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Strategic Petroleum Reserve
President Gerald R. Ford (tenure: 1974-1977) in December 1975 established the Strategic Petroleum Reserve (SPR) by signing into law the Energy Policy and Conservation Act (EPCA, Public Law 94-163) passed by the 94th US Congress. The purpose of the law was “to reduce the impact of severe energy supply interruptions” such as a repetition of the economic dislocation cause by the 1973-1974 oil embargo by the Organization of Petroleum Exporting Countries (OPEC). (1)



The 1973-1974 Oil Embargo on the US, the Netherlands, and Other Countries

The oil embargo on the US was a “stark, politically motivated event intended to create a very discernible physical disruption of oil,” according to Strategic Petroleum Reserve specialist Robert Bamberger. The angry members of the OPEC struck back at the United States for supporting Israel in the Arab-Israeli War, in which Arab states Egypt and Syria launched a surprise attack against Israel and were routed. (2) The OPEC is an association of oil-producing countries set up in 1960 with the express purpose of influencing oil prices by controlling supplies. Its members account for over half of the world’s crude oil exports.

During the oil embargo of 1973-4, the Arab OPEC members not only reduced oil production, but all OPEC members agreed to use their then considerable leverage over the world price-setting mechanism for oil, to double, triple or even quadruple the world price for a barrel of oil. Thus, oil that DID reach the US from non-Arab countries during the oil embargo was remained shockingly expensive.

For example, in 1974, the West African country Gabon, which had acquired associate member status in OPEC, promptly increased the price of Gabonese crudes to fall in line with those of other OPEC member states. Accordingly, the price per barrel of Gabon’s “Mandji” crude increased from $2.40 in January 1973 to $13.03 in January 1974, and “Gamba” crude from $2.40 to $13.79, which created a handsome windfall for the country’s leadership. “This veritable explosion of oil prices was not due to any physical shortage of oil” but rather was the result of “the successful use of the oil weapon by the Arab states in connection with the Middle East war of October 1973,” noted one researcher. (3) Indeed, Gabon and other oil-producing countries descended into a “rentier economy” at that time, as described elsewhere. (3)

The OPEC’s 1973-4 oil embargo and unilateral arbitrary barrel price increase were extremely efficacious in creating the intended maelstrom in the US and other “non-friendly” countries (to the OPEC members) whose economies faced severe inflationary pressure, problems with the balance of trade, and dramatic suppression of economic activity. (2) Major changes in the US that occurred as a result of the embargo were: 1) an increase at the gas pump of a price of a gallon of gas from an average of 38.5 cents in May 1973 to 55.1 cents in June 1974, but people continued to purchase the commodity anyway (inelasticity in demand for gasoline up to about $3.00/gallon) thereby siphoning away of disposable income that might have been spent to support other economic activities; 2) New York Stock Exchanges shares loss of $97 billion in six weeks; 3) drop of import of oil from Arab countries from 1.2 million bbl/day to a mere 19,000 bbl/day; 4) implementation of price controls and rationing, leading to “stagflation”; 5) speed limit reduction to 55 mph; 6) year-round daylight savings; 7) factory layoffs; 8) creation of a cabinet-level Department of Energy (DOE) in 1977; 8) passage of the National Energy Act of 1978; and creation of a Strategic Petroleum Reserve in 1975, among other changes.

The embargo ended on March 17, 1974 (with the exception of Libya). US Secretary of State Henry Kissinger unveiled on February 11, 1974 the so-called “Project Independence” plan to help make US energy independent. The very next day, “progress in Arab-Israeli disengagement brought discussion of oil strategy to the heads of state of Algeria, Egypt, Syria, and Saudi Arabia.” (4) Less than a month later the embargo ended without the OPEC Arab countries achieving their demands. They became hugely wealthy, however, over the next decade as enormous amounts of cash from the sale of their oil poured in. State leaders responded with building projects, lavish consumption, and buying sprees for military weapons. (4) President Richard M. Nixon, who led the US efforts during this perilous period, resigned from office just four months later on August 9, 1974, passing on the dilemma to his Vice President Gerald R. Ford who became President. As previously noted, Congress passed and President Ford signed the Energy Policy and Conservation Act that eventually set a national policy to create a reserve for the storage of crude oil. (5)

Launching the Strategic Petroleum Reserve

The Strategic Petroleum Reserve (SPR) was a revolutionary idea in 1974. The new Department of Energy assumed management of the operations of the SPR in 1977 under President Jimmy Carter’s Administration. “It was generally believed that the mere existence of a large, operational reserve of crude oil would deter future oil cutoffs and would discourage the use of oil as a weapon. In the event of an interruption, introduction into the market of oil from the SPR was expected to help calm markets, mitigate sharp price spikes, and reduce the economic dislocation that had accompanied the 1973 disruption.” (6)


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The SPR currently consists of five large underground caverns hollowed out from naturally occurring salt domes near the US Gulf Coast in both Louisiana and Texas. These sites are close to the extensive port faciltiites, pipelines to the rest of the US, and refineries in the region; offer the best security; and are the most affordable means of storage, costing up to ten times LESS than using above the ground tanks, and twenty times LESS than storing the oil in hard mines. (7)



Salt caverns along the Gulf Coast had long been used for storage by the private petrochemical concerns. So the federal government, to speed oil storage, purchased some of these salt caverns to store the first 250 million barrels of crude oil (7) New Orleans became headquarters for the DOE SPR program office.

Creating the Cavern Space

Salt caverns are carved by human processes from naturally-occuring underground geologic structures called salt domes by a process called “solution mining.” A well is drilled into a salt dome through which massive amounts of fresh water are injected. The water dissolves the salt to form a brine that is removed and either reinjected into “disposal wells” or, more commonly, is piped several miles offshore into the Gulf of Mexico and dumped. According to Department of Energy materials, salt caverns of very precise dimensions result from control of the freshwater injection process. (7) Seven barrels of injected water will create room for a single barrel of crude oil stored in the SPR’s salt caverns.



The capacity of individual caverns ranges from 6 to 35 million barrels. A typical cavern holds 10 million barrels, is cylindrical in shape with a diamter of 200 feet, and has a depth of 2,000 feet into the earth, according to the DOE. Indeed, one storage cavern will contain Chicago’s Sears Tower with room to spare. The entire SPR contains 62 of these huge underground caverns at the four sites. To remove petroleum from the caverns entails pumping fresh water into the bottom of the cavern, which displaces the crude oil to the surface where spigots are opened to send the oil along pipelines to various terminals and refineries around the US. (7)



Filling Her Up

The original goal of the SPR in 1975 was to contain enough crude oil to replace imports for 90 days. An initial goal of 500 million barrels in SPR storage was set and then, in May 1978, raised to 750 million barrels. As it turned out, it’s not easy to reach pre-determined goals for stockpiling oil, particularly when additional shocks occur, such as the Iranian revolution that again cut supplies in the spring of 1979, or when Iraq invaded oil producer Kuwait in 1990-1992. Drawdowns on the existing stored oil also worked against reaching goals. For example, the Exxon Valdez oil spill interrupted the shipment of Alaskan oil. By 1994, the SPR contained 592 million barrels of crude oil. (8)

The Drawdown Authorities

The original drawdown authority articulated in the Energy Policy and Conservation Act of 1975 was strict—that is, drawdown is authorized only upon a finding by the President of a “severe energy supply interruption.” What is a severe energy supply interruption? According to the statute, this situation exists if three conditions are joined, as follows: “(a) an emergency situation exists and there is a significant reduction in supply which is of significant scope and duration; (b) a severe increase in the price of petroleum products has resulted from such emergency situation, and (c) such price increase is likely to cause a major adverse impact on the national economy.” (9) One of the reasons for such a strict interpretation was to set the bar high for use of the stockpiled oil to encourage private oil companies to continue to stockpile their own supplies and NOT rely on the government supplies when their own supplies became temporally scarce for a variety of reasons. As we will see, this is exactly what happened later on.

Jimmy Carter Administration and the SPR (1977-1981)

The filling up the SPR got underway during President Carter’s term in office (1977-1981). A second oil crisis occurred during in 1979 when the Ayatollah Khomeini coup decimated Iran’s oil industry. The Carter Administration reacted to the mild decline in petroleum flow to the US from Iran by encouraging citizens to conserve energy. Long lines returned at gas stations. According to one source, the average vehicle consumed between two and three liters of gas an hour while engines idled in gas station lines, wasting up to 150,000 barrels of oil per day. (12) By the end of 1978 the SPR was supposed to hold 250 million barrels of crude, but held only 69 million. In addition, the 1979 oil shock caused the Administration suspended purchase of oil to fill the SPR to ease the upward pressure on world oil prices.

Ronald Reagan Administration and the SPR (1981-1989)

The SPR Drawdown Plan submitted by the Reagan Administration in late 1982 provided for price-competitive sale of SPR. This Administration did not like the idea of basing a decision to distribute SPR oil on any “trigger” or formula. To do so would discourage private sector initiatives for preparedness or investment in contingency inventories, according to Bamberger. (10) Furthermore, the Administration believed that the shortages of 1973 and 1979 would probably have been less disruptive than the price and allocation regulations that were imposed on the country.

Nevertheless, other parties disagreed with the Administration, arguing that the SPR SHOULD be used to moderate the price effects that can be triggered by even small shortages like those of the 1970s and lack of confidence in supply availability. These other parties pushed for early drawdown of the SPR, and the Reagan Administration came around in 1984, announcing that the SPR would be drawn upon early in a disruption. (10)

George H.W. Bush Administration and the SPR (1989-1993)

The 101st Congress enacted additional drawdown authority in 1990 when the Exxon Valdez ran aground spilling oil and interrupting the shipment of Alaskan oil. Spot shortages and price increases occurred as a result of the interruption. The new legislation (Energy Policy and Conservation Act Amendments of 1990 Public Law 101-383) provided for SPR drawdown under less rigorous findings, according to Bamberger. (9) The President could sell on the market a maximum of 30 million barrels of SPR oil over a maximum of 60 days without having to declare the existence of a “severe energy supply interruption” or the need to meet obligations of the US under the international energy program, which is beyond the scope of this discussion. Under the new provision, the President could initiate a drawdown for a situation that “constitutes, or is likely to become, a domestic or international energy supply shortage of significant scope or duration” and where “action taken…would assist directly and significantly in preventing or reducing the adverse impact of such a shortage.” (9) As it turned out, the oil market stabilized obviating the need to access the SPR during the Exxon Valdez crisis.

Following the Iraqi invasion of Kuwait on August 2, 1990, the George H.W. Bush Administration declined an SPR drawdown arguing there was no physical shortage of oil and it was imprudent to flood the market with oil simply to lower oil prices. The Bush Administration however suspended further filling of the SPR. Then, within hours of the first air strike against Iraq in January 1991, President Bush authorized a drawdown of the SPR. Crude prices plummeted by nearly $10/barrel in the next day’s trading, falling below $20/bbl! Optimistic reports about the allied forces smashing Iraqi air power was thought to be the reason for the dramatic change. Nevertheless, more than 30 million barrels of SPR oil were bid out. OF these 30 million barrels, only 17.3 million were sold and delivered in early 1991, according to Bamberger. (11) President H.W. Bush’s drawdown of the SPR in early 1991 was the only time the SPR has been accessed in the manner for which it was intended when the EPCA passed and was signed into law by President Ford in 1975.

Bill Clinton Administration and the SPR

The Clinton Administration was very creative with the SPR. From 1995 until late 1998, it was uninterested in purchasing more crude oil to fill up the SPR to reach goals. In 1993, when President Clinton took office, the SPR contained 592 million barrels. The Clinton Administration wanted to sell off some of the existing barrels of oil in the SPR to reduce and then eliminate the annual deficit. Stockpiling the oil over the years since 1975 had, by FY1997, cost nearly $16 billion ($27/barrel), and total appropriations for the SPR through FY 1996, including the costs of operation, facilities and maintenance totaled almost $21 billion. (13) Congress considered defraying the cost of maintaining the SPR by instituting what amounted to a 1% tax on domestic and imported crude, but this idea died for a number of reasons.

The Clinton Administration introduced a clever proposal in its FY1996 budget to sell 7 million barrels of SPR oil to finance the SPR program so that it wasn’t adding to the annual budget deficit. Others believed that this would set a particularly poor precedent—that is, selling off some of the SPR oil for budgetary reasons. President Clinton nevertheless authorized three sales of SPR oil during FY 1996 to1) pay for decommission of the Weeks Island site (the salt walls were cracking); 2) reduce the federal budget deficit; and 3) offset FY1997 appropriations. The total quantity of SPR sold on the market was 28.1 million barrels. The revenues raised for the federal government were $544.7 million. (11)

Then New York Senator Charles Schumer approached the Clinton Administration’s Secretary of Energy Bill Richardson with a request to access the SPR to offset the high price for home heating oil in the Northeast expected for the winter of 1999-2000. The Clinton Administration was faced with the decision of using SPR oil to primarily ameliorate oil supply shortages or to use it to explicitly regulate prices.

The original reasoning used by the Clinton Administration for not selling SPR oil in an effort to force down the cost of heating oil for the East Coast was sound. Doing so would not solve the problem! The Administration contended that “high prices were the consequence of a number of temporary factors that could not be resolved any faster by intervention.” The home heating oil problem in the Northeast was “due in part to idle refinery capacity and refiners’ drawdown of [their private] stocks during recent moths while crude prices were escalating. Refiners preferred to use lower-cost inventory rather than purchasing higher-priced crude. Prolonged freezing temperatures also…made certain ports less accessible, adding to the distribution problems.” (11)

Furthermore, the Clinton Administration argued that the prevailing high prices of crude oil would encourage increased production of home heating oil, a shift of refined product stocks to the Northeast, and additional product imports that would arrive in due course. The market would correct the supply problem long before a drawdown from the SPR could help.

Low home heating oil supplies persisted. In September 2000, President Clinton announced a “swap” of 30 million barrels of oil from the SPR. Oil companies and refiners bid to purchase the oil to bulk up their reserves for the upcoming winter. The DOE sold 24 million barrels of sweet crude (low sulphur content) and 6million barrels of sour (high concentration of sulphur requiring additional refining). Under the contracts, 31.5 million barrels would be returned to the SPR in 2001. During the course of these sales, crude prices softened from $37/barrel to less than $31/barrel. Some observers argued that US willingness to use the SPR temporarily took the wind out of a speculative element in the futures market, according to Bamberger. (14) Other observers tsk-tsked the swap reasoning that oil is a world-wide commodity. Selling SPR reserves could result in purchase by European countries also experiencing high heating oil prices. The irony of the SPR oil sale is that the US SPR might well have ended up relieving European, rather than domestic, market woes!

In 2000, the US Congress voted to establish a regional home heating oil reserve of 2 million barrels just for the Northeast incase of a severe oil shortage. President Clinton endorsed establishment of a regional reserve and announced on July 10, 2000, his intention to make this happen. The Clinton Administration also submitted to Congress an amendment to the Strategic Petroleum Reserve Plan that would give the regional reserve permanent status. Thus was established the regional reserve officially titled the Northeast Heating Oil Reserve (NHOR), which private contractors store above ground in New Haven and Woodbridge, NJ. Clinton successfully avoided a drawdown on this new little reserve before leaving office in 2001.

One other major SPR use innovation introduced by the Clinton Administration in February 1999 was the “royalty in kind” (RIK) program, which is described elsewhere. (15,16) Briefly, the Clinton Administration announced a new plan to resume fill of the SPR with federal royalty oil from production in the Central Gulf of Mexico. The initiative was designed to replace approximately 28 million barrels of oil which were sold from the SPR in FY 1996 and 1997 largely for deficit reduction purposes.

“Royalty oil is owed to the US government by operators who acquire leases on the federally-owned Outer Continental Shelf. Under current law, federal ownership ranges from 12.5 percent to 16.7 percent of the oil produced from federal leases. The Minerals Management Service (MMS) is responsible for collecting royalties. MMS has traditionally collected royalties from federal oil and gas leases in cash, but in 1998 it started testing the effectiveness of collecting royalties “in kind”--that is, acquiring the crude oil itself. This mechanism was adopted to begin refilling the SPR,” according to the DOE website. (15)

George W. Bush Administration and the SPR

In November 2001, following the terrorist Arab Muslim attacks of September 11, 2001, the George W. Bush Administration ordered fill of the SPR to its reported capacity at that time of roughly 700 million barrels, principally through oil acquired as royalty-in-kind (RIK) for production from federal offshore leases, as described above, according to Bamberger. (17) Bush was criticized by some for continuing to fill the SPR with RIK crude even as crude prices increased, but achieved his goal of a 700 million barrel fill in August 2005. (18) On August 8, 2005, President Bush signed the Energy Policy Act of 2005 (Public Law 109-58), which permanently authorizes the SPR, just like the Northeast Heating Oil Reserve (NHOR, see above) made permanent by President Clinton, and also requires expansion of the SPR to its authorized maximum of 1 billion barrels of crude “as expeditiously as practicable.” (18)

Hurricanes Katrina and Rita introduced new challenges to management of the SPR. On August 31, 2005, just two days after Hurricane Katrina made landfall on the Gulf Coast, Bush Administration Secretary of Energy Bodman indicated that the Bush Administration was authorizing release of SPR crude oil. The rationale for releasing the oil was that the SPR could be used to address oil emergencies internal to the US as well as interruptions to the external supply chain. On September 14, 2005, the DOE announced that bids for 11 million barrels had been accepted. The damage to production and refining facilities in the Gulf region was expected to be brought back online by the first quarter of 2006.

The International Energy Agency, of which the US is a member, responded to the disasters by releasing 60 million barrels of American, European, and Asian strategic oil stocks at the rate of 2 million barrels a day, according to Bamberger. (20) Half of the total drawdown was 30 million barrels of SPR crude that were offered for bid. Then on October 7, 2005, the House passed the Gasoline for America’s Security Act, which allowed sales of SPR oil to finance expansion of the SPR to 1 billion barrels. The legislation also authorized expansion of the Northeast Heating Oil Reserve to 5 million barrels, according to Bamberger (20) The legislation has been referred to the Senate Committee on Energy and Natural Resources (as of November 2005). (21)

An interesting aspect of using the SPR as a policy tool to respond to the hurricane-induced shortages, as pointed out by Bamberger, is that a barrel of crude contributes to product supply only if there is refining capacity to turn the crude into gasoline or diesel fuel. We saw a similar situation with the home heating oil issue in the Northeast described above. Following the hurricane impacts, refineries representing about 800,000 barrels of daily refining capacity remained closed as of November 2005. (21) As a result, the “Environmental Protection Agency temporarily lifted Clean Air Act requirements on gasoline nationwide until September 15 to improve refinery yields of gasoline, and to make it possible for any gasoline that reached the market to be sent anywhere in the country. The waivers were continued for some areas until mid-October.” (21)

Summary

The US Congress and President Ford in 1975 created the US Strategic Petroleum Reserve to reduce the impact of future external oil shocks similar to the one experienced during the OPEC oil crisis of 1973-1974. Since the 1970s, however, the use of the SPR has expanded to include resolving a variety of undesirable national situations ranging from annual federal deficit problems to hurricane-induced shortages of oil.

Sources:

1. Cornell Law School US Code Collection. Title 42, Chapter 777 (6201). Congressional statement of purpose. http://www.law.cornell.edu/uscode/html/uscode42/us...; accessed April 23, 2006.

2. Robert Bamberger: “The Strategic Petroleum Reserve: History, Perspectives, and Issues.” CRS Report for Congress. April 3, 2006. Available online at http://fpc.state.gov/documents/organization/64938....; accessed April 23, 2006.

3. SEMP Biot #227: “What is a Rentier State?” June 24, 2005. Available at: http://www.semp.us/biots/biot_227.html; accessed April 23, 2006.

4. Wikipedia: “1973 Oil Crisis”. Available at: http://en.wikipedia.org/wiki/1973_energy_crisis; accessed April 23, 2006.

5. Robert Bamberger: “IB87050: Strategic Petroleum Reserve.” August 2, 2001. CRS Issue Brief for Congress. Available at: http://www.cnie.org/nle/crsreports/energy/eng-23.c...; accessed April 23, 2006.

6. Robert Bamberger: “The US Strategic Petroleum Reserve”. October 2001. Available at: http://www.senate.gov/~gov_affairs/psisec2sprprogr..."; accessed April 23, 2006.

7. US Department of Energy SPR website: at: http://www.fossil.energy.gov/programs/reserves/spr... and http://www.fe.doe.gov/images/programs/reserves/spr...; accessed April 23, 2006.

8. Robert Bamberger: “IB87050: Strategic Petroleum Reserve.” August 2, 2001. CRS Issue Brief for Congress, p. 2. Available at: http://www.cnie.org/nle/crsreports/energy/eng-23.c...; accessed April 23, 2006.

9. Ibid, p. 4.

10. Ibid, p. 6.

11. Ibid, p. 7.

12. Wikipedia: “1979 Oil Crisis”. Available at: http://en.wikipedia.org/wiki/1979_energy_crisis; accessed April 23, 2006.

13. Robert Bamberger: “IB87050: Strategic Petroleum Reserve.” August 2, 2001. CRS Issue Brief for Congress, p. 3. Available at: http://www.cnie.org/nle/crsreports/energy/eng-23.c...; accessed April 23, 2006.

14. Ibid, p. 8.

15. The RIK program is described in the DOE’s Office of Fossil Energy website at: http://www.fossil.energy.gov/programs/reserves/spr...; accessed April 24, 2006.

16. Robert Bamberger: “The US Strategic Petroleum Reserve”. October 2001, pp. 19-20. Available at: http://www.senate.gov/~gov_affairs/psisec2sprprogr..."; accessed April 23, 2006.

17. Robert Bamberger: “Strategic Petroleum Reserve.” November 25, 2005. CRS Issue Brief for Congress. Available at: http://www.usembassy.at/en/download/pdf/petrol_res..."; accessed April 24, 2006.

18. Ibid, “Summary”.

19. For more information on the International Energy Agency, go to: http://www.iea.org/Textbase/about/index.htm; accessed April 24, 2006.

20. Robert Bamberger: “Strategic Petroleum Reserve.” November 25, 2005. CRS Issue Brief for Congress, p. 1. Available at: http://www.usembassy.at/en/download/pdf/petrol_res..."; accessed April 24, 2006.

21. For more information on US Senate Committee on Energy and Natural Resources, see: http://energy.senate.gov/public/index.cfm?FuseActi...; accessed April 24, 2006.

22. Ibid, p. 2