Strategic Petroleum Reserve
Available Oil Can Provide Significant Benefits, but Many Factors Should Influence Future Decisions about Fill, Use, and Expansion Gao ID: GAO-06-872 August 24, 2006Congress 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.
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 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.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-06-872, Strategic Petroleum Reserve: Available Oil Can Provide Significant Benefits, but Many Factors Should Influence Future Decisions about Fill, Use, and Expansion
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Report to Congressional Requesters:
August 2006:
Strategic Petroleum Reserve:
Available Oil Can Provide Significant Benefits, but Many Factors Should
Influence Future Decisions about Fill, Use, and Expansion:
GAO-06-872:
GAO Highlights:
Highlights of GAO-06-872, a report to congressional requesters
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.
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 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.
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.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-06-872].
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Jim Wells at (202) 512-
6877 or wellsj@gao.gov.
[End of Section]
Contents:
Letter:
Results in Brief:
Background:
Based on Historical Experience, Experts Suggested Alternative Practices
for SPR Fill and Points to Consider for Use:
SPR Use during Disruptions Can Provide Substantial Benefits, but the
Magnitude of These Benefits Is Uncertain:
A Larger SPR Is Warranted If Demand for Oil Grows as Expected:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendixes:
Appendix I: Scope and Methodology:
Appendix II: Economic Modeling of Oil Supply Disruptions:
Oil Supply Disruption Scenarios:
Modeling of Economic Impacts:
Appendix III: Comments from the Department of Energy:
Appendix IV: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Ability of the SPR and International Reserves to Replace Oil:
Table 2: Maximum Monthly Increases in Oil Price, According to the
Office of Petroleum Reserves' Model:
Table 3: Ability of the SPR and International Reserves to Reduce Damage
to GDP, According to the Office of Petroleum Reserves' Model:
Table 4: Maximum Quarterly Increases in Oil Price, According to the EIA
Model:
Table 5: Ability of the SPR and International Reserves to Reduce Damage
to GDP, According to the EIA Model:
Table 6: Consumption of Imported Oil and Shipping Time for SPR Oil to
Various Regions:
Table 7: Members of the Group of Experts Compiled by GAO and the
National Academies:
Table 8: Amount of Crude Oil Disrupted over a 2-Year Period, by
Hypothetical Scenario:
Figures:
Figure 1: World Primary Energy Consumption:
Figure 2: U.S. Oil Consumption, by Sector, 2004:
Figure 3: United States' Use of Domestic and Imported Crude Oil:
Figure 4: World Oil Consumption, by Region:
Figure 5: SPR Inventory Over Time:
Figure 6: SPR Maximum Drawdown Capability:
Figure 7: United States' Current and Estimated Compliance with
International Energy Agency Obligation to Hold Reserves:
Abbreviations:
CAFE: Corporate Average Fuel Economy:
DOE: Department of Energy:
EIA: Energy Information Administration:
GDP: gross domestic product:
ORNL: Oak Ridge National Laboratory:
SPR: 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:
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.[Footnote 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 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.[Footnote 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."[Footnote 3] Crudes with relatively low
sulfur content are known as "sweet," while crudes with higher sulfur
content are known as "sour."[Footnote 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 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 goal was to maximize long-term protection against oil
supply disruptions. Some criticized filling the SPR at that time
because they believed doing so was increasing 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.[Footnote 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.
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 Sciences[Footnote 6] 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.[Footnote 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 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 little or no 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 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 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.[Footnote 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.[Footnote 9]
Figure 1: World Primary Energy Consumption:
[See PDF for image]
Source: GAO analysis of EIA data.
Note: Percentage shares may not add to 100 percent due to rounding.
[End of figure]
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.[Footnote 10]
Figure 2: U.S. Oil Consumption, by Sector, 2004:
[See PDF for image] - graphic text:
Source: GAO analysis of EIA data.
[End of figure] - graphic text:
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.
Figure 3: United States' Use of Domestic and Imported Crude Oil:
[See PDF for image] - graphic text:
Source: GAO analysis of EIA data.
[End of figure] - graphic text:
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 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.[Footnote 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.[Footnote 12] China
has overtaken Japan as the second largest oil consumer in the world,
second to the United States.
Figure 4: World Oil Consumption, by Region:
[See PDF for image] - graphic text:
Source: GAO analysis of EIA data.
[End of figure] - graphic text:
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).[Footnote 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 SPR-quality 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.
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 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.
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 claimed that
filling the SPR in 2001 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 little to no 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.[Footnote 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-term protection
against potential oil supply disruptions.[Footnote 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.[Footnote 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.
Figure 5: SPR Inventory Over Time:
[See PDF for image] - graphic text:
Source: GAO analysis of EIA data.
Note: Congress authorized the SPR in 1975, but filling the reserve did
not begin until 1977.
[End of figure] - graphic text:
Experts Generally Agreed That Recent SPR Acquisitions Caused Little
Increase in Oil Prices, and Suggested Practices to Reduce the Future
Cost of SPR Fill:
The President's directive to fill SPR in 2001 was controversial.
Several oil analysts and experts claimed 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,
believed that filling the SPR had little to no 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 small
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.
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-cost-averaging 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 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.[Footnote 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.[Footnote 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
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 oil-producing 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 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,[Footnote 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
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 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.
Figure 6: SPR Maximum Drawdown Capability:
[See PDF for image] - graphic text:
Source: DOE's Office of petroleum Reserves.
[End of figure] - graphic text:
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
government-controlled for emergency purposes.[Footnote 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 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.[Footnote 21] We did not independently verify the potential
drawdown rates of international reserves.
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 disruption.[Footnote 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.)
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.
Table 1: Ability of the SPR and International Reserves to Replace Oil:
Barrels in millions.
Hypothetical oil supply disruption scenario: Gulf Coast hurricane;
Disruption length (months): 6;
Disruption size: 155;
Excess capacity and fuel switching: 131;
Release from the SPR alone: Can replace oil?: Yes;
Release from the SPR alone: Volume of release: 24;
Release from the SPR and international reserves: Can replace oil?: Yes;
Release from the SPR and international reserves: Volume of release: 24.
Hypothetical oil supply disruption scenario: Venezuelan strike;
Disruption length (months): 5;
Disruption size: 307;
Excess capacity and fuel switching: 220;
Release from the SPR alone: Can replace oil?: Yes;
Release from the SPR alone: Volume of release: 87;
Release from the SPR and international reserves: Can replace oil?: Yes;
Release from the SPR and international reserves: Volume of release: 87.
Hypothetical oil supply disruption scenario: Iran embargo;
Disruption length (months): 18;
Disruption size: 1,478;
Excess capacity and fuel switching: 465;
Release from the SPR alone: Can replace oil?: No;
Release from the SPR alone: Volume of release: 684;
Release from the SPR and international reserves: Can replace oil?: Yes;
Release from the SPR and international reserves: Volume of release:
1,013.
Hypothetical oil supply disruption scenario: Saudi terrorism;
Disruption length (months): 8;
Disruption size: 882;
Excess capacity and fuel switching: 207;
Release from the SPR alone: Can replace oil?: No;
Release from the SPR alone: Volume of release: 650;
Release from the SPR and international reserves: Can replace oil?: Yes;
Release from the SPR and international reserves: Volume of release:
675.
Hypothetical oil supply disruption scenario: Strait of Hormuz closure;
Disruption length (months): 3;
Disruption size: 882;
Excess capacity and fuel switching: 78;
Release from the SPR alone: Can replace oil?: No;
Release from the SPR alone: Volume of release: 344;
Release from the SPR and international reserves: Can replace oil?: No;
Release from the SPR and international reserves: Volume of release:
688.
Hypothetical oil supply disruption scenario: Saudi shutdown;
Disruption length (months): 24;
Disruption size: 6,205;
Excess capacity and fuel switching: 620;
Release from the SPR alone: Can replace oil?: No;
Release from the SPR alone: Volume of release: 684;
Release from the SPR and international reserves: Can replace oil?: No;
Release from the SPR and international reserves: Volume of release:
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).
[End of table]
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 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 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.[Footnote 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.
Table 2: Maximum Monthly Increases in Oil Price, According to the
Office of Petroleum Reserves' Model:
Dollars per barrel.
Hypothetical oil supply disruption scenarios: Gulf Coast hurricane;
Maximum monthly oil price increase: No release: $5;
Maximum monthly oil price increase: SPR release: $0;
Maximum monthly oil price increase: SPR and international release: $0.
Hypothetical oil supply disruption scenarios: Venezuelan strike;
Maximum monthly oil price increase: No release: 11;
Maximum monthly oil price increase: SPR release: 0;
Maximum monthly oil price increase: SPR and international release: 0.
Hypothetical oil supply disruption scenarios: Iranian embargo;
Maximum monthly oil price increase: No release: 16;
Maximum monthly oil price increase: SPR release: 5;
Maximum monthly oil price increase: SPR and international release: 0.
Hypothetical oil supply disruption scenarios: Saudi terrorism;
Maximum monthly oil price increase: No release: 47;
Maximum monthly oil price increase: SPR release: 7;
Maximum monthly oil price increase: SPR and international release: 0.
Hypothetical oil supply disruption scenarios: Strait of Hormuz
closure[A];
Maximum monthly oil price increase: No release: 175;
Maximum monthly oil price increase: SPR release: 121;
Maximum monthly oil price increase: SPR and international release: 34.
Hypothetical oil supply disruption scenarios: Saudi shutdown;
Maximum monthly oil price increase: No release: 89;
Maximum monthly oil price increase: SPR release: 77;
Maximum monthly oil price increase: SPR and international release: 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.
[End of table]
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 6-month 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 24-month Saudi shutdown scenario, the model shows that economic
damage of approximately $662 billion occurs even if international
reserves were used in response to the disruption.
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.
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;
GDP damage caused by disruption: $7;
GDP damage that can be eliminated by reserves: SPR alone: $7;
GDP damage that can be eliminated by reserves: SPR and international
reserves: $7.
Hypothetical oil supply disruption scenarios: Venezuelan strike;
GDP damage caused by disruption: 23;
GDP damage that can be eliminated by reserves: SPR alone: 23;
GDP damage that can be eliminated by reserves: SPR and international
reserves: 23.
Hypothetical oil supply disruption scenarios: Iranian embargo;
GDP damage caused by disruption: 201;
GDP damage that can be eliminated by reserves: SPR alone: 132;
GDP damage that can be eliminated by reserves: SPR and international
reserves: 201.
Hypothetical oil supply disruption scenarios: Saudi terrorism;
GDP damage caused by disruption: 149;
GDP damage that can be eliminated by reserves: SPR alone: 142;
GDP damage that can be eliminated by reserves: SPR and international
reserves: 149.
Hypothetical oil supply disruption scenarios: Strait of Hormuz closure;
GDP damage caused by disruption: 146;
GDP damage that can be eliminated by reserves: SPR alone: 56;
GDP damage that can be eliminated by reserves: SPR and international
reserves: 118.
Hypothetical oil supply disruption scenarios: Saudi shutdown;
GDP damage caused by disruption: 832;
GDP damage that can be eliminated by reserves: SPR alone: 77;
GDP damage that can be eliminated by reserves: SPR and international
reserves: 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.
[End of Table]
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 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 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 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 4: Maximum Quarterly Increases in Oil Price, According to the EIA
Model:
Dollars per barrel.
Hypothetical oil supply disruption scenarios: Gulf Coast hurricane;
Maximum quarterly oil price increase: No release: $1 - $2;
Maximum quarterly oil price increase: SPR release: $0;
Maximum quarterly oil price increase: SPR and international release:
$0.
Hypothetical oil supply disruption scenarios: Venezuelan strike;
Maximum quarterly oil price increase: No release: 9 - 13;
Maximum quarterly oil price increase: SPR release: 0 - 2;
Maximum quarterly oil price increase: SPR and international release:
0 - 2.
Hypothetical oil supply disruption scenarios: Iranian embargo;
Maximum quarterly oil price increase: No release: 19 - 28;
Maximum quarterly oil price increase: SPR release: 11 - 17;
Maximum quarterly oil price increase: SPR and international release:
6 - 11.
Hypothetical oil supply disruption scenarios: Saudi terrorism;
Maximum quarterly oil price increase: No release: 39 - 67;
Maximum quarterly oil price increase: SPR release: 18 - 39;
Maximum quarterly oil price increase: SPR and international release:
15 - 35.
Hypothetical oil supply disruption scenarios: Strait of Hormuz closure;
Maximum quarterly oil price increase: No release: 54 - 82;
Maximum quarterly oil price increase: SPR release: 32 - 52;
Maximum quarterly oil price increase: SPR and international release:
11 - 24.
Hypothetical oil supply disruption scenarios: Saudi shutdown;
Maximum quarterly oil price increase: No release: 66 - 104;
Maximum quarterly oil price increase: SPR release: 60 - 96;
Maximum quarterly oil price increase: SPR and international release: 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.
[End of Table]
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.
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;
GDP damage caused by disruption: $0.4 - $1.0;
Damage that can be eliminated by reserves: SPR alone: $0.4 - $1.0;
Damage that can be eliminated by reserves: SPR and international
reserves: $0.4 - $1.0.
Hypothetical oil supply disruption scenarios: Venezuelan strike;
GDP damage caused by disruption: 2.6 - 7.5;
Damage that can be eliminated by reserves: SPR alone: 2.6 - 6.3;
Damage that can be eliminated by reserves: SPR and international
reserves: 2.6 - 6.3.
Hypothetical oil supply disruption scenarios: Iranian embargo;
GDP damage caused by disruption: 34 - 99;
Damage that can be eliminated by reserves: SPR alone: 15 - 38;
Damage that can be eliminated by reserves: SPR and international
reserves: 23 - 60.
Hypothetical oil supply disruption scenarios: Saudi terrorism;
GDP damage caused by disruption: 21 - 71;
Damage that can be eliminated by reserves: SPR alone: 13 - 34;
Damage that can be eliminated by reserves: SPR and international
reserves: 15 - 38.
Hypothetical oil supply disruption scenarios: Strait of Hormuz closure;
GDP damage caused by disruption: 16 - 48;
Damage that can be eliminated by reserves: SPR alone: 6.9 - 17;
Damage that can be eliminated by reserves: SPR and international
reserves: 13 - 34.
Hypothetical oil supply disruption scenarios: Saudi shutdown;
GDP damage caused by disruption: 137 - 442;
Damage that can be eliminated by reserves: SPR alone: 11 - 31;
Damage that can be eliminated by reserves: SPR and international
reserves: 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.
[End of table]
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.[Footnote 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.
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.[Footnote 25]
Table 6: Consumption of Imported Oil and Shipping Time for SPR Oil to
Various Regions:
Region[A]: 1 - East Coast;
2004 crude oil imports (millions of barrels per day)[B]: 1,370;
Days to reach region: 6 - 8.
Region[A]: 2 - Midwest;
2004 crude oil imports (millions of barrels per day)[B]: 519;
Days to reach region: 5 - 9.
Region[A]: 3 - Gulf Coast;
2004 crude oil imports (millions of barrels per day)[B]: 5,445;
Days to reach region:
