Office of Petroleum Reserves‘ model. Both models consider the amount of oil disrupted when calculating oil price increases, but the EIA model also estimates the impact of the disruption on market psychology. For example, an EIA official stated that disruptions caused by violent events would have larger price impacts than disruptions caused by peaceful events, such as a strike or natural disaster. Furthermore, the EIA model assumes that even if reserves can

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replace all of the oil lost in a disruption, oil prices may still increase because of‗ market psychology. For these reasons, in some cases, the EIA model predicts larger price increases when reserves are used than the Office of Petroleum Reserves‘ model. For example, for the Saudi terrorism scenario, the EIA model predicts a price increase of $18 to $39 if the SPR were used alone (see table 4), while the Office of Petroleum Reserves‘ model predicts a maximum price increase of only $7 (see table 2). Table 5. Ability of the SPR and International Reserves to Reduce Damage to GDP, According to the EIA Model Dollars in billions

Hypothetical oil supply disruption scenarios Gulf Coast hurricane Venezuelan strike Iranian embargo Saudi terrorism Strait of Hormuz closure Saudi shutdown

Damage that can be eliminated by reserves SPR alone SPR and GDP damage international caused by reserves disruption $0.4 - $1.0 $0.4 - $1.0 $0.4 - $1.0 2.6 - 7.5 2.6 - 6.3 2.6 - 6.3 34 - 99 15 - 38 23 - 60 21 - 71 13 - 34 15 - 38 16 - 48 6.9 - 17 13 - 34 137 - 442

11 - 31

24 - 66

Source: GAO analysis using the EIA model. Note: For each scenario, we assume that world excess crude oil production capacity and world fuel-switching capabilities, which together total 850,000 barrels per day, are available immediately to help offset a disruption.

As shown in table 5, the EIA model estimates that the ability of the SPR alone to mitigate increases in oil prices reduces damage to GDP by $0.4 billion to $1.0 billion for our Gulf Coast hurricane scenario up to $15 billion to $38 billion for our Iranian embargo scenario. As with the Office of Petroleum Reserves‘ model, the EIA model also shows that a coordinated international response reduces more economic harm in each scenario, except those where the SPR can replace the oil alone. As it does with oil price increases, the EIA model estimates a range of GDP damage for each scenario, rather than the single value that the Office of Petroleum Reserves‘ model produces.

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 65

DOE Models Yield Significantly Different Estimates of the Economic Damage Avoided by Using the SPR Under every scenario, the EIA model predicts much smaller avoided harm to GDP than the Office of Petroleum Reserves‘ model. For example, in the Iranian embargo scenario, the Office of Petroleum Reserves‘ model estimates that using international reserves could prevent $201 billion in economic harm, while the EIA Model predicts $23 billion to $60 billion in avoided harm. This difference occurs primarily because the EIA model assumes that oil price increases cause less harm to GDP, meaning that there is less economic harm for the SPR and other reserves to mitigate. The estimates of the effect of oil price spikes on GDP from the Office of Petroleum Reserves and EIA models are, respectively, near the high end and low end of the spectrum of such estimates in the economic literature. Officials from the Office of Petroleum Reserves and EIA acknowledged that they hold different views about how oil supply disruptions impact the economy. An EIA official also told us that EIA is currently updating its model, although the assumptions about how oil price changes impact GDP have not changed substantially.24 This discrepancy in results between the two models is potentially problematic because the results of the two models are used to support different decisions about the SPR. The Office of Petroleum Reserves‘ model has been used to estimate the net benefits of expanding the SPR, as described in the following section of this report. The larger economic impacts predicted by the Office of Petroleum Reserves‘ model would justify a larger SPR than if the model predicted smaller economic impacts. The EIA model is used to estimate the impact of oil supply disruptions and to advise officials about their potential consequences. The smaller economic impacts predicted by the EIA model could lead to recommendations that the SPR not be used as often or for as many oil supply disruptions as would be the case if the model found larger economic impacts. The results of these two models pull decision makers in opposite directions, making it important to clarify the differences between the two models and to ensure that policymakers are aware of the different views within DOE.

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OTHER FACTORS, IN ADDITION TO THE SPR’S ABILITY TO REPLACE OIL, MAY AFFECT THE EXTENT TO WHICH THE SPR CAN PROTECT THE U.S. ECONOMY FROM DAMAGE The purpose of the SPR is to protect the economy from harm during oil supply disruptions by replacing the disrupted oil. However, factors beyond the amount of oil that SPR can replace affect the extent to which SPR can protect the U.S. economy from damage. For example, during some situations, such as a hurricane, typical transportation routes for oil could be blocked, reducing the benefits of releasing SPR oil. Also, the benefits of releasing SPR oil could also diminish if the type of oil in the SPR is not a good substitute for the disrupted oil, or if refining capacity is damaged. On the other hand, the SPR can provide economic benefits to the United States when it is used as a tool for diplomacy and as a deterrent against intentional disruptions, even when no oil is released.

Transport of Oil to Refineries May Be Difficult during Some Disruptions During a drawdown, SPR oil is shipped through marine terminals or pipelines. Shipping time from the SPR to different parts of the country varies, as shown in table 6. The oil pipeline network and marine shipping allow SPR oil to reach every region of the United States, except for the Rocky Mountains. Canada provides the only imported oil to the Rocky Mountain region, and DOE believes that a disruption of Canadian oil is unlikely.25 The ability of the SPR to reduce economic damage may be impaired if transport of oil to refineries is delayed. For example, the SPR was large enough to replace the oil lost from recent Hurricanes Katrina and Rita, but petroleum product prices still increased dramatically following the hurricanes, in part because power outages shut down pipelines that refineries depend upon to supply their crude oil and to transport their refined petroleum products to consumers. For example, Colonial Pipeline, which transports petroleum products to the Southeast and much of the East Coast, was not fully operational for a week after Hurricane Katrina. Consequently, short-term gasoline shortages occurred in some places, and the media reported gasoline prices greater than $5 per gallon in Georgia.

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 67

SPR Oil Is Not Fully Compatible with Some Refineries The crude oils stored in the SPR are compatible with many refineries in the United States. However, some U.S. refineries process crude oils heavier than those stored in the SPR. Of the 8.3 million barrels of non-Canadian oil imported into the United States per day in 2004, 3.5 million barrels, or about 40 percent, were heavy oil.26 Refineries that process heavy oil may have difficulty operating at normal capacity if their supply of heavy oil is disrupted. A December 2005 DOE report identified 74 refineries that are connected to the SPR that receive non-Canadian imports of oil, and the report found that the types of oil currently stored in the SPR would not be fully compatible with 36 of those refineries, or slightly less than 50 percent.27, 28 DOE estimated that if these refineries had to use SPR oil, U.S. refining throughput would decrease by 735,000 barrels per day, or 5 percent. DOE estimated that production of distillate fuels, such as diesel and jet fuel, would decrease substantially from heavy oil refineries, but DOE estimated that production of gasoline would increase. Table 6. Consumption of Imported Oil and Shipping Time for SPR Oil to Various Regions Regiona 1 - East Coast 2 - Midwest 3 - Gulf Coast 4 - Rocky Mountain 5 - West Coast

2004 crude oil imports (millions of barrels per day)b 1,370 519 5,445 0 864

Days to reach region 6-8 5-9 <1 N/A 16 - 18

Source: GAO analysis of DOE data. a DOE divides the United States into five Petroleum Administration for Defense Districts for planning purposes. The result is a geographic aggregation of the 50 states and the District of Columbia into five districts. b This table does not include data on imports from Canada.

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, DOE may have underestimated how much heavy oil should be in the SPR to maximize compatibility with refiners and minimize oil acquisition cost. First, DOE determined the least amount of heavy oil that could be added to improve the compatibility of the SPR oil inventory with

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U.S. refineries. However, because heavy oil is less expensive to purchase than the lighter oils currently stored in the SPR, a cost-benefit analysis may show that a larger amount of heavy oil is beneficial, while still maintaining compatibility with U.S. refining capacity.29 Second, the DOE report 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 they used only SPR oil. For example, an official from one refinery stated that if it used solely SPR oil in its heavy crude unit, it would produce 11 percent less gasoline and 35 percent less diesel. Representatives from other refineries said that they might need to shut down portions of their facilities if they could not obtain heavy oil. A refining industry expert explained that a reduction in gasoline production would likely occur when some heavy oil refineries processed light oil, because the light oil would not provide enough feed to units designed to convert heavier products into gasoline.

Releasing Oil from the SPR Is Less Helpful If U.S. Refining Capacity Is Damaged In addition to disrupting crude oil supplies, disasters such as hurricanes and terrorist acts can disrupt supplies of petroleum products by damaging refineries. Crude oil must be processed in refineries to be useful. Following Hurricanes Katrina and Rita, nearly 30 percent of the refining capacity in the United States was shut down, disrupting supplies of gasoline and other products. Because the SPR contains only crude oil, it cannot replace petroleum products if a disruption in refining occurs. However, some countries in the International Energy Agency hold petroleum products in their reserves, and they released these products after Hurricanes Katrina and Rita. DOE reported that these releases of petroleum products helped reduce prices for gasoline and diesel after the hurricanes.

SPR Can Provide Benefits to the U.S. Economy Without Releasing Oil Several members of our group of experts and other experts noted that the SPR has value to the United States economy in addition to physically replacing oil during supply disruptions. First, the ability of the SPR to replace supply during disruptions may deter adverse behavior on the part of oilproducing nations. Since the SPR can replace a large amount of disrupted oil,

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 69 cutting off supply would not have the intended negative economic consequence. Second, the SPR could be used as a negotiation tool to encourage producers to increase oil production when needed. Third, experts told us that they believe the SPR may reduce oil prices by lowering the risk premium sometimes included in the price of oil. Oil prices can increase because of fear of a disruption, and some experts told us that the existence of the SPR may quell this fear.

A LARGER SPR IS WARRANTED IF DEMAND FOR OIL GROWS AS EXPECTED If demand for oil in the United States increases as expected, a larger SPR will be necessary to maintain the economy‘s present level of protection from oil supply disruptions. Expansion of the SPR could also be required under the U.S. agreement with the International Energy Agency. In addition, a recent study prepared for DOE shows that the benefits of expanding the SPR to as much as 1.5 billion barrels would exceed the costs over a range of future conditions, although expanding the reserve to this size would take approximately 18 years. However, factors influencing the SPR‘s ideal size are likely to change over time, including factors such as oil demand and the likelihood of oil supply disruptions.

Oil Demand Projections Support a Larger SPR Future oil demand in the United States has an important impact on the benefits of expanding the SPR, and current projections support the interest in a larger SPR. Under the base case in the EIA‘s most recent Annual Energy Outlook, published in February 2006, U.S. demand for petroleum will rise from 21.1 million barrels per day in 2005 to 23.6 million barrels per day in 2015 and 26.1 million barrels per day in 2025, increases of 12 percent and 24 percent, respectively.30 As a result, the volume of imported oil and petroleum products is projected to increase over time to meet this demand, from 12.5 million barrels per day in 2005 to 13.2 million barrels per day in 2015 and 15.7 million barrels per day in 2025. The amount of protection that the SPR provides to the U.S. economy is generally measured in days of net import protection. The SPR contained enough crude oil in 2005 to offset about 58 days of imports. Using the most recent EIA forecast, we calculate that the net import protection that the SPR

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provides at its current size will decrease to 53 days in 2015 and 45 days in 2025. The United States‘ agreement with the International Energy Agency could also require an expanded SPR as imports of oil and oil products increase, if private inventories do not increase enough to cover the difference in demand. As we previously mentioned, the United States agrees to hold inventories of oil and petroleum products totaling 90 days of net imports as part of its obligation to the International Energy Agency, and the United States meets its obligation with a combination of public and private inventories. Privately held inventories of oil and petroleum products vary, but in 2005 DOE assumed these inventories could offset 58 days of imports. In total, the SPR and private inventories could offset 127 days of imports in 2005. As shown in figure 7, DOE estimates that without SPR or private inventory expansion, the United States will drop below its 90-day stockholding obligation in 2025. With the expansion of the SPR to 1 billion barrels included in the Energy Policy Act of 2005, DOE estimates that the United States will remain in compliance with its 90-day obligation through 2030.31 As figure 7 shows, the number of days of net import protection provided by private inventory of oil and petroleum products has generally decreased since the mid-1980s, and DOE officials expect this trend to continue. Holding inventory is costly to private companies, so they have an incentive to keep their inventory as low as possible.

DOE Estimates That Long-term Benefits of SPR Expansion to 1.5 Billion Barrels Exceed Costs To evaluate the costs and benefits of expanding the SPR to a capacity of up to 1.5 billion barrels, DOE‘s Oak Ridge National Laboratory (ORNL) prepared a study for DOE in late 2005.32 This study relies on the same model that the Office of Petroleum Reserves used, as discussed in the previous section, to estimate the reduction in economic damage from using the SPR during oil supply disruptions. The study shows that the benefits of expanding the reserve to 1.5 billion barrels exceed the costs over a 45-year horizon. The study estimates the costs and benefits of SPR expansion through 2050 because of the long construction time for additional SPR capacity and the large upfront investment required. The costs of constructing and filling the additional capacity dominate the analysis until 2020, while benefits of the additional capacity accrue from 2021 through the end of the analysis in 2050. The study uses EIA forecasts of oil price and demand through 2025, and a linear

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 71 extrapolation of these forecasts from 2025 through 2050. Any analysis of costs and benefits so far in the future is inherently uncertain. However, this study is the only one of its kind to analyze the future net benefits of SPR expansion. The costs of expanding the SPR to 1.5 billion barrels consist of capital costs to acquire and construct the facilities, the cost of crude oil to fill the new capacity, and ongoing maintenance and security costs for the additional facilities. DOE estimates that expanding the physical structure of the SPR to 1.5 billion barrels would take approximately 18 years and cost approximately $5.4 billion, in 2004 dollars. DOE assumed that expanding the reserve to this size would involve purchasing or constructing additional storage capacity at three existing SPR sites: West Hackberry and Bayou Choctaw in Louisiana, and Big Hill in Texas. The remaining expansion would be accomplished by constructing new storage sites at three sites selected from five potential sites in Texas, Louisiana, and Mississippi. The ORNL study‘s authors estimate the cost of filling the additional SPR capacity at $23.0 billion, in 2004 dollars. This estimate is based on the base-case oil price forecast from the 2005 Annual Energy Outlook because the 2006 volume was not yet published when the ORNL study was completed. The 2006 Outlook forecasts higher crude oil prices than the 2005 Outlook. Using the most recent base-case forecast, the ORNL authors estimated a fill cost of $36.2 billion in 2004 dollars. These calculations assume that the new SPR capacity is filled as it is completed at a maximum fill rate of 100,000 barrels per day, a fill rate achievable using the royalty-in-kind program. The ORNL study does not separately consider the costs and benefits of the expansion to 1 billion barrels authorized in the Energy Policy Act of 2005. DOE estimates that expanding to this size would take approximately 15 years and cost at least $1.3 billion, in 2004 dollars, based on selection of the lowestcost expansion options. This cost includes, as we previously described, purchasing or constructing additional capacity at three existing SPR sites and constructing a new storage site at one of the five potential locations. We estimate that filling the additional capacity would cost approximately $13.4 billion in 2004 dollars, using the base-case cost estimate in the 2006 Annual Energy Outlook.

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Source: DOE‘s Office of Petroleum Reserves. Figure 7. United States‘ Current and Estimated Compliance with International Energy Agency Obligation to Hold Reserves

The ORNL study estimates that the benefits of expanding the reserve to 1.5 billion barrels exceed the costs over a range of assumptions about future demand and oil prices. Expanding the SPR to 1.5 billion barrels is estimated to be cost-beneficial for each of the demand and world oil price forecasts in EIA‘s 2005 Annual Energy Outlook. The 2005 Outlook contains four forecasts of the world oil market: a base-case forecast, a lower-price forecast, and two higher-price forecasts.33 A different level of oil demand is associated with each of these price forecasts. The estimated net benefits of expanding the SPR are greatest in the EIA forecast when oil demand is highest and oil prices are lowest, and least when oil demand is lowest and prices are highest. The ORNL study used the 2005 forecasts because, as we previously mentioned, it was completed before the 2006 Outlook was published. The 2005 Outlook forecasts higher oil demand and lower oil prices than the 2006 edition, but the

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 73 author of the ORNL study noted that the highest-price case included in the 2005 report closely resembles the 2006 base case. Thus, SPR expansion appears to be cost-beneficial for the 2006 base-case forecast, but the study does not include oil prices as high as those in the 2006 high-price forecast, which would tend to decrease the benefits of a larger reserve. Beyond assumptions about future oil demand and price, the ORNL study makes a number of additional assumptions, including important assumptions about the probability of disruptions and the impact of oil price increases on GDP. The likelihood of oil supply disruptions in the future is uncertain and difficult to assess. The ORNL study considers two different estimates of the probability of oil supply disruptions: one that DOE created in 1990 and a second that the Stanford Energy Modeling Forum created in 2005.34 The benefits of expanding the SPR to 1.5 million barrels exceed the costs for both disruption probability estimates, but the benefits are larger for the 2005 Stanford Energy Modeling Forum estimate because this estimate (1) considers longer disruptions than those considered in the 1990 estimate and (2) recognizes that excess capacity will not be available from a part of the world where supply is disrupted. The measure of how much a given increase in oil price reduces GDP is known as the GDP elasticity of oil price. GDP loss avoided when the SPR is used during oil supply disruptions is a measure of the benefit of the SPR. The ORNL study used a range of GDP elasticity estimates and the results of the model runs indicate that, over that range, expanding the SPR is cost-beneficial. Some economists, however, believe that the GDP elasticity is lower than the bottom of the range of elasticity estimates used by the ORNL study. For example, the model we described in the previous section that EIA uses to estimate the impacts of oil supply disruptions uses values for this GDP elasticity derived from the Global Insight Macroeconomic Model that are one-quarter to one-half the size of the smallest value considered in the ORNL study. A smaller value for the GDP elasticity would reduce the calculated benefits of expanding the SPR.

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Factors Influencing the SPR’s Ideal Size Are Likely to Change Over Time Many factors influence the ideal size of the SPR, including world demand for oil and the probability and potential size of oil supply disruptions. Although current projections anticipate increasing future demand for oil in the United States and world, future oil demand conditions are uncertain. Predicting future demand is difficult because it depends on many factors, including the rates of economic growth, the price of oil, policy choices, and technology changes. The rate of world economic growth strongly influences oil demand. Strong economic growth in China has increased its demand for oil and petroleum products, contributing to rising world oil prices since 2004. In that year, China became the world‘s second largest consumer of oil, behind the United States, and its demand for oil grew at an annual rate of 15 percent. Conversely, the financial crisis in Asia in mid-1997 dramatically slowed the rate of oil demand growth in the region at that time, and oil demand even decreased between 1997 and 1998 in some countries. This change in demand contributed to lower oil prices in 1998 and early 1999, according to some experts. Future demand for oil will also depend on its price. As we previously described, crude oil prices are set in the world marketplace, and are largely outside the control of U.S. policymakers. High oil prices can encourage conservation and investment in fuel-efficient technologies and alternative fuels, reducing demand, while low oil prices can have the opposite effect. Members of our group of experts suggested several policy choices that might diminish growth in U.S. demand for oil. First, they suggested that research and investment in alternative fuels might reduce the growth of future U.S. oil demand. Vehicles that use alternative fuels, including ethanol, biodiesel, liquefied coal, and fuels made from natural gas, are now generally more expensive or less convenient to own than conventional vehicles, because of higher vehicle and fuel costs and a lack of refueling infrastructure. Alternative-fuel vehicles could become more viable in the marketplace if their costs and fuel delivery infrastructure become more comparable to vehicles fueled by petroleum products. Second, expert group members suggested that greater use of advanced fuel-efficient vehicles, such as hybrid electric and advanced diesel cars and trucks, could reduce U.S. oil demand. The Energy Policy Act of 2005 directs the Secretary of Energy to establish a program that includes grants to automobile manufacturers to encourage domestic production

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 75 of these vehicles. Third, several members of our group of experts suggested improving the Corporate Average Fuel Economy (CAFE) standards to curb demand for petroleum fuels in the United States. After these standards were established in 1975, the average fuel economy of new light-duty vehicles improved from 13.1 miles per gallon in 1975 to a peak of 22.1 miles per gallon in 1987.35 More recently, the fuel economy of new vehicles in the United States has stagnated at approximately 21 miles per gallon. New CAFE standards for light trucks, including minivans and sport-utility vehicles, were announced by the administration in March 2006, which include larger vehicles that were not regulated under past standards. Other experts have questioned the need for enhanced CAFE standards, noting that today‘s higher gasoline prices will bring about more efficient use of gasoline. Additionally, studies from the Congressional Budget Office suggest that a tax on gasoline could reduce demand at lower cost to the economy than enhanced CAFE standards.36 The size of the SPR needed to protect the U.S. economy also depends on the likelihood of oil supply disruptions. A number of factors in today‘s energy market cause particular concern, including a reduction in global surplus oil production capacity in recent years, the fact that much of the world‘s supply of oil is produced in relatively unstable regions, and rapid growth in world oil demand that has led to a tight balance between demand and supply. However, factors influencing disruption probability are likely to change over time. As we described in the previous section, international reserves augment the SPR‘s ability to replace oil during supply disruptions. Since a release of oil anywhere in the world during a disruption can lower oil prices everywhere, strategic reserves in other countries are beneficial to the United States and influence the SPR‘s ideal size. Along these lines, some members of our group of experts stressed the importance of international reserves to U.S. oil security and suggested that the United States and the International Energy Agency should encourage construction of strategic reserves abroad to be used during oil supply disruptions and should offer technical assistance to countries that want to construct such reserves. Officials from DOE and the International Energy Agency described efforts to support construction of reserves in other countries, including sponsoring workshops and providing other assistance. Experts pointed out that encouraging the construction of strategic reserves is particularly important in developing countries that are significant oil consumers and that are not currently members of the International Energy Agency, such as China. EIA forecasts that through 2025, demand in China will increase at a much faster rate than demand in more developed countries.

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Projections of future oil demand and oil market conditions are inherently uncertain, but these projections are key to any estimate of the optimal or necessary size of the SPR. If demand for oil grows as projected, keeping the SPR at its current size may put the economy at greater risk from the negative effects of oil supply disruptions. However, the estimates of world oil demand used in current studies could be too high or too low, resulting in high or low estimates of the SPR‘s optimal size. Therefore, as time passes and oil markets change, periodic reassessments by DOE of the appropriate size of the SPR could be helpful as part of the nation‘s long-term energy security planning.

CONCLUSIONS The SPR is a valuable asset for protecting the U.S. economy, providing benefits as a source of oil during supply disruptions and as a tool of diplomacy in foreign policy discussions. Our work shows that the SPR, particularly in conjunction with reserves held by the other countries of the International Energy Agency, can replace the oil lost during all but the most catastrophic disruption scenarios and, thus, can reduce the negative consequences of oil supply disruptions on the U.S. economy. However, our work also describes issues that could impact the cost and effectiveness of the SPR, including the conditions under which the reserve is filled, how DOE estimates the economic impacts of using the reserve, and the type of crude oil in the reserve. Expanding the reserve makes sense and will be necessary to maintain the economy‘s present level of protection if demand for oil in the United States increases as expected. However, factors that influence the ideal size of the SPR are likely to change over time and will warrant periodic reassessments. Since the SPR‘s inception, it has been filled and used in response to world events and changing conditions. Although some experts claimed that acquiring oil for the SPR after the terrorism events of September 2001 caused substantial increases in oil prices, the majority of experts we talked with believe that this increase was minimal because the volume of oil going to the SPR was very small relative to world oil demand. Experts believe that changes in SPR practices—including following a ―dollar-cost-averaging‖ approach, where the government acquires a fixed dollar value of oil for the SPR over a specified time period, and allowing oil producers more flexibility in the timing of delivery for oil acquired for the SPR—could reduce the future cost of filling the SPR.

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 77 Different parts of DOE have very different opinions on the amount of economic harm oil supply disruptions can cause and, thus, implicitly about the ideal size and use of the SPR. The estimates of the effect of price spikes on GDP that these different parts of DOE use are, respectively, near the high end and low end of the spectrum of such estimates in the economic literature. The two models have been used to support different kinds of decisions—the Office of Petroleum Reserves‘ model has been used to support decisions about whether to expand the SPR, while the EIA model has been used to advise policymakers about the potential economic consequences of oil supply disruptions. Clarifying the differences between these models and how the models are used to provide policy advice would help ensure that DOE provides consistent transparent advice about the size and use of the SPR. The SPR protects the economy during oil supply disruptions by replacing the oil lost. For the SPR to be most effective, refiners need to be able to efficiently use the oil in the reserve in the absence of other sources of supply. The two types of crude oil currently stored in the SPR can be effectively used by most refineries during a supply disruption, but the lack of heavy sour oil in the SPR poses problems to refiners who use this type of oil. Adding some heavy sour oil to the SPR could provide a source of supply to these refiners during a disruption, while still leaving enough oil of other types for other refiners. A 2005 DOE study supports this finding, concluding that separately storing approximately 10 percent heavy sour crude in the SPR could provide oil supply to refiners who process heavy sour oil during a disruption and better protect the economy. Additionally, adding some heavy sour oil to the SPR could decrease the cost of filling the SPR, since this oil is generally less expensive than the lighter grades currently stored in the reserve. Although another 2005 study for DOE shows that expanding the SPR could be warranted, factors influencing the ideal size of the SPR are likely to change over time. Many factors influence the ideal size of the SPR, including oil demand levels and the likelihood of oil supply disruptions. Because these factors are very dynamic, decisions about expanding the SPR will always be made under uncertainty. Nonetheless, as the world changes, periodically revisiting decisions about SPR size would allow policymakers to use new information to refine their views on the SPR‘s proper size.

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RECOMMENDATIONS FOR EXECUTIVE ACTION The Secretary of Energy should take the following four steps to improve the operation of the current SPR and to improve decisions surrounding the SPR‘s use and expansion. Specifically, the Secretary should: Study how to best implement experts‘ suggestions to 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 and providing industry with more flexibility in the royalty-in-kind program to delay oil delivery to the SPR during times when supply and demand are in tight balance and current prices are higher than expected future prices. Conduct a new review about the optimal oil mix in the SPR that would examine the maximum amount of heavy sour oil that should be held in the SPR, in addition to the minimum amount determined in DOE‘s prior report. The Secretary should ensure that DOE, at a minimum, implements its own recommendation to have at least 10 percent heavy sour oil in the SPR. Clarify the differences in structure and assumptions between the models used by the Office of Petroleum Reserves and EIA and clarify to policymakers how the models are used when providing advice to Congress and the executive branch. Periodically reassess the appropriate size of the SPR in light of changing oil supply and demand in the United States and the world.

AGENCY COMMENTS AND OUR EVALUATION We provided a draft of this report to DOE for review and comment. DOE generally agreed with the conclusions and recommendations presented in the draft report, but provided additional information regarding the implementation of two of our recommendations. Additionally, DOE explained EIA‘s efforts to update its model of the economic impacts of oil supply disruptions. In reviewing our draft report, DOE also provided technical and clarifying

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 79 comments, which we incorporated as appropriate. DOE‘s written comments are reproduced in appendix III. In response to our recommendation to study how to implement experts‘ suggestions to fill the SPR more cost effectively, DOE noted that decisions on when to acquire oil are extremely complex and subject to many strategic and tactical considerations in addition to cost. We agree that SPR oil acquisition decisions must consider cost, market conditions, national security concerns, and other issues. DOE also stated that dollar cost averaging as a means to improve the cost-effectiveness of SPR fill could be employed only when DOE is purchasing oil, and noted that recent oil acquisition has been accomplished by the transfer of royalty oil from the Interior Department. However, we believe that dollar cost averaging when acquiring oil through the royalty-inkind program is possible, although it would require that DOE vary the amount of oil it accepts from royalties and perhaps purchase some oil at times of low prices. Because of the potential for cost savings, we continue to believe that DOE should study such an approach. Finally, regarding this recommendation, DOE stated that it believes that the value of deferring oil deliveries to the SPR during the period of 2002 to 2004 would have been less than $590 million. To clarify, we did not attempt to value deferrals that DOE might have approved during this time period. Instead, the $590 million of potential savings referred to in the report reflects the potential savings from applying a dollar-costaveraging approach from October 2001 through August 2005, not to the savings that could have occurred from deferring oil delivery. In response to our recommendation to consider storing heavy sour oil in the SPR, DOE stated that it does not believe the advantages of holding a heavier crude stream would justify replacing any of the current inventory. Instead, it believes that studying and implementing this recommendation should wait until the SPR is expanded. Neither our work nor DOE‘s recent study explored the costs and benefits of adding heavy sour oil to the SPR. We believe that DOE should study the costs and benefits of adding heavy sour oil with and without SPR expansion. Without such analysis, DOE does not have data to determine whether replacing of any of the current inventory with heavy sour oil is economically justified. Regarding the last two recommendations, DOE agreed that officials will work together to better articulate the different approaches and perspectives contained in their modeling of the effects of oil supply disruptions on the economy, and committed to periodic reassessments of the SPR‘s ideal size. DOE also described an ongoing update of the EIA model for assessing the impacts of supply disruptions. The new model is more complex than the older

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model, but according to EIA, its estimates of the GDP impacts of supply disruptions will remain smaller than those estimated by the Office of Petroleum Reserves‘ model. As agreed with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution of it until 21 days from the report date. At that time, we will send copies of this report to interested congressional committees, the Secretary of Energy, and other parties. We will also make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staffs have any questions about this report or need additional information, please contact me at (202) 512-6877 or [email protected]. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who have made major contributions to this report are listed in appendix IV.

Jim Wells Director, Natural Resources and Environment

APPENDIX I: SCOPE AND METHODOLOGY We addressed the following questions during our review: (1) Based on past experience, what factors do experts recommend be considered when filling and using the Strategic Petroleum Reserve (SPR)? (2) To what extent can the SPR protect the U.S. economy from damage during oil supply disruptions? (3) Under what circumstances would an SPR larger than its current size be warranted? In addressing these objectives, we conducted a comprehensive literature review of economic and public policy material relevant to the SPR‘s fill and use, and to its ability to provide energy security for the U.S. economy. To identify articles for our literature review, we searched databases using key terms. We also obtained recommended reading lists of studies from several experts on issues related to the questions we addressed. We considered the methodological soundness of the articles and studies included in our literature review and determined that the findings of these studies were sufficiently

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 81 reliable for our purposes. In addition, we conducted interviews with academics and experts, as well as industry representatives and officials from several offices within the Department of Energy (DOE), including the Energy Information Administration (EIA) and the Office of Petroleum Reserves. We also conducted interviews with academics and experts at institutes that study energy security issues. We selected these individuals on the basis of their expertise in energy security and SPR policy as represented by their presentations or publications. We present data and forecasts from EIA that have been deemed sufficiently reliable for our purposes. Additionally, we contracted with the National Academy of Sciences37 to convene a group of experts to collect opinions on the impacts of past SPR fill and use and on recommendations for the future, as well as on the benefit of the SPR in reducing economic losses in the event of oil supply disruptions. We worked closely with the National Academies to identify and select 13 group members (see table 7) who could adequately respond to our general and specific questions about current practices for filling and using the SPR and about the economic benefit the SPR could provide at its current size and at a larger size. In keeping with National Academies‘ policy, the group members were invited to provide their individual views, and the group was not designed to reach a consensus on the issues that we asked them to discuss. The group members convened at the National Academies in Washington, D.C., on December 1, 2005. The views expressed by the group members do not necessarily represent the views of GAO or the National Academies. After the group of experts met, we analyzed a transcript of the discussion to identify principal themes and group members‘ views. Although we were able to secure the participation of a balanced, highly qualified group of experts, the group was not representative of all potential views. Nevertheless, it provided a rich dialogue on current practices for filling and using the SPR and on what considerations are pertinent to identifying the best fill and use policies, as well as on how the SPR, at its current size and at a larger size, can protect the economy from significant losses in the event of oil supply disruptions. To learn what factors experts recommend be considered when making decisions about SPR fill and use, we reviewed records and reports from DOE and the International Energy Agency. We also reviewed available literature on the political and economic implications of various ways of filling and using the SPR, and interviewed experts from government, academia, and private industry on issues of SPR fill and use.

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Table 7. Members of the Group of Experts Compiled by GAO and the National Name Robert Hirsch (moderator) Joseph E. Aldy Kyle M. Cooper

Affiliation Senior Energy Program Advisor, SAIC Fellow, Resources for the Future Vice President, Futures/Fixed Income, Citigroup Global Markets, Inc.

Leonidas Drollas

Deputy Executive Director and Chief Economist, Centre for Global Energy Studies Chairman, Energy Program, Center for Strategic and International Studies President, PIRA Energy Group President, Goldwyn International Strategies, LLC Senior Manager, Trading, Valero Energy Corp. Executive Director, Stanford Energy Modeling Forum, Stanford University Head, Emergency Planning and Preparations Division, International Energy Agency

Robert Ebel Lawrence J. Goldstein David L. Goldwyn Les Harding Hillard G. Huntington Klaus Jacoby Paul Leiby John A. (Jack) Riggs John Shages Source: GAO.

Science and Technology Policy Group, Environmental Sciences Division, Oak Ridge National Laboratory Executive Director, Program on Energy, the Environment and the Economy, The Aspen Institute Deputy Assistant Secretary, Petroleum Reserves, Department of Energy

To estimate the potential savings of using a dollar-cost-averaging approach to fill the SPR, we calculated the cost of using this approach for SPR oil acquisitions between October 2001 and August 2005. In addition, we ran simulations to project potential savings from a dollar-cost-averaging approach going forward over 5 years. Specifically, we evaluated 12 possible paths that future oil prices may take. First, starting from an initial price of $70 per barrel, we allowed prices to increase or decrease on average by varying degrees—the price paths increased or decreased at average rates of 1, 5, and 10 percent per year. Second, for each of these 6 possible price paths, we allowed prices to fluctuate to account for potential price volatility—for each of the 6 possible

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 83 price paths, we allowed for a low- and high-price volatility case. Specifically, prices for each month were drawn randomly from a normal distribution, with standard deviations of $15 for the low volatility case and $50 for the high case. For each of these 12 scenarios, we then simulated future prices for 60 months and compared the average price per barrel under dollar cost averaging versus acquiring oil at a steady rate. We ran 1,000 simulations for each of the 12 scenarios and found that in all but 10 of the resulting 12,000 simulations, dollar cost averaging saved money. These simulations are not intended to measure the magnitude of savings. To do so would require using actual projections of oil prices and price volatility, something that was beyond the scope of this report. We did not independently verify information about security, drawdown rates, or other operational factors of the SPR or other strategic reserves held by countries that belong to the International Energy Agency. To analyze the ability of the SPR to reduce economic damage caused by oil supply disruptions, we present the results of two DOE models used to estimate the reduction of harm to U.S. gross domestic product (GDP) that would result from releasing oil from the SPR and international reserves during six hypothetical oil supply disruption scenarios. Oak Ridge National Laboratory (ORNL) produced one of these models under contract with DOE‘s Office of Petroleum Reserves. ORNL officials produced model results for us. EIA produced the second model. We produced model results using the EIA model, and then verified these results with EIA officials. (See app. II for a more detailed discussion of the hypothetical oil supply disruption scenarios and the economic modeling effort.) Additionally, we conducted semistructured interviews with representatives from the refining industry. We spoke with representatives from companies that comprise 76 percent of the refining capacity of the United States to learn about their views on SPR operations. We also reviewed studies of the potential for oil supply disruptions to occur and to reduce U.S. GDP. To learn about the circumstances under which an SPR larger than its current size could provide additional energy security benefits, we reviewed an ORNL study that analyzed the expected costs and benefits of expanding the SPR, U.S. stockholding obligations to the International Energy Agency, and estimates of future U.S. oil demand. Finally, we also reviewed studies and interviewed expert group members and other oil market experts about factors that influence future demand for oil in the United States and alternatives for reducing U.S. economic losses in the event of oil supply disruptions.

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APPENDIX II: ECONOMIC MODELING OF OIL SUPPLY DISRUPTIONS We present in this appendix the results of models that economists at ORNL and EIA created to simulate the effects of six hypothetical oil disruption scenarios. These scenarios illustrate the impacts of a variety of oil supply disruptions and the extent to which the SPR and international reserves could replace oil and protect the economy from losses. Both models make a number of assumptions in simulating the effects of disruptions on the economy, and some of these assumptions differ between models.

Oil Supply Disruption Scenarios To study the capabilities of the SPR and international reserves to replace oil and prevent economic damage during oil supply disruptions, we developed six hypothetical oil supply disruption scenarios. The six scenarios are as follows: A hurricane along the United States Gulf Coast decreases domestic oil production. This scenario is closely based on Hurricanes Katrina and Rita, which struck the U.S. Gulf Coast in August and September, 2005, and temporarily stopped a large percentage of the offshore crude oil production in the Gulf of Mexico. The disruption in production continued for several months as damaged offshore production platforms, pipelines, and onshore facilities were repaired. A strike occurs among oil workers in Venezuela. This scenario is based on the oil worker strike that occurred in Venezuela in 2002 to 2003. Although that strike lasted only 63 days, oil production was well below normal for several months and did not recover to its prestrike level. Iran stops exporting oil for 18 months. Although none of Iran‘s 2.7 million barrels per day of exported crude oil go directly to the United States, removing this oil from the market would raise prices everywhere, thus impacting the U.S. economy. Terrorists attack the Abqaiq oil-processing facility in Saudi Arabia, which handles more than half of Saudi Arabia‘s 10.4 million barrels

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 85 per day of oil output. This facility is the largest oil-processing plant in the world, removing water, gas, sulfur, and other impurities before the oil is exported. This scenario assumes that a terrorist attack cripples the facility for 1 month, and then production recovers over 7 additional months as the facility is repaired. Terrorists attempted to attack this facility in February 2006, but security forces turned back the attack. Table 8. Amount of Crude Oil Disrupted over a 2-Year Period, by Hypothetical Scenario Barrels in millions Oil supply disrupted per day, by hypothetical scenario Venezuelan Iranian Saudi Strait of Month of Gulf strike embargo terrorism Hormuz disruption Coast closure hurricane 1st 1.5 1.8 2.7 6.0 17.0 2nd 1.0 2.2 2.7 4.0 8.0 3rd 0.8 1.4 2.7 4.0 4.0 4th 0.8 0.5 2.7 4.0 0 5th 0.5 0.4 2.7 4.0 0 6th 0.5 0.2 2.7 4.0 0 0 0.2 2.7 2.0 0 7th 8th 0 0.2 2.7 1.0 0 9th 0 0.2 2.7 0 0 10th 0 0.2 2.7 0 0 0 0.2 2.7 0 0 11th 0 0.2 2.7 0 0 12th 13th 0 0.2 2.7 0 0 14th 0 0.2 2.7 0 0 15th 0 0.2 2.7 0 0 16th 0 0.2 2.7 0 0 17th 0 0.2 2.7 0 0 18th 0 0.2 2.7 0 0 19th 0 0.2 0 0 0 20th 0 0.2 0 0 0 21st 0 0.2 0 0 0 22nd 0 0.2 0 0 0 0 0.2 0 0 0 23rd 0 0.2 0 0 0 24th

Source: GAO.

Saudi shutdown 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 8.0 6.0 4.0 2.0 2.0 1.0

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For each scenario, table 8 shows the amount of crude oil disrupted during each month over a 2-year period. We selected these scenarios to illustrate the potential benefits of strategic reserves in disruptions of different size and duration, not because they are likely to occur. These scenarios are set in today‘s oil market, with global crude oil demand of approximately 83 million barrels per day and U.S. demand of approximately 21 million barrels per day.

Modeling of Economic Impacts We used two DOE models to estimate the economic effects of our six disruption scenarios. EIA developed one model and economists at ORNL developed the other, under contract to DOE‘s Office of Petroleum Reserves. Both models estimate U.S. GDP loss from oil supply disruptions by linking disruptions to oil price spikes and linking price spikes to GDP losses. We used both models to estimate the economic effects of our hypothetical disruptions under three conditions: that is, no reserves are used in response to the disruption, the SPR is used alone, and the SPR is used in conjunction with international reserves. In both models, we assumed that world excess crude oil production capacity and world fuel-switching capabilities, together totaling 850,000 barrels per day, are available immediately to help offset a disruption. We also assumed that private inventories of crude oil are neutral during a disruption— holders of private inventory neither draw down their inventories nor hoard oil. Finally, we assumed that SPR and international reserves are used immediately

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 87 at their maximum sustainable rate or at a rate large enough to replace disrupted oil supply.

EIA Model EIA‘s Division of Energy Markets and Contingency Information has developed ―rules of thumb‖ for estimating the oil price and U.S. macroeconomic impacts of oil supply disruptions, based on simulations from the Global Insight Macroeconomic Model of the U.S economy. The assumptions relating disruptions to oil price spikes are summarized in the ―price rules of thumb‖ and the assumptions relating price spikes to GDP losses are summarized in the ―economic rules of thumb.‖ EIA measures the response of world oil prices to a hypothetical supply disruption as the projected quarterly average increase in the price of West Texas Intermediate oil. EIA‘s oil market analysis is based on competitive forces producing a market price on the basis of market fundamentals and market psychology during an oil supply disruption. The ―price rules of thumb‖ are based on net disruption sizes and the current and expected future oil price level before the disruption. These rules of thumb provide a range of oil prices around an average price, and do not try to quantify the size of price spikes that could occur during disruptions. EIA estimates that a supply disruption when the price of oil is around $40 per barrel results in an oil price increase of between $4 and $6 per barrel for each 1 million barrels per day of oil that is disrupted. However, if the price of oil is about $50 per barrel, EIA estimates a price increase of between $5 and $7 per barrel for each 1 million barrels per day of oil that is disrupted. For a disruption of a given size, the higher the predisruption oil price, the bigger the price increase needed to balance supply and demand after the disruption. Additionally, EIA adds a ―market psychology price premium‖ to the price calculated using the rules of thumb in situations where it believes market psychology will further increase the price. To translate oil price increases into GDP losses, EIA uses ―economic rules of thumb,‖ based on simulations from the Global Insight Macroeconomic Model of the U.S. economy. These rules estimate that a sustained increase of 10 percent in the price of oil could result in a 0.05 to 0.l percent reduction in real U.S. GDP relative to its baseline value (the forecasted GDP without an oil disruption). EIA states that, for price increases greater than 10 percent, the GDP impacts would increase linearly with the price impacts, so that a doubling of the price impacts would result in a doubling of the GDP impacts. The EIA model‘s GDP responsiveness estimates are derived from the Global Insight model that EIA uses for its long-run forecasts of energy market and

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overall economic activity. EIA notes that additional factors, such as the effect of high oil prices on the rest of the world‘s economy, the reaction of the Federal Reserve to ameliorate the economic damage of high oil prices, and the change in the value of the dollar against foreign currencies, may also influence the economic impact of an oil price spike.

Office of Petroleum Reserves’ Model Economists at ORNL, under contract to DOE‘s Office of Petroleum Reserves, developed a model to estimate the costs and benefits of expanding the size and drawdown capability of the SPR. Economists at ORNL used a portion of this model to estimate the GDP impacts of our oil supply disruption scenarios. The model estimates the economic impacts of oil supply disruptions by first calculating the remaining oil shortfall after world excess oil production capacity has been utilized. Then the model assumes that world oil price increases sufficiently for world oil demand to contract enough to equal the now-reduced supply. On the basis of a review of the literature, the modelers assume a short-run price elasticity of demand for oil between -0.10 to -0.25. The elasticity gets larger as the duration of the supply shock gets larger and longer.38 The short-run oil demand elasticities then are used to determine the increase in the world price of oil. The GDP elasticity of oil price is then used to infer the losses in economic output that would follow a sudden, unanticipated oil price shock. The modelers draw on results from econometric studies of the sensitivity of the U.S. economy to oil price spikes to select a GDP elasticity, expressed in percentage terms, of -5.4 percent for a 100 percent spike in oil price. To estimate the benefits of expanding the size and drawdown capability of the SPR, the model simulates the impact of oil supply disruptions against DOE‘s baseline paths for oil prices, world oil demands, U.S oil demands, and U.S. oil supplies. The primary benefit from the SPR is the GDP loss avoided when it is used to prevent or lessen the effects of oil price spikes. Their costbenefit approach uses a simple model of the oil market and the U.S. economy to (1) assess the potential causes and likelihood that oil supply disruptions will occur, (2) account for the size of existing strategic oil stocks and expected degree of international cooperation on their use, (3) estimate the cost to the U.S. economy of oil supply disruptions and the incremental ability of additional SPR stocks and drawdown capability to reduce these costs, (4) estimate the costs of buying and storing oil in the SPR, and (5) determine the net benefit and efficient size of the SPR. The model uses a Monte Carlo

Strategic Petroleum Reserve: Available Oil Can Provide Significant... 89 simulation of the world oil market over the next several decades to model the likelihood of future oil supply disruptions.39

Similarities and Differences between the EIA Model and Office of Petroleum Reserves’ Model In assessing the economic costs of disruptions, the Office of Petroleum Reserves‘ model makes a number of assumptions similar to those made by EIA, in particular, assumptions about the responsiveness of oil price to supply disruptions. However, the Office of Petroleum Reserves‘ model assumes a considerably greater degree of responsiveness of the macroeconomy to oil price spikes than the EIA model. The Office of Petroleum Reserves‘ model assumes for its base case that a sudden doubling in the price of oil could reduce GDP in the following year by about 5.4 percentage points below what it otherwise would have been. This contrasts with the EIA model result that a sudden doubling of the price of oil would cause about a 0.5 to 1.0 percent reduction in the level of real GDP relative to its value if an oil price increase did not occur. Some experts have suggested that the EIA model and Office of Petroleum Reserves‘ model have assumptions that could be responsible for differences in their estimates of the responsiveness of GDP to disruptions. In the Office of Petroleum Reserves‘ model, the responsiveness of GDP to an oil price shock incorporates a controversial assumption, that U.S. monetary authorities would not intervene and increase the money supply to accommodate the price shock. Some experts have suggested that, by increasing the money supply, monetary authorities could restore consumers‘ purchasing power to its predisruption level and eliminate or moderate the GDP loss. Experts have also suggested deficiencies in the model that EIA uses for its estimates of the responsiveness of GDP to oil price shocks. A number of experts believe that large-scale macroeconomic models, such as the EIA model, underestimate the effects of oil price shocks on the economy. They question whether these models can distinguish between a price shock and a more gradual price increase. In contrast, the econometrically based estimates used by Office of Petroleum Reserves‘ model and others are derived from models of oil price shocks.

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APPENDIX III : COMMENTS FROM THE DEPARTMENT OF ENERGY

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End Notes 1 The 26 member countries of the International Energy Agency are Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Japan, Republic of Korea, Luxembourg, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States. 2 Pub. L. No. 94-163 (1975), as amended. 3 The density of crude oil is commonly described in terms of API gravity. Higher API gravity indicates less dense oil. 4 The sweet oil in the SPR contains less than 0.5 percent sulfur, while the sour oil in the SPR contains approximately 1.4 percent sulfur. 5 Although the strike among oil workers in Venezuela in 2002 to 2003 lasted only 63 days, the resulting oil supply disruption lasted for approximately 5 months. See GAO, Energy Security: Issues Related to Potential Reductions in Venezuelan Oil Production, GAO-06668 (Washington D.C.: June 27, 2006). 6 Four organizations comprise the National Academies: the National Academy of Sciences, the National Academy of Engineering, the Institute of Medicine, and the National Research council. 7 Leiby, Paul and David Bowman, Economic Benefits of Expanded Strategic Petroleum Reserve Size or Drawdown Capability, Oak Ridge National Laboratory (Oak Ridge, TN: Dec. 31, 2005)

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Primary energy is all energy consumed by end-users—excluding electricity, but including the energy consumed at electric utilities to generate electricity. 9 DOE, EIA, International Energy Outlook 2005, DOE/EIA-0484(2005) (July 2005). 10 DOE, EIA, Annual Energy Outlook 2006, DOE/EIA-0383(2006) (February 2006). 11 The countries included in Western Europe are as follows: Austria, Belgium, Bosnia and Herzegovina, Croatia, Denmark, Faroe Islands, Finland, France, Germany, Gibraltar, Greece, Iceland, Ireland, Italy, Luxembourg, Macedonia, Malta, the Netherlands, Norway, Portugal, Serbia and Montenegro, Slovenia, Spain, Sweden, Switzerland, Turkey, and the United Kingdom. 12 International Monetary Fund, World Economic Outlook, Globalization and External Imbalances (April 2005). 13 Our cost estimate for obtaining oil is the cost of filling the reserve to its current level. Funds appropriated for purchasing oil that were later rescinded are not included, nor are funds used to purchase oil that has since been withdrawn from the SPR and sold. 14 GAO, The United States Remains Unprepared For Oil Import Disruptions, Volumes I and II, GAO/EMD-81-117 (Washington, D.C.: Sept. 29, 1981). 15 Since 2003, due to physical changes in the caverns and the recertification of a previously outof-service cavern, SPR‘s capacity has increased to 727 million barrels. 16 Because oil was added to the SPR at that time using the royalty-in-kind program, the $4.3 billion cost represents forgone revenue to the U.S. government, rather than federal funds spent. 17 Expected future oil prices are reflected in the futures market, where oil is traded for delivery at a specified place, price, and time in the future. 18 Pub. L. No. 94-163 (1975). 19 GAO, Energy Security and Policy: Analysis of the Pricing of Crude Oil and Petroleum Products, GAO/RCED-93-17 (Washington, D.C.: Mar. 19, 1993). 20 Our definition of ―emergency stocks‖ held by member countries of the International Energy Agency includes those stocks completely financed by governments and agency stocks. Agency stocks are generally held under a cost-sharing agreement between private entities and government. 21 The Northeast Home Heating Oil reserve, located in Connecticut, Rhode Island, and New Jersey, contains 2 million barrels of heating oil that can be used during supply disruptions. This reserve is not considered in the following analysis. 22 Since the majority of excess oil production capacity is currently located in Saudi Arabia, assuming that this capacity would be available for our Saudi disruption scenarios produces a conservative estimate of the economic damage that could result from such a disruption. 23 For all price estimates, the models assume a base oil price of $55 per barrel. 24 The EIA model‘s update had not been publicly released as of May 25, 2006. 25 Although DOE considers a disruption of Canadian oil unlikely, oil supply disruptions can occur from any supplier, including domestic suppliers. 26 As defined by the Office of Petroleum Reserves in the Strategic Petroleum Reserve Crude Compatibility Study, heavy sweet oil has an API gravity less than 26 degrees and heavy sour oil has an API gravity less than 30 degrees. 27 DOE, Office of the Deputy Assistant Secretary for Petroleum Reserves, Strategic Petroleum Reserve Crude Compatibility Study (December 2005). 28 Our summary of DOE conclusions does not include asphalt plants, which also would be harmed by a disruption of heavy oil supply. 29 The price differential between light and heavy crude oils varies over time and depends on the types of crude oil involved. For example, the differential between Brent, a light European crude oil, and Maya, a heavy Mexican crude oil, varied from about $9 to nearly $18 during the last year.

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EIA publishes an Annual Energy Outlook each year that forecasts future prices and demand for oil and other energy sources. The 2006 edition includes a base-case forecast, a higher-price forecast, and a lower-price forecast. 31 This analysis assumes that the volume of private inventory remains constant in the future, meaning that the days of import coverage from private inventory decrease as demand increases. 32 All benefits assessed in the ORNL study were economic benefits. 33 The 2005 Annual Energy Outlook contained an additional high-price case, called the October futures price case. The results of this case are similar to the base case over the long term, and the ORNL study did not include this case. 34 The Stanford Energy Modeling Forum is a structured forum for discussing important energy and environmental issues. Participants are leading energy experts and advisors from government, industry, universities, and other research organizations. DOE sponsored an expert panel study by the Stanford Energy Modeling Forum to quantify oil disruption risk. 35 According to the Environmental Protection Agency, these fuel economy numbers are based on ―real world‖ estimates that the federal government provides to consumers and are about 15 percent lower than the values used for compliance with the CAFE program. 36 Congressional Budget Office, The Economic Costs of Fuel Economy Standards Versus a Gasoline Tax (December 2003); and Reducing Gasoline Consumption: Three Policy Options (November 2002). 37 Four organizations comprise the National Academies: the National Academy of Sciences, the National Academy of Engineering, the Institute of Medicine, and the National Research council. 38 Elasticity refers to the responsiveness of one variable to a change in another. For example, the price elasticity of demand for oil refers to the responsiveness of the quantity of oil demanded to a change in its price and the GDP elasticity of oil price refers to the responsiveness of GDP to a change in oil price. 39 A Monte Carlo simulation is a form of estimation that uses random numbers to measure the effects of uncertainty, such as the uncertainty associated with a future oil supply disruption. A simulation is composed of thousands of events, each event being a randomly selected projection of the world oil market through the year 2050. Some of these projections include supply disruptions, others do not. The thousands of sampled outcomes are recorded and averaged to produce an estimate of the average benefit from the SPR in the presence of uncertainty about the likelihood and duration of future supply disruptions.

In: Strategic Petroleum Reserve Editors: Albert L. Strait

ISBN: 978-1-60692-290-3 © 2010 Nova Science Publishers, Inc.

Chapter 4

EXPANSION OF THE STRATEGIC PETROLEUM RESERVE U.S. Department of Energy Memorandom for the secretary From Gergory H. Friedman, Inspector General Subject Information: Special Report on "Expansion of the Strategic Petroleum Reserve"

INTRODUCTION The Energy Policy Act of 2005 required the Department of Energy to expand the Strategic Petroleum Reserve's (Reserve) maximum storage capacity to 1 billion barrels of crude oil. The Department stores the oil in large underground caverns, which have been created in salt domes. After evaluating various alternatives, the Department decided to develop a new 160 million barrel storage facility at Richton, Mississippi, and to expand the storage capacity at two existing Reserve facilities. As part of the evaluation, the Department eliminated a salt dome in Bruinsburg, Mississippi, from consideration as a potential expansion site. According to Department officials, the Bruinsburg site was not selected because (1) the salt dome was too small to meet storage needs, and (2) the site presented significant technical risks since

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thc Department would have to use deep injection wells to dispose of nearly 1.2 million barrels per day of brine used to excavate the caverns. Subsequent to the announcement of the Richton site as the preferred expansion alternative, public and congressional entities raised serious concerns about the procedurcs uscd by the Department in eliminating Bruinsburg as an expansion location. For example, a member of Congress raised concerns to the Department on several occasions that in determining the size of the Bruinsburg salt dome, the Department had not (1) considered existing well data, (2) resolved questions about data reliability concerning the location of wells, and (3)used existing seismic data. Additionally, four private-sector geologists concluded that thc Bruinsburg salt dome was large enough to meet the Dcpartment's storage requirements for 160 million barrels of oil. Finally, the Congressman was concerned that the Department's planned approach at the Richton site to use a 100-mile long pipeline to the Gulf of Mexico to dispose of brine produced during the creation of the storage caverns could cause environmental damage due to pipeline leaks. We initiated this review to evaluate the above concerns.

OBSERVATIONS Our review found that the Department and its contractor analyzed all available well data and seismic data related to the Bruinsburg site and augmented this information with additional seismic tcsts. We found, as well, that there are inherent uncertainties involved in the process of estimating the size of the salt domes. As a consequence, the exact size and shape of the Bruinsburg salt dome is not fully known. Professional geologists have interpreted the available data differently, and we were not able to resolve these differences of opinion. With reference to the concern about brine leaks, we found that the Department has improved its pipeline protection measures at its existing facilities and plans to employ such improved measures in support of the Richton storage operations.

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EVALUAUON OF BRUINSBURG DOME Consideration of Well Data In evaluating the size of the Bruinsburg salt dome, Sandia National Laboratories (Sandia), which conducted the evaluation for the Department, considered previously collected well data. Specifically, Sandia gathered well data from multiple sources and evaluated the data in developing the geological model used to estimate the size of the Bruinsburg salt dome. Sandia used well data indicating the presence of salt, or lack thereof, to estimate the extent of the salt dome to establish the boundaries of the dome. Where well data conflicted with seismic data, Sandia relied on the seismic data to establish the boundaries of the salt dome. Overall, Sandia obtained data from 28 wells in the immediate vicinity of the Bruinsburg salt dome. In evaluating the size of the Bruinsburg salt dome, Sandia: Used data from 23 of the 28 wells to define the boundaries of the salt dome: 9 of the wells showed the presence of salt, and 14 did not; Determined that it could not use data from two wells either because the well was too shallow or geologic information about the well was insufficient to be of use in the evaluation; and, Did not rely on the data from three remaining wells because of uncertainties associated with the location of the wells. In each of these instances, Sandia decided to use seismic data, which it considered more definitive in analyzing the size and shape of the salt formation, rather than rely on well data that only indicated one point on the top of the salt dome.

RECONCILIATION OF WELL LOCATIONS We determined that Sandia, in conducting its analysis, was not able to fully reconcile the uncertainties related to well locations at the Bruinsburg site. The well location discrepancies resulted from Sandia obtaining relevant data from multiple sources. For example, Sandia obtained well data from a commercial vendor, a web site maintained by the State of Mississippi Oil and Gas Commission, and a compendium of salt dome information published by

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the Mississippi Department of Environmental Quality. These sources often reported conflicting locations for the same wells. These differences were compounded by the use of multiple maps with different coordinates. Sandia attempted to reduce the uncertainty related to the well locations by overlaying maps and adjusting map scales. However, significant discrepancies regarding well locations still existed for multiple wells. For example, at the project's completion, the spatial uncertainty for nine of the wells was 500 feet or more. Sandia's inability to fully reconcile the uncertainties with well locations at the Bruinsburg site was consistent with the Mississippi Office of Geology's Atlas of Shallow Mississippi Salt Domes, which identified issues with well locations in the Bruinsburg area. Sandia notified the Department of the issues regarding the well locations and recommended locating the wells in February 2006. Sandia restated its recommendation to locate the wells in June 2006. The Department, citing the difficulties and limited usefulness of locating buried well casings, decided to obtain existing and new additional seismic data to delineate the edge of the salt dome in lieu of attempting to locate the wells at Bruinsburg.

USE OF SEISMIC DATA To supplement its use of well data, Sandia used seismic data in the evaluation of the Bruinsburg salt dome. In May 2006, Sandia obtained and analyzed scismic data from two previous seismic surveys performed for oil exploration in the 1970s. Only one of the seismic surveys showed evidence of salt at depths needed to meet the Department's design criteria for storage caverns, which Sandia used in establishing the southwestern boundary of the dome. In addition to using existing seismic data, the Department directed and funded Sandia to conduct two additional seismic surveys to further define the boundaries of the Bruinsburg salt dome. We determined Sandia used the existing and additional seismic survey data. Although there were two other seismic tests that had been conducted in the Bruinsburg dome area, data from the tests were either not available for sale, or the brokerlonner could not find the data.

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INTCRPRETATION OF DATA Although Sandia used all publicly available data and obtained additional seismic data, large areas of the salt dome are not characterized by data. As a result, there are differing professional interpretations of the data and conclusions about the size and shape of the dome. The impact of additional data and professional interpretation of the data is illustrated by the revisions to Sandia's size estimates throughout the project. Sandia initially projected the size of the dome to be about 700 acres after a preliminary review of publicly available well data. Sandia later reduced that cstimate to 277 acres after incorporating data from two seismic surveys, which were shot in the 1970s for oil exploration. After adding additional data from two new seismic surveys, conducted specifically for the Reserve expansion project, Sandia reduced its estimate of the area of useable salt from 277 acres to 121 acres. Based upon the available well and seismic data, Sandia concluded that the Bruinsburg salt domc could hold a maximum of 70 million barrels of oil, was not sufficient to meet the Reserve's storage capacity requirement. Several private-sector geologists expressed disagreement with Sandia's estimate of the size of the dome and the decision to give preference to seismic data over coriflicting well data. The dissenting geologists provided summary estimates of the dome size, which ranged from 286 acres to 365 acres. These geologists also stated that all well data should have been incorporated into Sandia's analysis and relied upon. We were not able to resolve these professional differences of opinion. Departmental and Sandia personnel indicated that additional tests, such as 3-dimensional seismic tests, could be performed that might reduce the uncertainty as to the size and shape of the Bruinsburg dome. However, these individuals stated that the test results would not eliminate all questions related to the suitability of the Bruinsburg salt dome for Reserve expansion. One of the private-sector geologists provided a nonpublic salt proximity survey from a well located southeast of the Bruinsburg salt dome, to support that the donie was larger than Sandia estimated. After analyzing the data and contacting the generator of the data, Sandia concluded that the assunlptions (on which this 1989 vintage salt proximity survey was based) did not reflect what is currently known about the dome and had a probable error rate of about 25 percent. Overall, Sandia concluded [hat this data did not show that the Bruinsburg salt dome was larger.

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PIPELINE LEAKS Finally, we found with reference to the concern about brine leaks, that the Department planned to implement pipeline protection measures that it has used at other Reserve sites to minimize such leaks. About 20 years ago, the Reserve had problems with leaks in brine disposal pipelines. Specifically, the Reserve had two major brine disposal pipeline leaks in the 1980s, including 575,000 barrels of brine leaked at the West Hackberry site in 1985 and 825,000 barrels of brine inadvertently released at the Bryan Mound site in 1989. To protect against additional brine pipeline leaks, the Reserve instituted a corrosion prevention program and internally lined replacement brine pipelines. We found that the number of brine spills at the Reserve had greatly declined, and only 232 barrels were released by the Reserve between 1997 and 2005. This report is being provided for information purposes, and no fonnal recommendations are being made. The Office of Inspector General appreciates the cooperation of all parties that were contacted during the conduct of this review. Attachment cc: Acting Under Secretary of Energy Assistant Secretary, Office of Fossil Energy Assistant Secretary, Office of Congressional and Intergovernmental Affairs Chief of Staff Team Leader, Audit Liaison Team, CF-1.2 Audit Liaison, Office of Fossil Energy, FE-3

SCOPE AND METHODOLOGY We conducted this review from February 2007 through May 2007 at the Office of Fossil Energy in Washington, D.C. and Sandia National Laboratories in Albuquerque, New Mexico. The scope of the review included site selection and evaluation activities related to the Reserve expansion project. To accomplish the review objective, we: Met with Department officials responsible for recommendations for the Reserve expansion project;

developing

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Reviewed Sandia's February, June, and December 2006 reports on the geological assessment of the Bruinsburg salt dome; Interviewed personnel from Sandia regarding the methodology used for the Bruinsburg geological assessment; Interviewed two private-sector geologists who disagreed with Sandia's methodology and conclusions; Obtained a listing of wells in the vicinity of the Bruinsburg salt dome, reviewed supporting documentation, and deternlined the disposition of the data for each well; Gathered documentation related to the acquisition of seismic data at Bruinsburg; Obtained additional non-public geotechnical information from one well and provided the information to Sandia for review; and, Reviewed environmental reports for documentation of historical brine leaks at Reserve sites.

CUSTOMER RESPONSE FORM The Office of Inspector General has a continuing interest in improving the usefulness of its products. We wish to make our reports as responsive as possible to our customers' requirements, and, therefore, ask that you consider sharing your thoughts with us. On the back of this form, you may suggest inlprovements to enhance the effectiveness of future reports. Please include answers to the following questions if they are applicable to you: (A) 1. What additional background information about the selection, scheduling, scope, or procedures of the inspection would have been helpful to the reader in understanding this report? (B) 2. What additional infomlation related to findings and recommendations could have been included in the report to assist management in implementing corrective actions? (C) 3. What fomat, stylistic, or organizational changes might have made this report's overall message more clear to the reader?

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U.S. Department of Energy (D) 4. What additional actions could the Office of Inspector General have taken on the issues discussed in this report which would have been helpful? (E) 5. Please include your name and telephone number so that we may contact you should we have any questions about your comments.

Name ___________ Telephone ___________

Date _____________ Organization _________

When you have completed this form, you may telefax it to the Office of Inspector General at (202) 586-0948, or you may mail it to: Office of Inspector General (IG- 1) Department of Energy Washington, DC 20585 ATTN: Customer Relations If you wish to discuss this report or your comments with a staff member of the Office of Inspector General, please contact Judy Garland-Smith (202) 5867828.

In: Strategic Petroleum Reserve Editors: Albert L. Strait

ISBN: 978-1-60692-290-3 © 2010 Nova Science Publishers, Inc.

Chapter 5

STRATEGIC PETROLEUM RESERVE - QUICK FACTS AND FREQUENTLY ASKED QUESTIONS U.S. Department of Energy The Strategic Petroleum Reserve is a U.S. Government complex of four sites with deep underground storage caverns created in salt domes along the Texas and Louisiana Gulf Coast that store emergency supplies of crude oil.

INVENTORY Current inventory: Click to open inventory update window Highest inventory - On April 2, 2008, the SPR inventory exceeded 700 million barrels, the highest level ever previously held. The former record was reached in late August 2005, just days before Hurricane Katrina hit the Gulf Coast, causing the SPR to conduct emergency releases. Repayment of the Katrina loans and resumption of the RIK program (in 2007) has restored the inventory to its former level and beyond. Current storage capacity - 727 million barrels

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U.S. Department of Energy Current days of import protection in SPR - 58 days (Maximum days of import protection in SPR - 118 days in 1985) International Energy Agency requirement - 90 days of import protection (both public and private stocks) (SPR and private company import protection - approximately 118 days) Average price paid for oil in the Reserve - $28.42 per barrel

DRAWDOWN CAPABILITY Maximum drawdown capability - 4.4 million barrels per day Time for oil to enter U.S. market - 13 days from Presidential decision

PAST SALES [CLICK ON LINK FOR MORE DETAILS] 2005 Hurricane Katrina Sale - 11 million barrels 1996-97 total non-emergency sales - 28 million barrels 1990/91 Desert Shield/Storm Sale - 21 million barrels (4 million in August 1990 test sale; 17 million in January 1991 Presidentiallyordered d rawdown) 1985 - Test Sale - 1.1 million barrels

PAST EXCHANGES [CLICK ON LINK FOR MORE DETAILS] June 2006 - exchanged 750 thousand barrels of sour crude with ConocoPhillips and Citgo due to the closure for several days of the Calcasieu Ship Channel to maritime traffic. The closure resulted from the release of a mixture of storm water and oil. Action was taken to avert temporary shutdown of both refineries. January 2006 - exchanged 767 thousand barrels of sour crude with Total Petrochemicals USA due to closure of the Sabine Neches ship channel to deep-draft vessels after a barge accident in the channel. Action was taken to avert temporary shutdown of the refinery.

Strategic Petroleum Reserve - Quick Facts and Frequently Asked … 107 Sep/Oct 2005- exchanged 9.8 million barrels of sweet and sour crude due to disruptions in Gulf of Mexico production and damage to terminals, pipelines and refineries caused by Hurricane Katrina. Sep/Nov 2004 - exchanged 5.4 milliion barrels of sweet crude due to disruptions in the Gulf of Mexico caused by Hurricane Ivan. Sep/Oct 2004 - exchanged 5.4 million barrels in response to physical shortages of crude oil supplies in the Gulf of Mexico following Hurricane Ivan. Oct 2002 - exchanged 296,000 barrels with Shell Pipeline Co. to secure Capline storage tanks in advance of Hurricane Lili. Sep/Oct 2000 - exchanged 30 million barrels in response to concern over low distillate levels in Northeast. July/August 2000 - exchanged 2.8 million barrels of crude oil for 1styear tank storage and stocks for 2 million barrel Northeast Home Heating Oil Reserve. June 2000 - exchanged 500,000 barrels each with CITGO and Conoco, due to blockage of the ship channel that allowed incoming crude oil shipments to those refineries. Action taken in order to avert temporary shutdown of both refineries. August 1998 - exchanged 11 million barrels of lower quality Maya crude in SPR with PEMEX for 8.5 million of higher quality crude (more suitable for U.S. refineries) April/May 1996 - exchanged 900,000 barrels of SPR crude with ARCO to resolve company's pipeline blockage problem.

FINANCIAL Investment to date - About $22 billion ($5 billion for facilities; $17 billion for crude oil)

FREQUENTLY ASKED QUESTIONS Question: When will President Bush's 2001 fill initiative be completed? Answer: The President's November 2001 directive to fill the SPR to 700 million barrels at a moderate rate using royalty-in-kind crude oil from U. S.

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Outer Continental Shelf leases was completed on August 27, 2005. However, Hurricane Katrina hit the region on August 29, 2005 and the resulting emergency loans of 9.8 million barrels and sale of 11 million barrels reduced the inventory to about 680 million barrels. The SPR's 700-million barrel milestone was again reached on April 2, 2008, using a combination of repayments of the Katrina loaned volumes plus accompanying premium barrels and resumption of the royalty-in-kind transfer program in 2007. Of the Katrina loans and associated premium barrels, 4.2 million barrels were repaid during October and November 2005, an additional 4.4 million barrels were repaid between February and May 2006, and the remaining 1.7 million barrels owed were repaid in April and May 2007. The 11 million barrels of oil sold were replaced through royalty-in-kind transfers. Subsequent to the 2001 directive, the Energy Policy Act of 2005 directed the fill of the SPR to one billion barrels and the SPR is currently acquiring oil to reach its physical capacity of 727 million barrels using royalty-inkind transfers. Question: What are royalty-in-kind transfers? Answer: A royalty-in-kind (RIK) transfer refers to crude oil that is produced from federal leases in the Gulf of Mexico and paid to the U.S. Government in lieu of cash royalty payments. The "in kind" payment of a percentage of the lease's production is paid to the Department of the Interior; ownership is then transferred at the market center to the Department of Energy for SPR fill. The SPR frequently solicits to exchange the royalty oil in place (at the market center) for crude oil that meets the quality specifications of the SPR. The exchange contracts include adjustments to the volume to be delivered to the SPR due to quality differences in the crude oil and the transportation costs. The RIK program is authorized by the Outer Continental Shelf Lands Act and the Energy Policy and Conservation Act. Question: What are deferrals and premium barrels? Answer: The Department of Energy has occasionally agreed to delays in scheduled deliveries to the SPR due to tight markets or disruptions in the marketplace that lead to, or contribute to, a backwardated market, i.e., prices in the future are lower than current prices. Deferrals are a means of acquiring oil for the SPR at no cost to the taxpayer. Deferrals are requested by the contractor and, if agreed to by the Department of Energy, are negotiated to provide premium barrels (similar to

Strategic Petroleum Reserve - Quick Facts and Frequently Asked … 109 interest) to the SPR, along with the contracted volumes, at a later date. Both the contractor and the Government benefit from the arrangement. Question: How and when will the oil that was released after Hurricane Katrina in 2005 be replaced? Answer: The volume of crude oil that was released after Hurricane Katrina was restored to the SPR at moderate rates over time. Repayments of loaned oil began during late Fall 2005 and concluded in the final repayment delivery in May 2007. Replacement of the sold oil was managed through the royalty-inkind program. The pre-Katrina inventory level was reached in April 2008. Replacement of the sold crude oil was attempted in 2007 using both direct purchase and the royalty-in-kind program. Solicitations for crude oil acquisition by direct purchases were issued in April and May 2007; funds for the purchases were to be from the Fall 2005 emergency sale receipts. However, neither solicitation resulted in award because the Department determined that the prices proposed were too high, and not a reasonable value for the taxpayer. There are no plans at this time to resolicit for purchases of crude oil. Had the purchase offers been successful, it would have been the first direct purchases of crude oil for the SPR since 1994. Prior to releasing the solicitations for both the direct purchase exchange contracts, an economic analysis was prepared in accordance with the Procedures for the Acquisition of Petroleum for the Strategic Petroleum Reserve. Question: What actions are being taken in response to the Energy Policy Act of 2005 that requires fill of the SPR to its authorized size of one billion barrels? Answer: The August 2005 EPACT directs fill as expeditiously as practicable, without incurring excessive cost or appreciably affecting the market price of petroleum products to consumers. It also requires that procedures for acquisition of crude oil be promulgated, an action that was completed with publication of the final rule on November 8, 2006. Further, in order to fill to one billion barrels, the capacity of the SPR must be increased from its current size of 727 million barrels. The expansion will require increasing the size of two current SPR sites (identified as Bayou Choctaw in Louisiana, and Big Hill in Texas), a process that may take 3-5 years, and constructing a new site (near Richton, Mississippi) that will store 160 million barrels, a process that is expected to take 10-12 years.

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The selection of the sites for expansion followed a 16-month long proceeding that included extensive public involvement. It resulted in release of the Final Environmental Impact Statement for Selection of Sites for Expansion of the Strategic Petroleum Reserve on December 8, 2006. The Secretary of Energy signed the Record of Decision on February 14, 2007, and the Department published a Plan for Expansion of the SPR to One Billion Barrels in June 2007. In January 2008, DOE issued a Notice of Intent to prepare a Supplemental Environmental Impact Statement and to solicit additional public comments. For more information, visit the SPR Expansion Web Page. Question: How will the acquisition procedures ensure that oil is acquired "without incurring excessive cost or appreciably affecting the market price of petroleum products to consumers"? Answer: DOE will strive to avoid incurring excessive cost or appreciably affecting the price of petroleum products to consumers by analyzing market activity for crude oil and related commodities and prices of oil for delivery in future months, as well as the perceived availability of near term and forward supplies. In doing so, DOE will consider the current level of the SPR and private inventories; national and regional import dependency; the outlook for international and domestic production levels; oil acquisition by other stockpiling entities; the extent to which the SPR fill rate and prices paid will impact supply availability and prices in the marketplace; incipient disruptions of suppply or refining capability; the level of market volatility; the demand and supply elasticity to price changes; logistics and economics of petroleum movement; and any other considerations that may be pertinent to the balance of petroleum supply and demand. The timing of DOE entry into the market, its sustained presence, and the quantities sought will all be sensitive to these factors. Question: When can the Reserve be used? Answer: The circumstances that might require the use of the Strategic Petroleum Reserve are defined in the Energy Policy and Conservation Act (EPCA). Generally, there are three possible types of drawdowns envisioned in the Act: Full drawdown: The President can order a full drawdown of the Reserve to counter a "severe energy supply interruption." EPCA

Strategic Petroleum Reserve - Quick Facts and Frequently Asked … 111 defines this as "a national energy supply shortage which the President determines (A) is, or is likely to be, of significant scope and duration, and of an emergeHncy nature (B) may cause major adverse impact on national safety or the national economy; and (C) results, or is likely to result, from (i) an interruption in the supply of imported petroleum products, (ii) an interruption in the supply of domestic petroleum products, or (iii) sabotage or an act of God. EPCA also states that a severe energy supply interruption "shall be deemed to exist if the President determines that – (A) an emergency situation exists and there is a significant reduction in supply which is of significant scope and duration; (B) a severe increase in the price of petroleum products has resulted from such emergency situation; and (C) such price increase is likely to cause a major adverse impact on the national economy."

Limited drawdown: If the President finds that – (A) a circumstance, other than those described [above] exists that constitutes, or is likely to become, a domestic or international energy supply shortages of significant scope or duration; and (B) action taken.. ..would assist directly and significantly in preventing or reducing the adverse impact of such shortage"

then the Secretary may draw down and distribute the Strategic Petroleum Reserve, although in no case: (C) in excess of an aggregate of 30,000,000 barrels.... (D) for more than 60 days.... (E) if there are fewer than 500,000,000 barrels... .stored in the Reserve."

Test Sale: The Secretary of Energy is authorized to carry out test drawdowns and distribution of crude oil from the Reserve. If any such test drawdown includes the sale or exchange of crude oil, "then the

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U.S. Department of Energy aggregate quantity of crude oil withdrawn from the Reserve may not exceed 5,000,000 barrels during any such test drawdown or distribution."

Question: Can oil be withdrawn from the Reserve for other reasons? Answer: Yes. The Department of Energy has the authority to exchange oil from the Reserve. These exchanges have been used in the past to replace less suitable grades of crude oil with higher-quality crudes and for limited, shortduration actions to assist petroleum companies in resolving oil delivery problems. In 2000, crude oil from the Reserve was exchanged for storage capacity and stocks to create the Northeast Heating Oil Reserve. During Fall 2005, an exchange was was conducted at the request of refineries in the Gulf Region when Hurricane Katrina caused disruptions to scheduled deliveries. During 2006, small exchanges occured in January and June when accidents in shipping channels disrupted marine deliveries to refiners. Question: How fast can oil be released from the Reserve? Answer: Should the President order an emergency sale of Strategic Petroleum Reserve oil, DOE can conduct a competition, select offers, award contracts, and be prepared to begin deliveries of oil into the marketplace within 13 days. Oil can be pumped from the Reserve at a maximum rate of 4.4 million barrels per day for up to 90 days, then the drawdown rate begins to decline as storage caverns are emptied. At 1 million barrels per day, the Reserve can release oil into the market continuously for nearly a year-and-ahalf. Question: What type of crude oil is stored in the Reserve? Answer: During the 30 years that the Strategic Petroleum Reserve has existed, crude oil has been acquired from 25 countries. The oil is categorized as either "sweet" (with a sulfur content not exceeding 0.5 percent by weight) or "sour" (with a sulfur content greater than 0.5 percent but less than 2.0 percent). The SPR accepts only crude oil that meets its quality specifications and it is co-mingled in caverns designated as either sweet or sour. Question: Why is only crude oil stored in the Reserve? Answer: The SPR is authorized by law to store both refined products and crude oil. However, in preparing the 1977 SPR Plan for development of the Reserve, an analysis of the U.S. refining industry indicated that the industry was robust and had the refining capacity to satisfy the major portion of the

Strategic Petroleum Reserve - Quick Facts and Frequently Asked … 113 nation's demand for petroleum products. This continues to be true today--30 years later. The U.S. petroleum import dependency is overwhelmingly crude oil, not refined products. In addition, crude oil, is cheaper to acquire, store and transport than refined products. Crude oil quality does not degrade over time as do refined products and crude oil provides flexibility in responding to fluctuations in refined product market needs; whereas, refined products are expensive to maintain and are subject to changes in specifications mandated by environmental legislation. Question: What is the ratio of sweet and sour crudes in the SPR? How was the ratio determined? Answer: Crude oil stored in the SPR is currently about 40% sweet and 60% sour. The ratio was established to meet the needs of the U.S. refining industry, particularly those in the districts most likely to take SPR crude in the event of a drawdown. Sweet crude oil can be processed by nearly all refiners; the same is not true for sour crude. Question: Why is the crude oil stored in salt domes? Answer: Salt formations offer the lowest cost, most environmentally secure way to store crude oil for long periods of time. Stockpiling oil in artificially-created caverns deep within the rock-hard salt costs historically about $3.50 per barrel in capital costs. Storing oil in above-ground tanks, by comparison, can cost $15 to $18 per barrel - or at least five times the expense. Also, because the salt caverns are 2,000- 4,000 feet below the surface, geologic pressures will seal any crack that develops in the salt formation, assuring that no crude oil leaks from the cavern. An added benefit is the natural temperature difference between the top of the caverns and the bottom a distance of around 2,000 feet; the temperature differential keeps the crude oil continuously circulating in the caverns, giving the oil a consistent quality. Question: How were the caverns created? Answer: Salt caverns are carved out of underground salt domes by a process called "solution mining." Essentially, the process involves drilling a well into a salt formation, then injecting massive amounts of fresh water. The water dissolves the salt. In creating the SPR caverns, the dissolved salt was removed as brine and either reinjected into disposal wells or more commonly, piped several miles offshore into the Gulf of Mexico. By carefully controlling the pressure and direction of the freshwater injection process, salt caverns of very precise dimensions can be created.

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Question: How is the salt able to contain the oil? Doesn't it dissolve or allow the oil to seep? Answer: Rock salt has a combination of characteristics that makes it highly attractive for cavern construction and petroleum storage. If relatively pure and not interbedded with significant quantities of other types of rock, it is generally impervious to liquid and gas and inert to petroleum, has a compression strength comparable to concrete under the weight of the overlying and surrounding rock, moves like plastic to seal incipient fractures, and can be mined easily by dissolving (leaching) with water. Question: How was the authorized one billion barrel size of the Reserve determined? Answer: Prior to Congress authorizing a crude oil national security storage system, studies were conducted to determine the optimum amount of crude oil that should be stored. Based upon the level of imports at that time (19741975), a reserve of 500 million barrels was recommended. Congress, however, foresaw that consumption of petroleum in the United States would increase over time and that import levels would also increase. Therefore, when the Energy Policy and Conservation Act passed in late 1975, the SPR size was authorized up to one billion barrels, with an initial size target of 500 million barrels. Question: How is days of import protection determined? Answer: The number of days of import protection are based on the SPR's current inventory level and the EIA's reported net petroleum imports. Question: How many people work at the Strategic Reserve? Answer: The Project Management Office (in New Orleans) and the SPR storage sites operate with a federal workforce of approximately 100 full- time equivalents. Major contractors and subcontractors provide services that support the SPR's program, as it relates to overall management and operations, security, design, construction management, and technical and business management activities. Contractor employees total approximately 950 fulltime equivalents.

In: Strategic Petroleum Reserve Editors: Albert L. Strait

ISBN: 978-1-60692-290-3 © 2010 Nova Science Publishers, Inc.

Chapter 6

EXPANDING THE NATION'S STRATEGIC PETROLEUM RESERVE U.S. Department of Energy The Energy Policy Act of 2005 (EPAct) directs the Secretary of Energy to fill the Strategic Petroleum Reserve (SPR) to its authorized one billion barrel capacity and to select sites necessary to enable acquisition by the Secretary of the full authorized volume. The current physical capacity of the SPR is 727 million barrels. Following passage of the EPAct in August 2005, the Department of Energy (DOE) began proceedings to select sites necessary to expand the SPR to one billion barrels. Thus far, DOE has issued the following: Expansion Plan (2007) to fill the SPR beyond 700 million barrels Environmental Impact Statement (2006) and Record of Decision (2007) for selection of a new site Supplemental Environmental Impact Statement (2008) to address newly identified issues

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In addition to current law that directs expansion of the SPR to one billion barrels, the President announced in January 2007 that the SPR should be expanded to 1.5 billion barrels in order to increase the Nation's energy security.

ENVIRONMENTAL IMPACT STATEMENT AND RECORD OF DECISION On December 8, 2006, after a 16-month long proceeding that included extensive public involement, DOE released the Final Environmental Impact Statement that identified the salt domes at Richton, near Hattiesburg, Mississippi, as the preferred site to lead the expansion. DOE had initially proposed to expand capacity at three existing SPR sites; however, the final decision was for expansion of two existing sites.

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On February 14, 2007, Secretary Bodman signed the Record of Decision selecting the following three sites for the expansion of the SPR storage capacity from 727 million barrels to one billion barrels: Richton, Mississippi (160 million barrels) Big Hill, Texas (80 million barrels) Bayou Choctaw, Louisiana (23 million barrels)

SUPPLEMENTAL ENVIRONMENTAL IMPACT STATEMENT (SEIS) Following issuance of the Record of Decision in 2007 and further discussion with officials of the State of Mississippi and the U.S. Fish and Wildlife Service, DOE notified Mississippi officials on January 23, 2008, of its decision to prepare a SEIS to address new issues raised relating to the water source for leaching caverns and the location of certain facilities for the planned expansion site at Richton.

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A Notice of Intent was published on March 5, 2008, that provides details about the scope and content of the SEIS. The SEIS process includes a public comment period during which interested agencies, organizations, Native American tribes, and members of the public will be encouraged to provide input and submit comments regarding the issues and impacts to be addressed and alternatives to be considered. Three public meetings were also announced. An amended notice was published on March 21, 2008, to add a fourth public meeting. Meetings were held in the Mississippi counties of Perry, Greene, George and Jackson during April 7-10. The public scoping period, to include both oral and written comments, concluded on April 29, 2008. Transcripts from the public meetings and the comments received during the scoping period are available.

EXPANSION PLAN TO ONE BILLION BARRELS Section 159(j) of the Energy Policy and Conservation Act (Public Law 94163), the authorizing legislation for the Strategic Petroleum Reserve, requires that, "If the Secretary determines expansion beyond 700,000,000 barrels of petroleum product inventory is appropriate, the Secretary shall submit a plan for expansion to the Congress." A Strategic Petroleum Reserve plan for the expansion to one billion barrels has been prepared. This plan describes the expansion objectives, the site selection process, the site development plans, the oil distribution plan and the implementation strategy. The plan was submitted to Congress in June 2007. DOE plans to begin expansion efforts in fiscal year 2008.

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EXPANSION BEYOND ONE BILLION BARRELS On January 23, 2007, the President announced in the State of the Union Address, his decision to expand the Strategic Petroleum Reserve to 1.5 billion barrels "to further protect America against disruptions to our oil supply." The Nation's need for the further expansion of the SPR is based on (a) growing U.S. consumption, increased imports and ever greater international risks, and (b) U.S. obligations under the International Energy Program, which requires the U.S. to maintain a 90 day stockpile of petroleum imports.

CHAPTER SOURCES The following chapters have been previously published: Chapter 1 – This is an edited, excerpted and augmented edition of a United States Congressional Research Service publication, Report Order Code RL33341, dated June 6, 2008. Chapter 2 – These remarks were delivered as Statement of Frank Rusco, Acting Director, Natural Resources and Environment, before the Select Committee on Energy Independence and Global Warming, U.S. House of Representatives, dated April 18, 2007. Chapter 3 – This is an edited, excerpted and augmented edition of a United States Government Accountability Office (GAO), Report to Congressional Committees. Publication GAO-06-872, dated August 2006. Chapter 4 - This is an edited, excerpted and augmented edition of a United States Department of Energy, Office of Inspector General, Office of Audit Services, Special Report, dated June 2007. Chapter 5 – This is an edited, excerpted and augmented edition of a United States Department of Energy publication, dated July 2008. Chapter 6 – This is an edited, excerpted and augmented edition of a United States Department of Energy publication, dated July 2008.

INDEX A academics, 81 accidents, 114 accounting, 36, 43, 44, 46 acquisitions, 41, 83 administration, 75 administrative, 21, 23, 27 advocacy, 4 aggregation, 67 aid, 6, 112 Alabama, 11 alternative, 6, 43, 49, 74, 100 alternative energy, 43 alternatives, 35, 44, 84, 99, 120 amendments, 53 analysts, 6, 13, 49, 50 annual rate, 74 antitrust, 10 appendix, 41, 79, 80, 85 appropriations, 6, 15, 16 Appropriations Committee, 16 Arabia, 40, 56, 58, 85, 86, 96 argument, 4, 9 armed conflict, 17 artificially-created, 115 Asia, 46, 74 asphalt, 96 assessment, 105

assumptions, 7, 34, 40, 42, 43, 58, 60, 65, 72, 73, 78, 85, 88, 90 Atlas, 102 attacks, 39, 50 auditing, 23, 41 Australia, 17, 95 Austria, 17, 95, 96 authority, 2, 9, 10, 15, 25, 26, 39, 52, 53, 114 availability, 3, 13, 16, 38, 43, 55, 112 averaging, 20, 23, 25, 26, 30, 34, 41, 51, 76, 79, 83

B back, 50, 54, 86, 105 background information, 105 bargaining, 53 barges, 48 base case, 69, 73, 90, 97 behavior, 53, 69 Belgium, 17, 95, 96 benchmark, 28 benefits, 34, 35, 38, 40, 41, 42, 43, 50, 65, 66, 69, 70, 71, 72, 73, 76, 79, 84, 87, 89, 97 biodiesel, 74 blind spot, 29 borrowing, 48

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Index

Bosnia, 96 budget deficit, 5, 15, 21 Bush Administration, 2, 3, 7, 10, 14 business management, 116

C Canada, 3, 17, 66, 67, 95 capital cost, 22, 71, 115 cash flow, 29 channels, 114 Chief of Staff, 104 China, 46, 74, 75 clean air, 17 Clinton Administration, 15, 16 closure, 42, 58, 59, 61, 62, 63, 64, 86, 108 coal, 74 Columbia, 67 Committee on Homeland Security, 36 commodities, 112 communication, 18 compatibility, 25, 40, 56, 67 competition, 27, 114 complexity, 21, 23, 27 compliance, 4, 70, 97 composition, 24, 25, 30 concrete, 116 conditioning, 13 Congress, 1, 2, 3, 5, 6, 7, 8, 9, 13, 14, 15, 16, 18, 21, 29, 33, 36, 38, 51, 78, 100, 116, 120 Congressional Budget Office, 75 Connecticut, 96 consensus, 40, 54, 81 consent, 8 conservation, 43, 74 construction, 71, 75, 116 consumers, 11, 22, 36, 66, 75, 90, 97, 111, 112 consumption, 36, 43, 45, 46, 116, 121 contingency, 13 contractors, 27, 38, 52, 116

contracts, 5, 8, 21, 24, 27, 28, 29, 46, 110, 111, 114 control, 27, 74 Corporate Average Fuel Economy, 35, 75 correlation, 12, 13 corrosion, 104 cost saving, 26, 30, 51, 79 cost-benefit analysis, 68 cost-effective, xi, xiii, 19, 21, 22, 23, 26, 27, 28, 29, 31, 43, 50, 78, 79 costs, 20, 24, 26, 27, 29, 35, 41, 43, 47, 49, 50, 69, 70, 71, 72, 73, 74, 79, 84, 89, 90, 110, 115 cost-sharing, 96 crack, 47, 115 current prices, 31, 52, 78, 110 customers, 105 Czech Republic, 17, 95

D debates, 13 decision makers, 55, 65 decision making, 2 decisions, 8, 14, 29, 34, 42, 43, 52, 53, 54, 55, 65, 77, 78, 79, 83 defense, 55 deficit, 18, 21, 48, 52 definition, 96 delivery, 2, 4, 7, 8, 23, 26, 31, 34, 41, 43, 46, 52, 54, 74, 76, 78, 79, 96, 111, 112, 114 Denmark, 17, 95, 96 density, 37, 95 Department of Energy,1, 4, 10, 17, 19, 21, 31, 33, 35, 36, 81, 82, 91, 99, 106, 107, 110, 114, 117, 123 Department of Homeland Security, 7 Department of Interior, 8, 19 Department of the Interior, 6, 21, 46, 110 deregulation, 13 Desert Storm, 48 developed countries, 75

Index developing countries, 75 diesel, 15, 25, 36, 57, 67, 68, 74 diesel fuel, 15 disaster, 64 dislocation, xi, 1, 3, 16 disposable income, 3 disposition, 105 dissatisfaction, 8 distribution, 37, 48, 80, 83, 113, 120 District of Columbia, 67 domestic crude, 45 domestic markets, 16 domestic petroleum, 113 draft, xiii, 20, 43, 78, 108 duration, 9, 10, 14, 16, 24, 29, 38, 62, 87, 89, 97, 113, 114

E economic activity, 36, 60, 89 economic growth, 35, 43, 74 economic losses, 38, 81, 84 economics, 112 elasticity, 73, 89, 97, 112 electric utilities, 96 electricity, 96 embargo, 1, 3, 4, 17, 21, 36, 37, 38, 39, 42, 58, 59, 61, 62, 63, 64, 65, 86 emergency preparedness, 15 emergency response, 4, 52 employees, 116 end-users, 96 energy, 2, 4, 5, 8, 9, 10, 11, 12, 15, 18, 35, 36, 43, 44, 48, 50, 52, 53, 75, 76, 81, 84, 88, 96, 97, 112, 113, 118 energy consumption, 36, 43 Energy Information Administration, 25, 35, 38, 81 Energy Information Administration (EIA), 25, 38, 81 Energy Policy Act, 1, 2, 5, 7, 10, 19, 22, 38, 70, 71, 74, 99, 110, 111, 117

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Energy Policy Act of 2005, 1, 2, 5, 7, 10, 19, 22, 38, 70, 71, 74, 99, 110, 111, 117 Energy Policy and Conservation Act, 1, 2, 3, 9, 30, 37, 52, 110, 112, 116, 120 energy supply, 2, 9, 10, 11, 12, 52, 112, 113 environmental issues, 97 Environmental Protection Agency, 97 estimating, 88, 100 ethanol, 74 Europe, 46 evening, 8 exercise, 26, 52 expansions, 22 expertise, 81 exporter, 86 exports, 86 extrapolation, 71 Exxon, 9 Exxon Valdez, 9

F February, 6, 22, 69, 86, 96, 102, 104, 105, 110, 112, 119 federal budget, 5, 15, 21, 29 federal funds, 96 federal government, 21, 28, 29, 31, 36, 97 Federal Register, 17 Federal Reserve, 55, 89 feet, 47, 102, 115 fertilizer, 36 finance, 5, 6, 15, 22 financial crisis, 74 financial performance, 29 Finland, 17, 95, 96 Fish and Wildlife Service, 119 flexibility, 20, 23, 24, 26, 28, 30, 43, 49, 52, 76, 78, 115 flood, 8 flooding, 14 fluctuations, 7, 26, 51, 115 foreign policy, 76

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Index

fossil, 18 fractures, 116 France, 17, 95, 96 fresh water, 115 freshwater, 115 fuel, 44, 58, 59, 61, 62, 63, 64, 67, 74, 87, 97 fuel efficiency, 44 fuel-efficient vehicles, 74 funding, 7 funds, 2, 5, 9, 46, 96, 111 futures, 31, 96, 97

G gas, 11, 17, 21, 74, 86, 116 gasoline, 2, 3, 8, 12, 14, 17, 25, 36, 37, 55, 57, 67, 68, 75 GDP, 35, 38, 40, 42, 55, 60, 62, 64, 65, 73, 77, 80, 83, 87, 88, 89, 90, 97 Georgia, 67 Germany, 17, 95, 96 Global Insight, 73, 88 Global Warming, 123 Globalization, 96 goals, 49 God, 113 goods and services, 36, 38 government, 1, 4, 6, 9, 19, 21, 23, 24, 27, 28, 29, 31, 35, 36, 37, 38, 41, 46, 54, 57, 76, 83, 96, 97 Government Accountability Office (GAO), 33, 123 grades, 24, 77, 114 grants, 74 gravity, 30, 31, 95, 96 Greece, 17, 95, 96 gross domestic product, 35, 38, 83 growth, 12, 35, 43, 44, 55, 74, 75 guidance, 52, 55 guidelines, 16

Gulf Coast, 10, 20, 23, 26, 28, 39, 42, 48, 56, 58, 61, 62, 63, 64, 65, 67, 85, 86, 107 Gulf of Mexico, 6, 11, 38, 46, 48, 85, 100, 109, 110, 115 Gulf War, 9, 14, 17, 39, 54

H harm, 33, 40, 55, 63, 65, 66, 76, 83 hearing, 21 heating, xi, 1, 5, 11, 13, 15, 16, 18, 36, 48, 55, 96 heating oil, 1, 5, 11, 15, 16, 18, 48, 55, 96 heavy oil, 20, 24, 25, 30, 31, 43, 67, 68, 96 higher quality, 48, 109 home heating oil, 15, 16, 36 homeland security, 7 Homeland Security, 7, 36 horizon, 70 House, xii, 2, 7, 8, 16, 123 Hungary, 17, 95 hurricane, 39, 42, 58, 61, 62, 63, 64, 65, 66, 85, 86 Hurricane Katrina, 31, 39, 48, 54, 67, 107, 108, 109, 110, 111, 114 hurricanes, 10, 12, 66, 68 hybrid, 74

I images, 35 implementation, 78, 120 imports, 3, 4, 11, 21, 26, 33, 37, 42, 46, 56, 67, 70, 116, 121 impurities, 86 in situ, 60, 88 incentive, 70 income, 3, 11 India, 46 industry, 4, 6, 22, 23, 26, 37, 40, 43, 49, 55, 57, 68, 78, 81, 83, 84, 97, 114, 115 inefficiency, 21, 24, 27

Index inert, 116 infrastructure, 4, 9, 74 injection, 4, 100, 115 injections, 4, 17 injury, viii inspection, 105 Inspector General, 21, 27, 31, 99, 104, 105, 106, 123 instabilities, 3 insurance, 8 integrity, 4, 17 International Energy Agency, 4, 10, 11, 14, 22, 37, 40, 41, 43, 53, 57, 68, 69, 70, 72, 75, 76, 82, 83, 84, 95, 96, 108 International Monetary Fund, 46, 96 interviews, 54, 81, 84 inventories, 10, 13, 16, 38, 46, 48, 50, 53, 55, 58, 70, 87, 112 Investigations, 6, 36 investment, 3, 13, 71, 74 Iran, 17, 40, 58, 85 Iraq, 7, 14 Ireland, 17, 95, 96 Israel, 3 Italy, 17, 95, 96

J Japan, 17, 46, 95 jet fuel, 67 judgment, 52, 53

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L lack of confidence, 13 land, 2, 5, 38 land acquisition, 2, 5 language, 2, 8, 16 large-scale, 90 law, 2, 8, 10, 52, 114, 118 laws, 23 leaching, 116, 119 leaks, 47, 100, 104, 105, 115 learning, 14 legislation, 2, 8, 9, 14, 17, 49, 115, 120 light trucks, 75 likelihood, 14, 21, 24, 28, 69, 73, 75, 77, 89, 97 linear, 71 loans, 107, 110 location, 4, 48, 100, 101, 119 logistics, 47, 112 long period, 47, 115 losses, 38, 42, 55, 82, 84, 85, 87, 88, 89 Louisiana, 2, 4, 11, 21, 22, 28, 37, 47, 48, 71, 107, 111, 119 Low Income Home Energy Assistance Program, 11 lower prices, 14 low-income, 11 Luxembourg, 17, 95, 96

M K

Katrina, 4, 7, 10, 11, 12, 15, 17, 31, 36, 39, 48, 54, 66, 68, 85, 107, 108, 109, 110, 111, 114 Korea, 17, 95 Kuwait, 5, 14, 50

Macedonia, 96 macroeconomic, 88, 90 macroeconomic models, 90 maintenance, 71 Malta, 96 management, 105, 116 marginal product, 5 maritime, 108 market value, 38 marketplace, 13, 74, 110, 112, 114

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Index

markets, 2, 3, 7, 8, 11, 12, 13, 14, 17, 23, 37, 76, 110 maximum price, 60, 64 Maya, 24, 96, 109 measures, 4, 18, 88, 100, 104 media, 67 Mexican, 18, 96 Mexico, 11, 47, 48, 104 military, 7, 86 million barrels per day, xiv, 11, 36, 39, 40, 46, 57, 59, 69, 85, 86, 87, 88, 100, 108, 114 Minerals Management Service (MMS), xiii, 6, 19, 21, 46 mining, 47, 115 minority, 6 misinterpretation, 11 Mississippi, 2, 5, 22, 71, 99, 101, 111, 118, 119, 120 MMS, xiii, 19, 20, 21 modeling, 79, 84 models, 33, 34, 38, 40, 42, 43, 56, 60, 62, 64, 65, 77, 78, 83, 85, 87, 90, 96 monetary policy, 55 money, 20, 26, 31, 38, 41, 51, 55, 83, 90 money supply, 55, 90 Monte Carlo, 89, 97 Montenegro, 96 movement, 4, 112 MS, 21

N nation, 3, 13, 21, 35, 43, 76, 115 National Academy of Sciences, xi, xiii, 22, 33, 40, 81, 95, 97 national security, 7, 52, 53, 79, 116 Native American, 120 natural, 11, 47, 64, 74, 115 natural gas, 11, 74 negative consequences, 76 negotiation, 69

Netherlands, 3, 17, 95, 96 network, 66 New Jersey, 96 New Mexico, 104 New Orleans, 116 New Zealand, 17, 95 non-emergency, 108 nongovernmental, 22 normal, 12, 25, 67, 68, 83, 85 normal distribution, 83 North America, 8 Northeast, 1, 5, 16, 48, 96, 109, 114 Northeast Home Heating Oil Reserve, 109 Norway, 17, 95, 96

O obligation, 43, 70 obligations, 10, 40, 53, 84, 121 Oceania, 46 Office of Management and Budget, 6 Offices of Congressional Relations and Public Affairs, 80 offshore, 1, 10, 31, 85, 115 oil production, 1, 36, 38, 39, 40, 42, 45, 46, 47, 55, 56, 58, 69, 75, 85, 86, 89, 96 oil refineries, 67, 68 oil spill, 9, 15 oils, 23, 25, 26, 30, 31, 67, 68 omnibus, 15 opportunity costs, 30 opposition, 7 oral, 120 ownership, 110

P perceptions, 3 periodic, 35, 43, 76, 79 permit, xii, 2, 8, 15, 17 Persian Gulf, 9, 14, 39, 40, 86 Persian Gulf War, 9, 14, 39

Index Petrochemicals, 108 petroleum, 2, 4, 9, 12, 13, 15, 17, 22, 30, 35, 36, 37, 42, 57, 66, 68, 69, 70, 74, 111, 112, 113, 114, 115, 116, 120, 121 petroleum products, 2, 9, 12, 22, 30, 35, 36, 37, 42, 57, 66, 68, 69, 70, 74, 111, 112, 113, 115 pipelines, 37, 48, 66, 85, 104, 109 planning, 35, 43, 67, 76 plants, 96 plastic, 116 platforms, 85 policy choice, 35, 43, 74 policy makers, 7 policymakers, xii, 2, 6, 8, 13, 43, 54, 66, 74, 77, 78 population, 46 Portugal, 17, 95, 96 power, 14, 66, 90 preference, 103 premium, 15, 52, 69, 88, 110 preparedness, 13 President Bush, xii, 2, 6, 8, 14, 30, 109 President Clinton, 10 press, 18 pressure, 2, 5, 6, 12, 13, 47, 48, 115 prevention, 104 price changes, 65, 112 price effect, 13 price elasticity, 89, 97 private, 4, 9, 13, 16, 37, 38, 46, 48, 58, 70, 83, 87, 96, 97, 100, 103, 105, 108, 112 private sector, 4, 9, 13, 16 private-sector, 100, 103, 105 probability, 73, 74, 75 producers, 3, 5, 34, 41, 52, 69, 76 product market, 115 production, 3, 10, 11, 12, 17, 25, 35, 36, 42, 45, 46, 53, 55, 56, 58, 59, 61, 62, 63, 64, 67, 68, 74, 85, 86, 87, 109, 110, 112 program, 1, 4, 10, 15, 19, 20, 21, 22, 23, 26, 27, 28, 29, 38, 43, 46, 50, 71, 74, 78, 79, 96, 97, 104, 107, 110, 111, 116

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property, 19, 21 protection, 35, 39, 42, 49, 50, 69, 70, 76, 100, 104, 108, 116 psychology, 60, 64, 88 public, 4, 9, 37, 57, 70, 81, 100, 105, 108, 112, 118, 120 public policy, 81 public sector, 9 purchasing power, 90

R random, 97 random numbers, 97 range, 31, 35, 40, 43, 47, 51, 54, 60, 64, 65, 69, 72, 73, 88 reading, 81 Reagan Administration, 5, 13 reasoning, 27 recession, 54 reconcile, 101 refineries, 10, 11, 20, 25, 35, 37, 40, 42, 48, 56, 66, 67, 68, 77, 108, 109, 114 refiners, 11, 23, 25, 31, 37, 39, 68, 77, 114, 115 refinery capacity, 11, 12 refining, 11, 12, 17, 20, 23, 25, 26, 35, 40, 48, 55, 66, 67, 68, 84, 112, 114, 115 reflection, 11 regional, 15, 16, 112 regulation, 10 regulations, 13 reliability, xiv, 100 research and development, 9 reserves, 4, 15, 17, 18, 34, 37, 38, 40, 41, 42, 46, 54, 56, 57, 58, 59, 60, 62, 63, 64, 65, 68, 75, 76, 83, 85, 87 resolution, 3 resources, 10 responsiveness, 88, 90, 97 revenue, 7, 22, 29, 96 Rhode Island, 96

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Index

risk, 69, 76, 97 risks, xiv, 99, 121 Rita, 4, 7, 10, 11, 12, 15, 17, 36, 39, 66, 68, 85 rolling, 16, 17 royalties, 1, 6, 7, 19, 21, 38, 46, 79 royalty, 1, 6, 8, 19, 20, 21, 22, 23, 26, 27, 28, 29, 30, 31, 38, 43, 46, 50, 71, 78, 79, 96, 109, 110, 111

S sabotage, 113 safety, 113 sales, 5, 15, 17, 18, 28, 48, 52, 53, 108 salt, 2, 4, 21, 37, 47, 48, 99, 100, 101, 102, 103, 105, 107, 115, 116, 118 salt domes, 2, 4, 48, 99, 100, 107, 115, 118 salt formation, 47, 101, 115 Saudi Arabia, 40, 56, 58, 62, 85, 86, 96 savings, 3, 24, 26, 30, 51, 79, 83 scarcity, 38 scheduling, 23, 105 security, 5, 7, 35, 39, 41, 43, 50, 52, 53, 55, 71, 75, 76, 79, 81, 83, 84, 86, 116, 118 seismic, xiv, 100, 101, 102, 103, 105 seismic data, xiv, 100, 101, 102, 103, 105 selecting, 119 senate, 17 Senate, 2, 6, 8, 16, 36 sensitivity, 89 September 11, 39, 50 Serbia, 96 series, 53 services, viii, 36, 38, 116 shape, 100, 101, 103 shares, 44 sharing, 10, 96, 105 Shell, 8, 109 shipping, 40, 66, 114 shock, 55, 89, 90 shocks, 36, 55, 90

short period, xii, 2, 9, 10 shortage, 3, 4, 10, 12, 14, 16, 37, 48, 53, 113 shortages, 2, 9, 12, 13, 14, 15, 39, 67, 109, 113 short-term, 39, 55, 67 simulation, 40, 90, 97 simulations, 20, 26, 51, 83, 88 siphon, 3 sites, xiv, 16, 22, 37, 38, 47, 71, 104, 105, 107, 111, 112, 116, 117, 118, 119 Slovenia, 96 Spain, 17, 95, 96 spare capacity, 13, 56, 59 spatial, 102 spectrum, 65, 77 speech, 30 spills, 104 stages, 56 standard deviation, 83 standards, 17, 23, 41, 75 Standards, 97 State of the Union, 30, 121 stock, 9, 13 stockpile, 3, 121 stockpiling, 112 storage, 1, 2, 3, 4, 5, 19, 22, 30, 47, 48, 56, 71, 99, 100, 102, 103, 107, 109, 114, 116, 119 storms, 4, 11 strains, 17 Strait of Hormuz, 40, 42, 58, 59, 61, 62, 63, 64, 86 Strategic Petroleum Reserve, 1, 3, 7, 15, 17, 18, 19, 21, 30, 33, 35, 36, 81, 95, 96, 99, 107, 111, 112, 113, 114, 117, 120, 121 strength, 116 stress, 13 sulfur, 37, 86, 95, 114 summer, 7, 8, 28, 55 suppliers, 31, 96 supply shock, 89 surplus, 75

Index Sweden, 17, 95, 96 switching, 58, 59, 61, 62, 63, 64, 87 Switzerland, 17, 95, 96

T tankers, 48 tanks, 47, 109, 115 technical assistance, 75 telephone, 106 temperature, 47, 115 terminals, 16, 66, 109 terrorism, 40, 42, 58, 59, 60, 61, 62, 63, 64, 76, 86 terrorist, 39, 50, 68, 86 terrorist acts, 68 terrorist attack, 39, 50, 86 Terrorists, 85 testimony, 19, 20, 22, 23 Texas, 2, 4, 11, 21, 22, 24, 37, 47, 71, 88, 107, 111, 119 threshold, 16, 17, 49 timing, 14, 30, 49, 50, 76, 112 title, 2, 8 trade, 3, 18, 22 trading, 14, 37 traffic, 108 transactions, 29 transcript, 82 transfer, 13, 46, 79, 110 transparent, 29, 51, 77 transport, 31, 66, 115 transportation, 12, 36, 44, 66, 110 Treasury, 1, 6, 7, 21, 22, 24, 28 tribes, 120 triggers, 20 trucks, 74 Turkey, 17, 95, 96

131

U U.S. economy, 19, 33, 34, 35, 36, 38, 39, 42, 43, 54, 55, 56, 66, 70, 75, 76, 81, 85, 88, 89 U.S. Treasury, 6, 21, 22, 24, 28 uncertainty, 53, 77, 97, 102, 103 United Kingdom, 17, 95, 96 universities, 97 updating, 23, 26, 65

V Valdez, 9 values, 29, 73, 97 vehicles, 74 Venezuela, 16, 26, 36, 39, 50, 52, 53, 56, 58, 85, 95 vessels, 37, 108 Vice President, 82 violent, 64 volatility, 20, 26, 41, 51, 83, 112

W war, 7, 14, 54 water, 4, 47, 86, 108, 115, 116, 119 web, 17, 101 Weeks Island, 15, 17 wells, 100, 101, 102, 105, 115 Western Europe, 46, 96 White House, 14 winter, 6, 11, 13, 15, 16, 26, 55 wisdom, 7 workers, 26, 39, 52, 53, 58, 85, 95 workforce, 116