By John Kemp
LONDON, Oct 4 (Reuters) - Now that domestic oil production is rising and imports are falling, should the United States reduce the amount of emergency oil it holds in giant salt caverns along the coast of Louisiana, or at least switch from stockpiling crude to holding refined products like gasoline, jet fuel and diesel?
"The United States will soon start selling oil from its Strategic Petroleum Reserve (SPR)," predicted leading energy analyst Phil Verleger in a thought-provoking article for "Petroleum Intelligence Weekly" last month ("Major SPR oil sales likely over next few years" Sep 17).
"The sales will occur not because prices are too high or too low, but rather because the U.S. now holds more oil than required under International Energy Agency (IEA) obligations," Verleger wrote. "Rising U.S. production combined with falling use will make roughly 100 million barrels superfluous every year until 2020. This means the U.S. government will be putting 200,000 barrels every day or more on the market."
Facing the urgent need to cut government spending or raise revenue, Verleger argues SPR sales will be an irresistible target for the president and Congress as they grapple with the budget deficit.
Based on the declining import trend, Verleger estimates that the United States could cut the amount of crude stored in the SPR from its current level of 696 million barrels to 630 million barrels by September 2013 and 530 million by September 2014, while still meeting its IEA obligation to hold stocks equivalent to 90 days worth of net imports.
The temptation for a cash-strapped Congress is obvious. And there is a good precedent. Following the end of the Cold War, the Department of Defense determined that over 99 percent of the formerly critical and strategic materials held in the National Defense Stockpile (NDS) were excess to its requirements.
At its height, the stockpile was valued at more than $11 billion, and included more than 70 minerals like diamonds, metals like tantalum and copper, and even agricultural products, like the anti-malarial agent quinine.
But from 1993 onwards, Congress has authorised a programme of gradual sales. Sales from the NDS have raised billions of dollars.
While some of the proceeds have been used to cover the continuing costs of running the stockpile, including the environmental cleanup, most of the surplus has been credited to the U.S. Treasury, or applied to other parts of the budget.
Congress could raise tens of billions of dollars by disposing of excess stocks from the SPR and apply them to deficit reduction.
Alternatively, the crude oil in the SPR could be sold or swapped for refined products. "The U.S. could gain flexibility in its response to disruption in commercial supplies by changing the content of its reserves to contain both crude and refined products," explained Javier Blas in an illuminating piece in the "Financial Times" this week ("The limitations of America's petroleum reserve" Oct 2).
Blas points out that the European members of the IEA already hold the majority of their emergency stocks in the form of refined products. The United States is unusual in holding virtually all its emergency stocks in the form of unrefined crude.
In 2005, when the hurricanes Katrina and Rita wreaked havoc in the Gulf of Mexico, it was storm damage to refineries and the resulting shortfall in gasoline and diesel, not crude, that were the main problem. "The U.S. had to ask its European allies to release their gasoline and diesel-rich emergency reserves to make up for the shortage," Blas explains.
In 2012, many observers blamed upward pressure on U.S. pump prices on a shortage of gasoline, especially the reformulated sort used heavily in the Northeast, rather than any shortfall in crude oil supplies. Releasing crude from the SPR would not relieve the shortage of reformulated gasoline available around New York and New Jersey.
Rising domestic oil production as a result of fracking in North Dakota and Texas, as well as falling domestic fuel consumption stemming from more efficient vehicles and increased ethanol blending, could allow the United States to lower the amount of petroleum it holds in reserve, and switch some of its holdings from crude to refined products.
But policymakers should not rush to dispose of the crude stockpile or convert it to products. Even with rising domestic production, the United States will remain a net importer for some years, and it remains most vulnerable to a disruption of crude supplies from the Middle East or Venezuela, rather than refined products from Europe.
Notwithstanding occasional refinery outages, the majority of the volatility in gasoline and heating oil prices experienced by U.S. businesses and consumers stems from instability in the crude oil market, not refinery capacity and margins ().
It would only make sense to stockpile products if policymakers were primarily concerned about the availability of refining capacity rather than crude oil inputs.
But after the fleeting shortages of refinery capacity during the "golden age of refining", which lasted from just 2005 to 2008, the United States now has plenty of refining capacity to convert even the toughest crudes into high-quality products. Refinery capacity is set to improve even further owing to continued improvements in vehicle fuel economy.
The United States obtains around 40 percent of its oil imports from neighbouring Canada and Mexico, and that proportion is set to grow. The remaining oil comes from a fairly diversified group of countries, with less than 25 percent from the volatile Mideast Gulf region.
Nevertheless, oil trades in a global market. Any disruption to Middle East crude supplies would inevitably drive up the price paid by U.S. fuel consumers.
While the U.S. maintains unchallenged naval and air superiority, the primary threat which the SPR guards against is economic (the damage wrought by spiking oil prices) rather than physical (shortages of gasoline at filling stations).
The SPR was established to ensure the United States could never again be coerced by the threat to withhold crude supplies. The president and Congress have a unique opportunity to render it more effective simply by leaving stocks unchanged.
It is a mistake to assume the SPR contains a lot of surplus oil. The 1975 Energy Policy and Conservation Act envisaged a reserve of up to 1 billion barrels. The SPR has never held anything like that amount. For most of its life, the SPR held less than 600 million, before being increased to 727 million between 2002 and 2009.
In fact, for most of the time since 1994, the SPR held fewer barrels than needed to meet the IEA's 90-day obligation. In 2005, the SPR held 685 million, when the 90-day obligation implied 1.129 billion. Even this year, after net imports have fallen, the SPR still does not contain enough crude to cover the 90-day obligation completely ().
In future, if net imports continue to decline, the SPR may contain more than enough crude to satisfy the IEA obligation. But that is no reason to reduce it.
It has taken decades to build up a reserve of 700 million barrels. Stock building tends to push up crude prices. The United States should not rush to dispose of a stockpile it might need again in future if circumstances change.
The rise in import cover also gives the president important flexibility. Unlike Germany and many other European IEA members, who replaced emergency reserves released during the summer of 2011 by the end of the year or early 2012, the United States has not tried to replenish the 30 million barrels sold last year.
The rising ratio of SPR stocks to net imports ensures the president is under no pressure to reverse a stock release quickly, making the stockpile a more effective deterrent.
Rather than realise a one-off gain by selling barrels from the reserve, which would make only a tiny dent in the projected budget deficit, Congress and the president should retain the full volume as an important tool for ensuring the United States is not susceptible to coercion.