Strategic Petroleum Reserve
Issues Regarding the Inclusion of Refined Petroleum Products as Part of the Strategic Petroleum Reserve Gao ID: GAO-09-695T May 12, 2009The possibility of storing refined petroleum products as part of the Strategic Petroleum Reserve (SPR) has been contemplated since the SPR was created in 1975. The SPR, which currently holds about 700 million barrels of crude oil, was created to help insulate the U.S. economy from oil supply disruptions. However, the SPR does not contain refined products such as gasoline, diesel fuel, or jet fuel. The Energy Policy Act of 2005 directed the Department of Energy (DOE) to increase the SPR's capacity from 727 million barrels to 1 billion barrels, which it plans to do by 2018. With the possibility of including refined products as part of the expansion of the SPR, this testimony discusses (1) some of the arguments for and against including refined products in the SPR and (2) lessons learned from the management of the existing crude oil SPR that may be applicable to refined products. To address these issues, GAO relied on its 2006 report on the SPR (GAO-06-872), 2007 report on the globalization of petroleum products (GAO-08-14), and two 2008 testimonies on the cost-effectiveness of filling the SPR (GAO-08-512T and GAO-08-726T). GAO also reviewed prior DOE and International Energy Agency studies on refined product reserves.
Since the SPR, the largest emergency crude oil reserve in the world, was created in 1975 a number of arguments have been made for and against including refined petroleum products. Some of the arguments for including refined products in the SPR are: (1) the United States' increased reliance on imports and resulting exposure to supply disruptions or unexpected increases in demand elsewhere in the world, (2) possible reduced refinery capacity during weather related supply disruptions, (3) time needed for petroleum product imports to reach all regions of the United States in case of an emergency, and (4) port capacity bottlenecks in the United States, which limit the amount of petroleum products that can be imported quickly during emergencies. For example, the damage caused by Hurricane Katrina demonstrated that the concentration of refineries on the Gulf Coast and resulting damage to pipelines left the United States to rely on imports of refined product from Europe. Consequently, regions experienced a shortage of gasoline and prices rose. Conversely, some of the arguments against including refined products in the SPR are: (1) the surplus of refined products in Europe, (2) the high storage costs of refined products, (3) the use of a variety of different type of blends of refined products--"boutique" fuels--in the United States, and (4) policy alternatives that may diminish reliance on oil. For example, Europe has a surplus of gasoline products because of a shift to diesel engines, which experts say will continue for the foreseeable future. Europe's surplus of gasoline is available to the United States in emergencies and provided deliveries following Hurricanes Katrina and Rita in 2005. The following three lessons learned from the management of the existing SPR may have some applicability in dealing with refined products. (1) Select a cost-effective mix of products. In 2006, GAO recommended that DOE include at least 10 percent heavy crude oil 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 and heavy crude, the average differential from 2003 through 2007. Similarly, if directed to include refined products as part of the SPR, DOE will need to determine the most cost-effective mix of products. (2) Consider using a dollar-cost-averaging acquisition approach. Also in 2006, GAO recommended that DOE consider acquiring a steady dollar value--rather than a steady volume--of oil over time when filling the SPR. This would allow DOE to acquire more oil when prices are low and less when prices are high. GAO expects that a dollar-cost-averaging acquisition method would also provide benefits when acquiring refined products. (3) Maximize cost-effective storage options. According to DOE, below ground salt formations offer the lowest cost approach for storing crude oil for long periods of time--$3.50 per barrel in capital cost versus $15 to $18 per barrel for above ground storage tanks. Similarly, DOE will need to explore the most cost-effective storage options for refined products.
GAO-09-695T, Strategic Petroleum Reserve: Issues Regarding the Inclusion of Refined Petroleum Products as Part of the Strategic Petroleum Reserve
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Testimony:
Before the Committee on Energy and Natural Resources, U.S. Senate:
United States Government Accountability Office:
GAO:
For Release on Delivery:
Expected at 2:30 p.m. EDT:
Tuesday, May 12, 2009:
Strategic Petroleum Reserve:
Issues Regarding the Inclusion of Refined Petroleum Products as Part of
the Strategic Petroleum Reserve:
Statement of Frank Rusco, Director:
Natural Resources and Environment:
GAO-09-695T:
GAO Highlights:
Highlights of GAO-09-695T, a report to Committee on Energy and Natural
Resources, U.S. Senate.
Why GAO Did This Study:
The possibility of storing refined petroleum products as part of the
Strategic Petroleum Reserve (SPR) has been contemplated since the SPR
was created in 1975. The SPR, which currently holds about 700 million
barrels of crude oil, was created to help insulate the U.S. economy
from oil supply disruptions. However, the SPR does not contain refined
products such as gasoline, diesel fuel, or jet fuel. The Energy Policy
Act of 2005 directed the Department of Energy (DOE) to increase the SPR‘
s capacity from 727 million barrels to 1 billion barrels, which it
plans to do by 2018.
With the possibility of including refined products as part of the
expansion of the SPR, this testimony discusses (1) some of the
arguments for and against including refined products in the SPR and (2)
lessons learned from the management of the existing crude oil SPR that
may be applicable to refined products.
To address these issues, GAO relied on its 2006 report on the SPR
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-06-872], 2007 report
on the globalization of petroleum products [hyperlink,
http://www.gao.gov/cgi-bin/getrpt?GAO-08-14], and two 2008 testimonies
on the cost-effectiveness of filling the SPR [hyperlink,
http://www.gao.gov/cgi-bin/getrpt?GAO-08-521T] and [hyperlink,
http://www.gao.gov/cgi-bin/getrpt?GAO-08-726T]. GAO also reviewed prior
DOE and International Energy Agency studies on refined product
reserves.
What GAO Found:
Since the SPR, the largest emergency crude oil reserve in the world,
was created in 1975 a number of arguments have been made for and
against including refined petroleum products. Some of the arguments for
including refined products in the SPR are: (1) the United States‘
increased reliance on imports and resulting exposure to supply
disruptions or unexpected increases in demand elsewhere in the world,
(2) possible reduced refinery capacity during weather related supply
disruptions, (3) time needed for petroleum product imports to reach all
regions of the United States in case of an emergency, and (4) port
capacity bottlenecks in the United States, which limit the amount of
petroleum products that can be imported quickly during emergencies. For
example, the damage caused by Hurricane Katrina demonstrated that the
concentration of refineries on the Gulf Coast and resulting damage to
pipelines left the United States to rely on imports of refined product
from Europe. Consequently, regions experienced a shortage of gasoline
and prices rose. Conversely, some of the arguments against including
refined products in the SPR are: (1) the surplus of refined products in
Europe, (2) the high storage costs of refined products, (3) the use of
a variety of different type of blends of refined products”’boutique“
fuels”in the United States, and (4) policy alternatives that may
diminish reliance on oil. For example, Europe has a surplus of gasoline
products because of a shift to diesel engines, which experts say will
continue for the foreseeable future. Europe‘s surplus of gasoline is
available to the United States in emergencies and provided deliveries
following Hurricanes Katrina and Rita in 2005.
The following three lessons learned from the management of the existing
SPR may have some applicability in dealing with refined products.
* Select a cost-effective mix of products. In 2006, GAO recommended
that DOE include at least 10 percent heavy crude oil 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 and heavy crude,
the average differential from 2003 through 2007. Similarly, if directed
to include refined products as part of the SPR, DOE will need to
determine the most cost-effective mix of products.
* Consider using a dollar-cost-averaging acquisition approach. Also in
2006, GAO recommended that DOE consider acquiring a steady dollar value”
rather than a steady volume”of oil over time when filling the SPR. This
would allow DOE to acquire more oil when prices are low and less when
prices are high. GAO expects that a dollar-cost-averaging acquisition
method would also provide benefits when acquiring refined products.
* Maximize cost-effective storage options. According to DOE, below
ground salt formations offer the lowest cost approach for storing crude
oil for long periods of time”$3.50 per barrel in capital cost versus
$15 to $18 per barrel for above ground storage tanks. Similarly, DOE
will need to explore the most cost-effective storage options for
refined products.
View [hyperlink, http://www.gao.gov/products/GAO-09-695T] or key
components. For more information, contact Frank Rusco at (202) 512-3841
or ruscof@gao.gov.
[End of section]
Mr. Chairman and Members of the Committee:
I am pleased to be here today to participate in the Committee's hearing
on the proposal to include refined petroleum products as part of the
Strategic Petroleum Reserve (SPR). The Energy Policy and Conservation
Act authorized the establishment of the SPR in 1975 to help protect the
U.S. economy from damage caused by oil supply disruptions following the
Arab oil embargo of 1973 to 1974.[Footnote 1] The SPR, which consists
of over 700 million barrels of crude oil stored in salt caverns in
Texas and Louisiana, is owned by the federal government and operated by
the Department of Energy (DOE). When processed, crude oil is refined to
produce petroleum products such as gasoline, diesel, and jet fuel. As
originally enacted, the Energy Policy and Conservation Act envisioned
the possibility that the SPR would include a variety of petroleum
products stored at locations across the country. Specifically, section
154(d) of the 1975 act stated that:
The Strategic Petroleum Reserve Plan shall be designed to assure, to
the maximum extent practicable, that the Reserve will minimize the
impact of any interruption or reduction in imports of refined petroleum
products and residual fuel oil in any region which the Administrator
determines is, or is likely to become, dependent upon such imports for
a substantial portion of the total energy requirements of such region.
The Strategic Petroleum Reserve Plan shall be designed to assure, to
the maximum extent practicable, that each noncontiguous area of the
United States which does not have overland access to domestic crude oil
production has its component of the Strategic Petroleum Reserve within
its respective territory.[Footnote 2]
However, a Federal Energy Administration (FEA) study in 1977[Footnote
3] found that, at that time, it was less costly to maintain a
centralized crude oil reserve rather than dispersed storage with
multiple product reserves. The possibility of including refined
petroleum products at part of the SPR has been studied periodically by
DOE since the mid-1970s and each time the idea has been rejected.
Since 1974, the United States and 27 other nations have become members
of the International Energy Agency (IEA) and 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 4] IEA member nations fulfill this obligation in
various ways; some countries require that industry hold reserves,
others have created government reserves, and some countries hold a
combination of the two. Additionally, some IEA countries hold refined
products in addition to crude oil reserves while the U.S. holds only
crude oil. In May 2009, the SPR contained about 719 million barrels,
equal to about 65 days of 2008 U.S. average net monthly oil imports. In
addition to government reserves, private industry inventory of crude
oil and petroleum products varies over time, but DOE estimates that
private inventory contains an amount equivalent 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 and
petroleum products to exceed the United States' 90-day reserve
requirement.
The Energy Policy Act of 2005 directed DOE to increase the SPR
inventory to 1 billion barrels.[Footnote 5] DOE plans to accomplish
this increase by 2018 and has chosen to increase the size of two
current SPR sites and create one new site to accommodate the expansion
in inventory. In August 2006 we made a number of recommendations to the
Secretary of Energy to improve the operation of the SPR and to improve
decisions surrounding the SPR's use and expansion.[Footnote 6]
Specifically, we recommended, among other things, that the Secretary
should study how to best implement experts' suggestions to fill the SPR
more cost-effectively and to conduct a new review about the optimal oil
mix in the SPR. Largely based on our August 2006 report, we testified
twice in 2008 on options for DOE to improve the cost-effectiveness of
filling the SPR to 1 billion barrels.[Footnote 7]
With the expansion of the SPR, the issue of including refined petroleum
products has resurfaced. As Congress debates whether to require DOE to
include refined petroleum products, our testimony today will (1)
summarize some of the arguments for and against including refined
petroleum products and (2) highlight some of the lesson learned from
the management of the existing SPR that may be applicable to refined
petroleum products.
To address these issues, we reviewed our August 2006 report on the SPR,
our December 2007 report on the globalization of petroleum products,
[Footnote 8] and our two 2008 testimonies on the cost-effectiveness of
filling the SPR. We also reviewed the Energy Policy and Conservation
Act, as amended; the regulations on the acquisition of petroleum for
the SPR;[Footnote 9] and prior DOE studies on the feasibility of
including refined petroleum products as part of the SPR. In addition,
we spoke with an IEA official and we reviewed IEA documents dealing
with the issue of refined petroleum product reserves in the United
States and other IEA member countries overseas. We conducted our work
from April 2009 to May 2009 in accordance with all sections of GAO's
Quality Assurance Framework that are relevant to our objectives. The
framework requires that we plan and perform the engagement to obtain
sufficient and appropriate evidence to meet our stated objectives and
to discuss any limitations in our work. We believe that the information
and data obtained, and the analysis conducted, provide a reasonable
basis for any findings and conclusions.
Background:
The United States is the largest consumer of crude oil and petroleum
products. In 2007, the U.S. share of world oil consumption was
approximately 24 percent. While DOE projects that U.S. demand for oil
will continue to grow, domestic production has generally been in
decline for decades, leading to greater reliance on imported oil. U.S.
imports of oil have increased from 32 percent of domestic demand in
1985 to 58 percent in 2007.
In managing the SPR, the Secretary of Energy is authorized by the
Energy Policy and Conservation Act, as amended, to place in storage,
transport, or exchange, (1) crude oil produced from federal lands; (2)
crude oil which the United States is entitled to receive in kind as
royalties from production on federal lands; and (3) petroleum products
acquired by purchase, exchange, or otherwise.[Footnote 10] The act also
states that the Secretary shall, to the greatest extent practicable,
acquire petroleum products for the SPR in a manner that minimizes the
cost of the SPR and the nation's vulnerability to a severe energy
supply interruption, among other things.[Footnote 11] In addition,
until being repealed in 2000, the act provided the Secretary
discretionary authority to require importers and refiners of petroleum
products to store and maintain readily available inventories, and it
directed the Secretary to establish and maintain regional petroleum
reserves under certain circumstances.[Footnote 12]
Under conditions prescribed by Energy Policy and Conservation Act, as
amended, the President has the discretion to authorize the Secretary of
Energy to release the oil in the SPR to minimize significant supply
disruptions.[Footnote 13] 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. 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. 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. 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.
Oil markets have changed substantially in the 34 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.
In response to various congressional directives, DOE has studied the
issue of including refined petroleum products at various times since
1975. After the initial SPR plan was developed, the issue was reviewed
again in whole, or in part, in 1977, 1982, 1989, and 1998.[Footnote 14]
Except for the 1998 report, DOE concluded that including refined
petroleum products as part of the SPR was unnecessary and too
expensive. The 1998 study dealt with establishing a home heating oil
reserve and while it did not conclude that a reserve should or should
not be established, it did find the construction of such a reserve
would have net negative benefits. The 2000 amendments to the Energy
Policy and Conservation Act authorized the Secretary to establish a
Northeast Home Heating Oil Reserve, which was created and filled that
same year. Although this reserve is considered separate from the SPR,
it is authorized to contain 2 million barrels of heating oil and
currently holds nearly that amount.[Footnote 15] The Reserve is an
emergency source of heating oil to address a severe energy supply
interruption in the Northeast.[Footnote 16] According to DOE, the
intent was to create a reserve large enough to allow commercial
companies to compensate for interruptions in supply of heating oil
during severe winter weather, but not so large as to dissuade suppliers
from responding to increasing prices as a sign that more supply is
needed. To date, the Northeast Home Heating Oil Reserve has not been
used to address an emergency winter shortage situation.
Some of the Arguments For and Against Including Refined Petroleum
Products in the SPR:
Some of the arguments for including refined petroleum products in the
SPR are: (1) the United States' increased reliance on foreign imports
and resulting exposure to supply disruptions or unexpected increases in
demand elsewhere in the world, (2) possible reduced refinery capacity
during weather related supply disruptions, (3) time needed for
petroleum product imports to reach all regions of the United States in
case of an emergency, and (4) port capacity bottlenecks in the United
States which limit the amount of petroleum products that can be
imported quickly during emergencies. Some of the arguments against
including refined petroleum products in the SPR are: (1) the surplus of
gasoline in Europe, (2) the high storage costs of refined products, (3)
the use of 'boutique' fuels in the United States, and (4) policy
alternatives may diminish U.S. reliance on oil.
Some of the Arguments for Including Refined Petroleum Products in the
SPR:
First, in our December 2007 report,[Footnote 17] we found that while
the United States was largely self-sufficient in gasoline in 1970, in
fiscal year 2007, we imported over 10 percent of our annual consumption
of gasoline and smaller percentages of jet fuel and some other
products.[Footnote 18] We also found that along with an increased
reliance on imports the United States is exposed to supply disruptions
or unexpected increases in demand anywhere else in the world. Because
the SPR contains only crude oil, if an unexpected supply disruption
occurs in a supply center for the United States, the government's
emergency strategy would rely on sufficient volumes of the SPR and a
refinery sector able to turn out products at a pace necessary to meet
consumer demands in a crisis. Any growth in demand in the United States
would put increasing pressure on this policy, and for much of the past
25 years, demand for refined petroleum products in the United States
and internationally has outpaced growth in refining capacity.
Second, in our August 2006 report,[Footnote 19] we found that the
ability of the SPR to reduce economic damage may be impaired if
refineries are not able to operate at capacity or transport of oil to
refineries is delayed. For example, petroleum product prices still
increased dramatically following Hurricanes Katrina and Rita, in part
because many refineries are located in the Gulf Coast region and power
outages shut down pipelines that refineries depend upon to supply their
crude oil and to transport their refined petroleum products to
consumers. DOE reported that 21 refineries in affected states were
either shut down or operating at reduced capacity in the aftermath of
the hurricane. In total, nearly 30 percent of the refining capacity in
the United States was shut down, disrupting supplies of gasoline and
other products. Two pipelines that send petroleum products from the
Gulf coast to the East Coast and the Midwest were also shut down as a
result of Hurricane Katrina. 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, average retail gasoline prices increased 45 cents per
gallon between August 29 and September 5, short-term gasoline shortages
occurred in some places, and the media reported gasoline prices greater
than $5 per gallon in Georgia. The hurricane came on the heels of a
period of high crude oil prices and a tight balance worldwide between
petroleum demand and supply, and illustrated the volatility of gasoline
prices given the vulnerability of the gasoline infrastructure to
natural or other disruptions.
Third, because some foreign suppliers are farther from the U.S. demand
centers they serve than the relevant domestic supply center, the time
it takes to get additional product to a demand center experiencing a
supply shortfall may be longer than it would be if the United States
had its own product reserves. For example, imports of gasoline to the
West Coast may come from as far away as Asia or the Middle East, and
the transport time and therefore cost is greater. To the extent that
imported gasoline or other petroleum products come from far away, the
lengthening of the supply chain has implications for the ability to
respond rapidly to domestic supply shortfalls. Specifically, if
supplies to relieve a domestic regional supply shortfall must come from
farther away, the price increases associated with such shortfalls may
be greater and/or last longer. In this sense, the West Coast and the
middle of the country are more vulnerable to price increases or
volatility than is the Northeast, which can receive shipments of
gasoline from Europe, often on voyages of less than a week.
Fourth, the receipt of petroleum products may be delayed because port
facilities are operating at or near capacity. For example, one-fourth
of the ports in a U.S. Maritime Administration (MARAD) survey described
their infrastructure impediments as "severe." Officials from the
interagency U. S. Committee on the Maritime Transportation System,
which includes MARAD, the National Oceanic and Atmospheric
Administration, and the U.S. Army Corps of Engineers, told us that U.S.
ports and waterways are constrained in capacity and utilization, and
anticipate marine supply infrastructure will become more constrained in
the future. Officials at the Ports of Los Angeles, Long Beach, Oakland,
Houston, Savannah, and Charleston reported congestion and emphasized in
a 2005 report that they are experiencing higher than projected growth
levels. In fact, one European product transporter we spoke with said
that the European response to Hurricanes Rita and Katrina were hindered
because East Coast ports in the United States could not handle the
number of oil tankers carrying petroleum products from Europe, with
some tankers waiting for as long as 2 weeks at port.
Some of the Arguments Against Including Refined Petroleum Products in
the SPR:
First, a key impetus for global trade in petroleum products has been a
structural surplus in production of gasoline and a deficit in
production of diesel in Europe. This surplus of gasoline is largely the
result of a systematic switch in European countries toward automobiles
with diesel-powered engines, which are more fuel efficient than
gasoline-powered engines. European regulators promoted diesel fuel use
in Europe by taxing diesel at a lower rate, and European demand for
diesel vehicles rose. The European refining and marketing sector
responded to this change in demand by importing increasing amounts of
diesel, and exporting a growing surplus of gasoline to the United
States and elsewhere. The United States has purchased increasing
amounts of gasoline, including gasoline blendstocks, from Europe in
recent years. These imports have generally had a strong seasonal
component, with higher levels of imports during the peak summer driving
months and lower imports during the fall and winter. The major
exception to this seasonality came in the months of October 2005
through January 2006, when imports surged in response to U.S.
shortfalls resulting from Hurricanes Katrina and Rita in August and
September 2005, respectively. Experts and company representatives told
us they believe this structural imbalance within the European Union
will continue for the foreseeable future, and perhaps widen, resulting
in more exports of European gasoline and blending components to the
United States.
Second, in its prior reports on the subject, DOE found that refined
petroleum product reserves are more costly than crude oil to store and
must be periodically used and replaced to avoid deterioration of the
products. Although DOE officials said some refined products can be
stored in salt caverns just as the SPR crude oil is currently stored,
these caverns are predominantly found on the Gulf Coast. In order to
store refined product in other parts of the United States, storage
tanks may need to be built, which is costlier than centralized salt
cavern storage. According to DOE, stockpiling oil in salt caverns costs
about $3.50 per barrel in capital costs. Storing oil in aboveground
tanks, by comparison, can cost $15 to $18 per barrel. One of the
maintenance costs of refined petroleum products that is not associated
with crude oil storage is turnover, or replacement costs, because
refined products deteriorate more quickly. Turnover of the product is
required to ensure quality. For example, DOE found that when gasoline
is stored in above-ground tanks, the turnover time is 18 to 24 months.
Conversely, DOE found that crude oil could be stored for prolonged
periods without losing quality. The more frequent the turnover, the
higher the throughput and administrative costs.
Third, while the language in the Energy Policy and Conservation Act
addresses refined petroleum products as well as crude oil, DOE
conducted a study in 1977 that found geographically dispersed, small
reserves of a variety of petroleum products would be more costly than a
centralized crude oil reserve. For example, many states have adopted
the use of special gasoline blends--or 'boutique' fuels, which could
pose a challenge in incorporating refined products in the SPR. Unless
requirements to use these fuels were waived during emergencies, as they
were in the aftermath of Hurricanes Katrina and Rita, boutique fuels
could need to be strategically stored at multiple regional, state, or
local locations due to reduced product fungibility. Conversely, crude
oil provides flexibility in responding to fluctuations in refined
product market needs as regional fuel specifications and environmental
requirements change over time. Furthermore, the switching of seasonal
blends to meet environmental requirements and product degradation would
require inventory turnover as compared to crude oil storage, which does
not require the same level of turnover.
Fourth, there are several policy choices that might diminish the growth
in U.S. demand for oil. First, research and investment in alternative
fuels might reduce the growth of 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, 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, as
amended, directs the Secretary of Energy to establish a program that
includes grants to automobile manufacturers to encourage domestic
production of these vehicles.[Footnote 20] Third, improving the
Corporate Average Fuel Economy (CAFE) standards could curb demand for
petroleum fuels. 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.
[Footnote 21] More recently, the fuel economy of new vehicles in the
United States has stagnated at approximately 21 miles per gallon.
However, CAFE standards have recently been raised to require auto
manufacturers to achieve a combined fuel economy average of 35 miles
per gallon for both passenger and non-passenger vehicles beginning in
model year 2020.[Footnote 22] Any future increases could further
decrease the U.S. oil demand.
Lessons Learned from the Management of the Existing SPR that May Be
Relevant to Refined Petroleum Products:
The following three lessons learned from the management of the existing
crude oil SPR highlight some of the issues that may need to be
considered in acquiring refined petroleum products.
* Select a cost-effective mix of products. To fill the SPR in a more
cost-effective manner, we recommended in August 2006 that DOE include
in the SPR at least 10 percent heavy crude oils,[Footnote 23] which are
generally cheaper to acquire than the lighter oils that comprise the
SPR's volume.[Footnote 24] Including heavier oil in the SPR could
significantly reduce fill costs because heavier oil is generally less
expensive than lighter grades. For example, 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 SPR
with 100 million barrels of heavy oil.[Footnote 25] Similarly, refined
petroleum products included as part of the SPR may comprise a number of
different types of products (e.g., gasoline, diesel, and jet fuel) and
possibly different blends of products (e.g., different grades and
mixtures of gasoline); DOE will need to determine the most cost-
effective mix of products in light of existing legal and regulatory
requirements to use specific blends of fuels.
* Consider using a dollar-cost-averaging acquisition approach. Also in
our August 2006 report, we recommended that DOE consider filling the
SPR by acquiring a steady dollar value of oil over time, rather than a
steady volume as has occurred in recent years. This "dollar-cost-
averaging" 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 August 2006, we reported 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 would expect a dollar-cost-averaging
acquisition method to also provide positive benefits when acquiring
refined petroleum products.
* Maximize cost-effective storage options. According to DOE, 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 rock-hard salt, has
historically cost about $3.50 per barrel in capital costs. In
comparison, storing oil in above-ground tanks can cost $15 to $18 per
barrel. Similarly, for those refined petroleum products that can be
stored below ground, salt formations may offer a cost-effective storage
option. However, possible storage options would need to be evaluated
hand-in-hand with the need to (1) turn over the refined stocks
periodically because their stability deteriorates over time, and (2)
transport the refined petroleum products quickly to major population
centers where the products will be used.
Mr. Chairman, this concludes my prepared statement. I would be pleased
to answer any questions that you or other Members of the Committee may
have at this time.
GAO Contacts and Staff Acknowledgments:
For further information about this testimony, please contact Frank
Rusco at (202) 512-3841 or ruscof@gao.gov. Contact points for our
Offices of Congressional Relations and Public Affairs may be found on
the last page of this statement. Individuals making key contributions
to this testimony include Jeffery D. Malcolm, Assistant Director, and
Holly Sasso. Also contributing to this testimony were Josey Ballenger,
Philip Farah, Quindi Franco, Michelle Munn, Benjamin Shouse, Karla
Springer, and Barbara Timmerman.
[End of section]
Footnotes:
[1] Pub. L. No. 94-163, Title I, Part B, 89 Stat. 881-90 (1975),
codified as amended at 42 U.S.C. §§ 6231-6247(b).
[2] Repealed by Pub. L. No. 106-469, Title I, § 103(7)(C), 114 Stat.
2030 (2000).
[3] FEA, which was a predecessor agency to DOE, authored the 1977
study. FEA's functions were transferred to DOE effective October 1,
1977.
[4] The 28 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, Poland,
Portugal, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United
Kingdom, and United States.
[5] Pub. L. No. 109-58, Title III, § 301(e)(1), 119 Stat. 684 (2005).
[6] GAO, Strategic Petroleum Reserve: Available Oil Can Provide
Significant Benefits, but Many Factors Should Influence Future
Decisions about Fill, Use, and Expansion, [hyperlink,
http://www.gao.gov/products/GAO-06-872] (Washington, D.C.: Aug. 24,
2006).
[7] GAO, Strategic Petroleum Reserve: Options to Improve the Cost-
Effectiveness of Filling the Reserve, [hyperlink,
http://www.gao.gov/products/GAO-08-521T], (Washington, D.C.: Feb. 26,
2008); and GAO, Strategic Petroleum Reserve: Improving the Cost-
Effectiveness of Filling the Reserve, [hyperlink,
http://www.gao.gov/products/GAO-08-726T] (Washington, D.C.: Apr. 24,
2008).
[8] GAO, Energy Markets: Increasing Globalization of Petroleum Products
Markets, Tightening Refining Demand and Supply Balance, and Other
Trends Have Implications for U.S. Energy Supply, Prices, and Price
Volatility, [hyperlink, http://www.gao.gov/products/GAO-08-14]
(Washington, D.C.: Dec. 20, 2007).
[9] 10 C.F.R. Part 626.
[10] 42 U.S.C. § 6240(a).
[11] 42 U.S.C. § 6240(b).
[12] Pub. L. No. 94-163, Title 1, Part B, §§ 156, 157, 89 Stat. 885-86
(1975), previously codified as amended at 42 U.S.C. § 6236 (Industrial
Petroleum Reserve) and § 6237 (Regional Petroleum Reserve),
respectively. Repealed by Pub. L. No. 106-469, Title I, §§ 103(9),(10),
114 Stat. 2030 (2000).
[13] Pub. L. No. 94-163, § 161, 89 Stat. 888-89 (1975), codified as
amended at 42 U.S.C. § 6241.
[14] Federal Energy Administration, Strategic Petroleum Reserve Office,
Strategic Petroleum Reserve Plan, Energy Publication No. 95-2
(Washington, D.C.: January 1977); DOE, Office of the Secretary, A
Report to the Congress: Regional Petroleum Reserves, DOE/EP-0080
(Washington, D.C.: Dec. 31, 1982); DOE, Office of the Assistant
Secretary for Fossil Energy, Report to the Congress on Expansion of the
Strategic Petroleum Reserve to One Billion Barrels, DOE/FE-0126
(Washington, D.C.: Apr. 1989); DOE, Office of the Assistant Secretary
for Fossil Energy, Report to Congress on the Feasibility of
Establishing a Heating Oil Component of the Strategic Petroleum
Reserve, DOE/FE-0376 (Washington, D.C.: June 1998).
[15] During June 2007, DOE sold 35,000 of its two million barrel
reserve in order to cover the higher costs of new storage contracts. In
August 2008, DOE repurchased 19,253 barrels of heating oil using $3
million of appropriated funds, taking the inventory to 1,984,253
barrels.
[16] Pub. L. No. 106-469, Title II, 114 Stat. 2034-37 (2000), codified
as amended at 42 U.S.C. §§ 6250-6250e.
[17] [hyperlink, http://www.gao.gov/products/GAO-08-14].
[18] Total gasoline includes both finished motor gasoline and motor
gasoline blending components.
[19] [hyperlink, http://www.gao.gov/products/GAO-06-872].
[20] Pub. L. No. 109-58, Title VII, § 712, 119 Stat. 818 (2005),
codified as amended at 42 U.S.C. 16062.
[21] 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.
[22] Pub. L. No. 110-140, §102, 121 Stat. 1498 (2007).
[23] [hyperlink, http://www.gao.gov/products/GAO-06-872].
[24] The weight of oil is measured by its gravity index. According to
DOE's Energy Information Administration, light oil is greater than 38
degrees gravity; intermediate oils, such as those in the SPR, are 22 to
38 degrees gravity; and heavy oil is 22 degrees gravity or below. See
DOE, Office of the Assistant Secretary for Fossil Energy, Strategic
Petroleum Reserve: Annual Report for Calendar Year 2007 (DOE/FE-0525),
for information on the composition of the SPR.
[25] 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 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.
[End of section]
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