For other versions of this document, see http://wikileaks.org/wiki/CRS-RL31972
------------------------------------------------------------------------------

                                                   Order Code RL31972




                  CRS Report for Congress
                                      Received through the CRS Web




                              Private Crude Oil Stocks
                            and the Strategic Petroleum
                                        Reserve Debate




                                                     June 23, 2003




                                                   Robert Pirog
                        Analyst in Energy Economics and Policy
                       Resources, Science, and Industry Division




Congressional Research Service ~ The Library of Congress
 Private Crude Oils Stocks and the Strategic Petroleum
                    Reserve Debate

Summary
      Periodically, since the inception of the Strategic Petroleum Reserve (SPR) in
1975, debate has occurred concerning its optimal size. In the 108th Congress, the
House has passed energy legislation (H.R. 6) which would require the SPR to be
filled to its current capacity of approximately 700 million barrels and would
authorize funds to further expand the capacity of the reserve to 1 billion barrels.

       Analysis of the SPR issue has been carried out in a benefit/cost framework in
which benefits, the avoided cost to the national economy of a supply disruption, are
set against the real resource costs associated with investing in the SPR. The role of
the privately held stock of crude oil has been largely static in these analyses. The
data show, however, that private stock behavior has been changing. Industry holds
less crude oil, and has less capacity to hold crude oil, than a decade ago. These
changes reflect a decade long strategy of reducing operating costs to remain
competitive. However, oil markets face greater exposure to supply disruption today
because our dependence on imported crude oil has risen substantially since 1992.
The effectiveness of the SPR in providing security from crude oil supply disruptions
may be primarily a function of its size, but may also be dependent on the underlying
stocks of crude oil held by the private sector.

     The International Energy Agency (IEA) has studied the behavior of crude oil
stocks in the U.S. since 1989. It finds that our total stocks, measured as days of net
imports that can be replaced by stock draw-down, have been declining. This trend
results from the interaction of increasing import dependency, the essentially constant
size of the SPR over the period, and the declining size of privately held stocks. The
IEA concludes that with no change in any of these factors, the U.S. will no longer be
able to replace ninety days of net imports from domestic stocks in 2006.

      Because the IEA focuses on total reserves, its analysis may overstate the ability
of U.S. stocks to mitigate oil supply disruptions. This is because not all privately
held oil stocks can be drawn upon without disrupting the functioning of the system
itself. Once these lower operational inventory levels are considered, the thinness of
privately held stocks is apparent. As a result, the ability of privately held stocks to
provide a buffer to supply disruptions is reduced.

     This report will be updated as events warrant.
Contents

Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Benefits/Costs of the SPR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Role of Private Stocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Implications of Current Stock Status . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8



List of Figures
Figure 1. U.S. Oil Stocks, 1989-2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Figure 2. Behavior of U.S. Stocks, 1973-2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Figure 3. Break Even Relationship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7



List of Tables
Table 1. Net Imports of Petroleum, 1989-2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
    Private Crude Oil Stocks and the Strategic
            Petroleum Reserve Debate

                                  Background
      The Energy Policy and Conservation Act of 19751 authorized the creation of the
Strategic Petroleum Reserve (SPR) for the storage of up to 1 billion barrels of crude
oil. The federal government began filling the SPR in 1977, mostly with imported oil.
By 1992, the SPR held 575 million barrels of crude oil, and in May 2003, over a
decade later, holds approximately 600 million barrels in reserve. Since the creation
of the SPR in 1975, debate has periodically focused on the optimal size of the SPR,
specifically whether it should be expanded to 700 million or 1 billion barrels of oil.
In the 108th Congress, legislation passed by the House (H.R. 6) would require the
SPR to be filled to its current capacity of 700 million barrels of crude oil and
provides funding of $1.5 billion to expand the capacity of the SPR to 1 billion
barrels.2

     Worldwide concern over the unstable nature of the crude oil market has led
other nations to establish emergency oil stocks as part of International Energy
Administration (IEA) agreements to manage supply disruptions. For example, at the
end of 1999 Japan held 315 million barrels of crude oil, OECD Europe held 325
million barrels, South Korea held 43 million barrels, and Taiwan held 13 million
barrels. The U.S. is the only country in this group where security stocks are totally
government owned. In Japan, South Korea, and OECD Europe, the total stock is
divided between government and mandated private stocks. In Taiwan, the stock is
completely mandated private.3

      Although decisions on the size of the SPR and private stocks are made through
very different decision processes, they are linked by the fact that both may be useful
in times of supply disruption. When supply is disrupted, prices rise quickly through
active futures, spot, and product markets. Higher prices give businesses an incentive
to bring product to market, which mitigates potential physical shortages, giving
policy makers time to consider an SPR draw-down. If businesses have reduced


1
    P.L. 94-163
2
 A detailed analysis of the history of petroleum allocations to the SPR as well as current
data and analysis of related policy issues can be found in CRS Issue Brief IB87050,
Strategic Petroleum Reserve, by Robert Bamberger.
3
 Paul N. Leiby and David Bowman, The Value of Expanding the U.S. Strategic Petroleum
Reserve, ORNL/TM-2000/179, November 30, 2000, p. 20. The report is available at the
Oak Ridge National Laboratory website, http://pzl1.ed.ornl.gov
                                          CRS-2

available inventories to cut costs, their ability to play this role is diminished. For this
reason, the size and availability of private stocks of crude oil is relevant to debates
over the optimal size of the SPR as well as when, and under what circumstances, to
use the SPR.


                       Benefits/Costs of the SPR
      The case for the existence of the SPR is usually framed in a benefit/cost
framework.4 The benefits are typically defined as avoided costs which are then set
against the real resource, or opportunity, costs of maintaining the reserve. The same
approach is followed for considering marginal adjustments to the reserve, but with
a focus on the additional value of avoided costs implied by a reserve expansion set
against the marginal resource cost of expanding the reserve. Although debate on the
size of the SPR is normally framed in terms of millions of barrels of crude oil held,
another measure, consistent with International Energy Agency (IEA) measurement,
is the number of days of net imports for which the reserve can substitute. Although
the primary focus of SPR usage is concerned with international oil market
disruptions, the SPR could also be used in times of emergency stemming from
domestic supply disruption.

     The benefit of maintaining the SPR lies in avoiding the effects of severe oil
price spikes and shortages that might result from supply disruptions. Significant,
rapid spikes in the price of crude oil and actual shortages can have damaging effects
on the macroeconomic performance of the economy. Reduced economic output,
leading to increased unemployment and a reduction in the rate of economic growth
are possible consequences. In terms of the balance of payments, higher oil prices will
mean a greater expense for oil imports, causing the balance of trade to deteriorate.

      The costs of the SPR are much like those of other public investment projects.
The capital cost of the reserve and/or expansion of the reserve, costs associated with
providing for the draw of the reserve, the operations and management cost, and the
cost of the oil stored in the reserve are all part of total cost. The cost of the stored oil
is a real budget cost in the year of acquisition to be recouped later when, and if, the
reserve is drawn down.

     Proponents of the SPR see the existence, as well as the use, of the reserve
contributing to stability in the oil market. The existence of the reserve could deter
some politically or economically motivated disruptions. If the reserve is drawn upon,
it might allow affected economies time to make other adjustments to the new market
conditions, including diplomacy, which might remedy, or mitigate the underlying
cause of the disruption. The existence and/or use of the reserve might calm uncertain
oil markets and dampen the effect of underlying market imbalances leading to a
moderated price spike.

     Those opposed to market intervention see less benefit associated with the SPR
and its use. They believe that the freely functioning market can mitigate most

4
    Ibid.
                                           CRS-3

disruptions and that government intervention in market processes is unlikely to
enhance resource allocation. In this view, friendly suppliers might expand short term
output in case of a disruption, and higher prices will allocate available supplies to
their most pressing needs, minimizing the effect of the supply disruption.

     The SPR is not a stand-alone policy for energy security. In the longer term,
diversifying energy sources and improving energy efficiency, engaging in productive
dialogue with oil producers and enhancing the price responsiveness of consumer
demand are all important measures. In the shorter term, encouraging fuel switching
capability and demand reduction can be useful energy security measures.


                           Role of Private Stocks
      The implicit assumption underlying the SPR debate appears to be that the stock
of private oil reserves held by the U.S. petroleum industry is known, unchanging, and
available to reach the market during a supply disruption. To put the SPR expansion
issue in proper context, the optimal size of the SPR might be considered as part of
the total stock of reserves the nation has to draw upon in times of emergency.5
Consider the following extreme, hypothetical cases. If the private sector were able,
technically and economically, to run the oil production system with zero inventories,
or reserve stocks, every world oil market supply disruption would be quickly
transmitted to the domestic consumer market, leading to immediate shortages and
price spikes. In this case, a large reserve, coupled with quick response usage rules
might be required for market stability. At the other extreme, if the oil industry found
it either technologically or economically useful to hold a year's worth of supply in
reserve which it was willing to draw down as needed, there might be little need for
any government reserve. If, in reality, we are somewhere between these extremes,
so might be the requirement for the SPR, and, as a corollary, if the capability of
privately held stocks varies, so must the capability of the SPR if our overall ability
to meet market challenges is to remain constant.




5
  Care must be exercised in evaluating private stocks of crude oil. The Energy Information
Administration, in the June 13, 2003 Weekly Petroleum Status Report, Figure 2, page 7,
reports that although the five year, average monthly holdings of crude oil in 2002 and 2003
in the private sector are between 280 and 350 million barrels, it would be incorrect to
assume that at any time there was that much oil available for draw-down. The system has
a lower operational inventory level of 270 million barrels. This value represents the oil that
is being held or in transit to refineries and bulk terminals as well as oil in pipelines. This
oil cannot be accessed for emergency use; it represents a kind of fill in the system, which
must be present for the continuous operation of the production process from well head to
consumption. Private stocks available for emergency draw-down should be considered to
be the total stocks held net of the lower operational inventory levels. Reserves held in the
SPR are, in principle, fully available for extraction and use. Therefore, stocks of crude oil
held in the SPR are not directly comparable to total stocks held in the private sector. The
correct comparison is between barrels of crude oil held in the SPR and the net level of
private stocks. This observation substantially reduces the effective private reserve stock
levels in the U.S. in terms of their ability to replace net imports.
                                         CRS-4

     In fact, the behavior of private levels of crude oil stocks have not been constant,
they have been declining. Crude oil stocks, excluding the SPR, stood at 285.1
million barrels on May 16, 2003. One year ago the stock stood at 325.6 million
barrels, which implies a reduction of 12.4 percent in stocks held by the nation's oil
industry.6 Figure 1, computed by the IEA, shows the behavior of total U.S. oil
stocks, measured as days of net imports.7


                    Figure 1. U.S. Oil Stocks, 1989-2002




      Figure 1 shows a decade long decline in the ability of industry stocks, along
with the SPR, to replace imported oil. Several forces are at work in Figure 1. First,
the increasing dependence of the U.S. on imported oil makes a stock of any size less
capable of replacing imports. Even if the actual stocks shown in the figure were
constant, days of imports would decline if the quantity of oil we import rises. Table
1 shows that net imports of crude oil have increased from approximately 5.7 million
barrels per day on average in 1989 to approximately 9.0 million barrels per day on
average in 2002.8 This increased dependency has contributed to the downward trend
of Figure 1.




6
 Stocks of refined petroleum products were also lower than the previous year by margins
ranging from 2 percent to 30 percent. Up to date information on petroleum stocks is
published in the Weekly Petroleum Status Reports available at www.eia.doe.gov.
7
 IEA data provided by William C. Ramsay, Deputy Executive Director, IEA, A Fossil Fuel
Future, presentation at CRS, May 22, 2003.
8
 Table 1 also shows that the U.S. has increased its imports of petroleum products, mostly
gasoline. Depending on the nature of future market disruptions, the U.S. could import more
petroleum products in lieu of importing crude oil.
                                         CRS-5

              Table 1. Net Imports of Petroleum, 1989-2002
                           (in thousands of barrels per day)

    Yearly average          Crude Oil          Petroleum Products         Net Imports
    1989                         5,701                     1,500                7,202
    1990                         5,785                     1,375                7,161
    1991                         5,666                       959                6,626
    1992                         5,994                       944                6,938
    1993                         6,689                       929                7,618
    1994                         6,964                     1,090                8,054
    1995                         7,135                       750                7,886
    1996                         7,398                     1,100                8,498
    1997                         8,117                     1,040                9,158
    1998                         8,596                     1,167                9,764
    1999                         8,613                     1,300                9,912
    2000                         9,021                     1,399               10,419
    2001                         9,308                     1,592               10,900
    2002                         9,038                     1,340               10,378
Source: U.S. Energy Information Administration. Monthly Energy Review, March 2003, p. 43.

       Secondly, as noted above, in the short term, stocks of privately held oil have
declined. Figure 2 shows the behavior of U.S. stocks, measured in billions of
barrels, in the longer term, from 1973-2002. The figure shows that non-SPR crude
oil stocks have experienced a long term decline since their peak in the mid 1970's,
even though in the last two decades imports and consumption have risen. Figure 2
also suggests some increased volatility in the level of privately held stocks since the
mid 1990's. This behavior might be expected if firms were optimizing their
inventory holdings. Additions to stock when prices of crude oil are low and draw
downs from inventory when prices are high enhance profit opportunities.9

     Trends similar to those observed in crude oil have also occurred in petroleum
products. The Petroleum Industry Research Foundation, Inc. calculates that finished
gasoline stocks fell from a 30 day stock in 1985 to an 18-19 day stock in 2001. This
translated into a 41 million barrel decline in gasoline stocks over the period. An
additional complication is that gasoline is not as fungible as it once was. Different




9
 Production is also price sensitive. Marginal production can be brought to market with the
incentive of higher prices.
                                         CRS-6

blends of gasoline to satisfy differing air pollution standards in various parts of the
country put further strain on a system that is reducing stocks.10

     Finally, not only privately held stocks have declined, but the privately held
capacity to hold stocks has also declined. In 1990, the capacity of refineries in the
U.S. to hold stocks of crude oil was 204 million barrels; by 2002 this capacity had
declined to 183.3 million barrels, a reduction of over 10 percent.11 This decline in
capacity, coupled with the decline in held stocks, suggests that the industry might be
attempting to reduce the level of inventory as a way of managing cost. Much of U.S.
industry has adopted "just in time" inventory techniques as a way to lower costs and
enhance efficiency. It would be consistent with this trend for the petroleum sector

               Figure 2. Behavior of U.S. Stocks, 1973-2002
                     (measured in billions of barrels)




to follow a similar strategy.




10
  Refining Concentration and Industry Dynamics, Petroleum Industry Research Foundation,
Inc., April, 2002, available at the web site, www.pirinc.org.
11
 Storage at refineries is not the only location for stocks of crude oil. Additional stocks
might be engaged in the transportation and distribution process at any of several levels.
                                        CRS-7

             Implications of Current Stock Status
     Figure 3 represents a "break even" analysis of the relationship between total
stocks of U.S. crude oil and time, assuming that the nation has a security target of
ninety days of import substitution, consistent with IEA targets. The IEA data are
based on total stocks of crude oil which ignores the lower operational inventory
constraint for industry and, therefore, may overstate the ability of combined stocks
to actually meet emergency needs.

                      Figure 3. Break Even Relationship




      Analysis by the IEA offers the tentative conclusion that U.S. ability to maintain
a target of ninety days of import replacement with current trends continuing, and no
change in current government policy, will end in 2006. An increase in the SPR
would push this date further into the future, while an acceleration of private sector
stock draw down would bring the date closer to the present time. Additionally, the
figure also implies that if the SPR fill were expanded to 700 million barrels, or even
1 billion barrels, the increase in security that we might receive from enhanced levels
of import replacement could be only temporary. The underlying decline of private
sector stocks and increasing dependence on imported oil will also influence our
susceptibility to supply disruptions in the future.

     Although the IEA analysis suggests a developing problem for the U.S. in terms
of replacing imported oil in times of emergency, the real situation may be even more
challenging than the IEA analysis suggests. Energy Information Administration data
shows that in the fall of 2002 and again in early 2003 private stocks of crude oil were
reduced to the lower operational inventory levels discussed earlier. At those times
there were no additional crude oil reserves in the private sector in a practical sense.12
The more the private sector economizes on crude oil stock holdings, the more likely



12
 Data included in the Weekly Petroleum Status Report for the week ending May 30,2003.
Available at the Energy Information Administration website, www.eia.doe.gov.
                                       CRS-8

it is that the lower operational inventory constraint will become effective during a
market disruption, limiting the ability of industry to meet consumer demand.


                                 Conclusion
      While private sector stocks exist primarily because of the economic and
technological requirements of the oil industry, they have also served a public
purpose. Private stocks have at least partially played the role of a public good. They
have provided benefits to the domestic oil market as a whole, as well as to policy
makers as they faced difficult decisions about when, and if, to draw on the SPR.
Private sector stocks are usually drawn down first, with market forces guiding the
decision. Decisions on the optimal size of the SPR may need to take into account
changes in industry practices which might affect the ability of private stocks of crude
oil to play this role in the future.

     Net stocks of privately held crude oil, in many ways the first buffer between an
international oil supply disruption and U.S. consumer markets, were reduced to very
low levels during the recent disruptions to the oil markets. Industry holds less stock
in 2003 than it did a decade ago, even though U.S. dependence on crude oil imports
has risen. The SPR currently holds approximately 600 million barrels of crude oil
which could be used in a supply emergency. The effect of the rising dependence on
imports and the reduced availability of private stocks implies that 600 million barrels
of crude oil translates into fewer days of replaced reserves.

------------------------------------------------------------------------------
For other versions of this document, see http://wikileaks.org/wiki/CRS-RL31972