How Falling Oil Imports Doubled the US Strategic Petroleum Reserve

• Falling oil imports have greatly expanded the capability of the US Strategic Petroleum Reserve to replace oil imports in a crisis, although prices would still rise.

• The SPR remains an imperfect backstop. Post-Syria, it is high time for Congress and the White House to address its gaps after four decades of change.

Last week's deal between the US and Russia defused the threat of an attack on Syria's military installations, along with the risks of unintended consequences for Mideast oil exports. However, we shouldn't lose sight of an important energy-related observation in the Wall St. Journal's “Heard on the Street” column as the crisis was peaking. It concerned the extraordinary degree to which reviving US oil production and weaker US energy demand have boosted the effectiveness of US oil inventories, including the US Strategic Petroleum Reserve (SPR).

Without adding a drop — the SPR actually shrank a bit in 2011 — the reserve’s potential to replace daily oil imports in a crisis has soared as those imports have declined. This could prove extremely helpful should the complex talks over securing Syria's chemical weapons break down, and the US and France proceed with missile or air strikes. Longer term, it serves as a further reminder that the existing SPR was designed for another era and is overdue for a major rethink.

Having 700 million barrels of oil available in federal facilities along the Gulf Coast has tempted presidents and other politicians, who saw opportunities to benefit from using it to attempt to crush periodic gasoline price spikes. However, the recent situation came much closer to the scenarios the SPR was intended to address when it was begun during the Ford administration, to provide a backstop for our vital energy supplies in emergencies involving the physical interruption of supply. When it comes to uses of the SPR, I’ve always been a purist, perhaps because I can recall sitting in gas lines and participating involuntarily in the bizarre “odd-even” rationing-by-license-plate scheme introduced during the oil crisis following the Iranian Revolution in 1979.

Here’s how the benefits of tapping the SPR in an actual crisis have improved, based on the rapid recent drop in US oil imports. In 2007, the SPR could have replaced just over half of our crude oil imports from countries other than Canada or Mexico for 165 days, at its maximum draw-down rate of 4.25 million barrels per day. With its current inventory and this year’s average crude oil imports through June running at around 7.6 million barrels per day, the SPR could substitute for 100% of our non-North American imports for 163 days. The value of such an insurance policy is rarely appreciated until it is needed.

Of course in practice the situation would be more complicated, mainly for reasons that support the case for rethinking the current 1970s-vintage reserve. One problem is that the oil stored in caverns near the Gulf of Mexico wouldn’t provide much immediate assistance for east coast refineries or for the West Coast, which has become increasingly dependent on imports as production in both Alaska and California declined steadily. Then there’s the issue of quality. Nearly 40% of the SPR oil is light and sweet (low in sulfur), while much of the oil we still import is heavy and sour (higher sulfur), to match the requirements of current refinery configurations. With production of light sweet crude in Texas and North Dakota booming, releasing sweet crude from the SPR could compound regional imbalances and possibly result in reduced refinery utilization. Any redesign of the SPR should take these important shifts into account.

Oil prices jumped just at the thought of a cruise missile attack on Syria, so it’s worth recalling what a back-up supply from the SPR can and can’t do. It can buffer the US economy from the impact of a serious interruption in the flow of crude oil cargoes from the Middle East or elsewhere, for some months. US refineries would continue to operate, as would the planes, trains, trucks and ships they fuel, and on which commerce depends. However, consumers wouldn’t be insulated from the price increases that would accompany any major disruption in Middle East oil exports, because the SPR oil must be auctioned to refiners at market prices. The resulting situation at gas stations might look a lot like price-gouging, with social media rapidly spreading outrage and conspiracy theories. The fallout from that could be disruptive, too, if somewhat less so than widespread fuel shortages and “out of gas” signs.

A different version of this posting was previously published on Energy Trends Insider.

What's the Alternative to Oil Sands?

I can recall when technologies like oil sands and coal gasification were commonly referred to as alternative energy, with the same high-tech aura now attached to solar power and advanced biofuels. Much has changed since then, not least our perspective on climate change and the greenhouse gases that contribute to it. It's no longer possible to consider Canada's oil sands production and the means of transporting it without a serious examination of the environmental consequences, both at the source and along its journey to market. However, while I understand that perspective, the reaction to the proposed Keystone XL pipeline seems disconnected from the reality that crucial supplies of Middle Eastern oil suddenly look much riskier than they did. We should certainly weigh the costs and benefits of oil sands carefully, but the missing element from this conversation is the question of what the alternative would be if we ruled out more oil sands imports.

This train of thought began with a sobering analysis of the energy implications of the unrest in the Middle East by Amy Myers Jaffe of the Baker Institute at Rice University in Houston. The challenge she highlights is much subtler than the risk of exports from countries like Libya being disrupted for a few months or even a few years. Existing spare capacity in other producing countries can cope with some of that, although a portion of that capacity is in other countries that could be just another domino or two down the road, while the rest is in Saudi Arabia, which might not be immune, either. Yet if the worst case is the disruption of exports, we have a substantial Strategic Petroleum Reserve to fall back on. Prices might rise significantly, but the prospect of no fuel at your local gas station at any price remains remote for now.

However, as Ms. Jaffe demonstrates, much of the incremental oil production capacity on which forecasters have been relying to meet additional oil demand over the next two decades, and to backstop declining production in non-OPEC countries, must come from the same region that is now in turmoil. And as the charts in her presentation show, revolutions--democratic or otherwise--rarely result in higher oil output. If new governments or chastened existing governments don't invest in developing that extra capacity, then Peak Oil won't just be a theoretical construct in geology; it will be a very real outcome in geopolitics, and one that strategic inventories like the SPR would be unable to mitigate.

We have had a tendency to view Canada as the Saudi Arabia of the north. Considering that we now receive more oil from there than from all the countries of the Persian Gulf combined, and that our NAFTA partner's proved reserves of 178 billion barrels are second only to those of the Kingdom, that's not unreasonable. As recently as 2002, though, Canada's oil reserves were under 6 billion barrels, before the oil sands could be booked as reserves in large quantities. Without its oil sands, Canada would be just another mature oil province with declining conventional output. The question of how rapidly to develop those resources, and whether to export their output outside North America to any significant degree, is currently a hot topic in Canadian politics. The pipeline to transport this oil to Kitimat, British Columbia for export to Asia seems to be subject to a similar debate to the one we're having in this country concerning the Keystone XL line from Alberta to the Gulf Coast. But what if these projects didn't go forward? A world without oil sands might have a little less in the way of greenhouse gas emissions, but it would also have much higher oil prices, and those prices would be more volatile.

So what are the alternatives to these "dirty tar sands", as environmentalists now invariably refer to them? Well, if you're been reading my blog for a while, you know that wind and solar power don't enter into this discussion, because very little electricity is used for transportation and very little oil is used for generating electricity, outside of the developing world and now post-Tohoku Quake Japan. If we don't have access to oil sands imports, then the only other near-to-medium term options for reducing our oil imports from less stable suppliers involve more domestic oil production, more efficient vehicles, and more biofuels production.

Unfortunately the latest Department of Energy forecast incorporating all of those options still leaves us importing nearly 9 million barrels per day of oil in 2025. Without a significant portion of it coming from Canadian oil sands, we will still be forced to rely on imports from places like Venezuela and the Middle East, some of which aren't much more environmentally sound than the oil sands production. And that assumes that all the domestic production in these plans actually materializes. Turning up our noses at both offshore drilling and oil sands is pretty much mutually exclusive. (Or for that matter, shale gas and oil sands, even though these are different forms of energy.)

As for biofuels, we've already got just about as much corn ethanol as we can handle for many reasons, and the more advanced variety has not been especially cooperative in turning up on schedule. Replacing the oil sands capacity that the proposed Keystone XL pipeline could deliver would require more than 23 billion additional gallons per year of ethanol, or 180% of last year's US ethanol output. That figure exceeds the entire 2022 cellulosic and advanced biofuel target under the federal Renewable Fuels Standard. Biofuels are an important part of our energy mix, but the time when they could make oil sands crude unnecessary is still a long way off.

Americans are conflicted. We complain about $4 gasoline, and we're uneasy about another military intervention in the oil patch of the Middle East and North Africa, but then we throw obstacle after obstacle in the path of one of the few options that can provide us with a larger supply of reliable fuel from North America. No matter how sympathetic I am with communities that don't want the new pipeline to pass through or near them, or with concerns about the 17% increase in lifecycle greenhouse gas emissions that oil sands represent, compared to conventional oil, closing our border to additional imports of oil sands crude can only undermine US energy security, at the worst possible time.

Are Strategic Inventories Adequate to Handle Another Oil Crisis?

In a thought-provoking op-ed, Michael Levi of the Council on Foreign Relations has provided a very timely reminder of the role that the strategic petroleum reserves of the US and other nations would play if the turmoil in North Africa and the Middle East spawned another oil crisis. Neither additional drilling nor an accelerated effort on renewable energy would make any near-term difference if oil exports from the Middle East were disrupted. Both strategies are important for our future needs, but the only two tools we have for dealing with an immediate oil crisis are the Strategic Petroleum Reserve (SPR) and old-fashioned conservation. Unfortunately, we've wasted the last couple of years of relative oil-market stability that could have been spent bringing the SPR into the 21st century.

The US government currently has 726 million barrels of oil stored in underground caverns around the Gulf Coast, for use in emergencies. At that level, the SPR is essentially full. The stored oil notionally equates to around 80 days of supply at our current rate of net crude oil imports, though in practice it would provide 165 days of drawdown at the SPR's maximum pumping rate of 4.4 million barrels per day. That is in addition to commercial supplies of crude oil and gasoline and other petroleum products, which currently stand at the equivalent of 24 and 28 days, respectively. However, commercial stocks aren't much of a backstop, because the difference between current levels and those at which the system would start to run out in places amounts to less than a week of normal consumption.

We needn't worry about relying on the SPR if exports from Libya dry up. As I noted in Tuesday's posting, OPEC has more than enough spare capacity to make up such a shortfall, although it's of different quality and might result in some tightness in global diesel markets. But if the current unrest spread and threatened exports from the big producers on the Arabian peninsula, the only thing standing between consumers and much higher oil and product prices would be the SPR and its counterparts in other consuming countries. With combined inventories of at least 1.6 billion barrels, these reserves are in good shape to respond to a drop in exports of a few million barrels per day for several months, though not necessarily a sustained curtailment or a much larger one. And any use of these reserves should be coordinated among consuming nations, as Mr. Levi pointed out in his op-ed.

This all sounds good in principle, and I have no doubt that even the announcement of the intent of the US and others to draw promptly on these stocks if the situation deteriorates further would do a lot to calm markets. At the same time, it's important to understand how much the world has changed since the SPR was first planned and implemented, as a result of the first oil crisis in 1973-74. As I commented three years ago:

"In addition to importing much larger volumes of crude oil, our refinery capacity hasn't kept pace with demand, resulting in steadily growing imports of gasoline and gasoline blending components. And in the interim, oil production in Alaska and California has fallen into deep decline, requiring crude and product imports into a maxed-out West Coast refining system.

So instead of a strategic reserve designed to provide a back-up supply of crude oil to Gulf Coast and Mid-continent refineries serving the entire US east of the Rockies, our needs have expanded to encompass oil and refined product imports on all three coasts. These altered circumstances suggest the need for a more diverse and dispersed SPR, perhaps modeled along the lines of the federal Northeast Heating Oil Reserve. Nor do I believe that the only practical model of such a reserve entails government ownership and custody of the hydrocarbons in question. Other countries achieve the same end with a requirement for oil companies to maintain mandatory minimum inventory levels at no direct cost to taxpayers."

That's as relevant today as when I wrote it, with the addition that the SPR's potential effectiveness has been further affected by the buildup of crude in the Mid-continent as a result of increased output from Canadian oil sands projects and the rapidly growing output of the Bakken Shale. This is one of the main reasons why West Texas Intermediate is trading at roughly $100 this morning, while UK Brent crude, which is normally within $2 of WTI, has spiked over $118. I also can't resist pointing out that the market is hitting us in the face with a two-by-four concerning the potential energy security value of US natural gas, which is still trading at an oil-equivalent price under $27 per barrel for all of 2011, despite the events in the Middle East.

I don't blame the last two administrations or Congress for not having made SPR reform a higher priority in the last three years. They had a few other things on their plate. However, even if the current crisis in Libya and the Middle East resolves itself quickly and without further impact on world oil supplies, it provides another unwelcome reminder that we live in a world in which the President and other world leaders might need to call on our strategic oil inventories on very short notice to prevent a catastrophic breakdown of the economy. In that context, redesigning our 1970s-vintage SPR to be more effective in a greatly altered landscape ought to rise to a similar priority as addressing other urgent concerns such as the deficit.

Presidential Debate: Energy Issues

In a presidential debate focused on foreign policy and the ongoing financial crisis, it was entirely appropriate that the subject of energy came up as often as it did. The two Senators discussed energy in at least three different contexts: the consequences of past energy legislation, policies to promote future energy independence, and the geopolitics of energy. Both expressed support for a broad mix of alternatives, fossil fuels, and nuclear power. The differences in their priorities might have been clearer, had either provided more details of his respective energy programs. Surprisingly, however, only Senator Obama referred directly to energy independence, a goal both men have mentioned frequently throughout their campaigns.

Longtime readers of this blog know that I regard energy independence, in its strictest definition, as an unattainable distraction from sound national energy policy in an inter-connected world. That concern is less relevant here, because the scope of Senator Obama's vision for energy independence appears to have been reduced to a goal of freeing ourselves from "dependence on Middle Eastern oil" within 10 years. Numerically, at least, that might just be feasible, since oil from the Persian Gulf accounted for only one-fifth of net US oil imports last year. The 17 billion gallons per year of additional biofuel mandated by 2018 under the current Renewable Fuels Standard would get us more than a third of the way there, after factoring in differences in energy content and refining efficiency. The phase-in of higher fuel economy standards over that period might deliver the rest, with a bit of help from the lifestyle changes that have contributed to this year's drop in demand. But that assumes that domestic US oil production would not continue to drop in the meantime. That is far from certain, and it has as much to do with government policies as it does with geology.

Between 1997 and 2007, US production of crude oil and natural gas liquids fell by 1.1 million barrels per day, an average net decline of 1.5% per year. Over the next decade, the continuation of that trend could slice another million barrels per day from our current output, making the achievement of Senator Obama's goal much harder, possibly putting it out of reach. That's why this year's drilling debate and the proposed new taxes on the oil industry are so important. Even if we can't drill our way to energy independence, we can certainly non-drill our way into even greater dependence, despite our best efforts on alternatives and fuel economy.

Senator Obama's citation Friday of the oft-quoted, though highly-misleading "3% of reserves but 25% of consumption" factoid suggests that he and his advisers should examine the dynamics of US oil production a little more closely. Perhaps they are encouraged by DOE forecasts of a modest resurgence of oil production, though history suggests those might be as optimistic as the same agency's estimate of only 200,000 barrels per day of production from the off-limits portions of the offshore seems overly pessimistic. But whether we are considering the production potential of current leases or the prospects of the estimated 18 billion barrels of additional oil that have been placed off-limits, the US oil industry's task of maintaining output at levels at least comparable to today's--amounting to 10% of the world's supply, not 3%--will be much harder, if it faces lawsuits attempting to block every new lease, or if it is subjected to new excise or windfall-profits taxes.

I look forward to hearing more about the candidates' visions for energy in the debates ahead, including more details from Senator McCain on the cost and feasibility of constructing another 45 nuclear power plants in this country. I'd also like to learn more about the role each of them sees for energy conservation, which I didn't hear mentioned last Friday. In addition, in the next few weeks I intend to take another look at each Senator's published energy plans, since I haven't reviewed these (McCain; Obama) since the primaries.

Living with the Bomb

With the media churning on the reports of Iranian IEDs in Iraq and fears of a slide into war with Iran over its nuclear program, it's worth spending a few minutes thinking about a different outcome, in which Iran ultimately gets the Bomb, and we enter a new kind of Cold War in the Persian Gulf region. That's what Zbigniew Brzezinski seemed to be hinting at, in his recent testimony on Iraq before Congress, and it's consistent with a new report from the EU on the likelihood of Iran producing enough fissionable material to build a nuclear weapon. As unappealing as the prospect of devoting years or decades to containing a nuclear-armed Iran may seem, it is starting to look more palatable than a wider war in the Middle East, which would have to be prosecuted by a tired and over-extended US military, and probably without allies. And that doesn't even begin to cover the energy implications of such an event.

Two years ago, I put together a lengthy report on Iran's nuclear ambitions. After looking at the relative economics of nuclear power and Iran's vast untapped hydrocarbon reserves, it seemed hard to credit that Iran's efforts were as innocent as they claimed. I concluded that buying time was the best of a batch of poor choices. Unfortunately, although the EU-3 talks with Iran have done just that, we find ourselves with no better options now than then, and if anything the military option looks even less workable. Oil prices have remained high, preserving Iran's economic leverage and the implicit threat of an embargo. Instead of settling down and releasing our deployed forces as a potent and proximate threat against Iran, Iraq is more chaotic, continuing to grind up US troops and equipment. And whatever its strategic and tactical merits, the Surge exacerbates the strain on our over-committed forces.

The most positive development has been the achievement of UN sanctions against Iran for its nuclear efforts. However weak they might seem to some, they demonstrate that even Iran's closest friends on the Security Council will not give it carte blanche. The sanctions have also complicated Mr. Ahmadinejad's life at home, by highlighting the price Iran pays for pursuing nuclear enrichment and drawing attention to his failure to deliver on the economy. In contrast, an attack on Iran's nuclear facilities by either the US or Israel would shatter the international alignment against Iran and shore up Ahmadinejad's shaky base.

So what might a Cold War with Iran look like? Perhaps not much different from what we see today, if we recall that the West bought oil and natural gas from the USSR, at the same time the latter was funding and arming insurgencies around the world. As then, successfully containing a nuclear Iran would require deft diplomacy, and it would hinge on a credible deterrent--which in the odd logic of mutually assured destruction is equally dependent on the willingness of the subject to be deterred. The US can certainly supply the former, on planes, submarines and ICBMs, though there's legitimate doubt about how deterrable a theocracy might prove. A clear shift to a strategy of containment could actually reduce tensions in the region, but it's never going to suppress all the other simmering grievances in the way the old Cold War with the Soviet Union did. And in this world there won't just be an Iranian Bomb; we could eventually see an Egyptian Bomb, a Saudi Bomb, and so on.

Dealing with a rising Islamic power--at least in their own eyes--would doubtless present some unique twists, compared with containing a decaying--though we didn't realize that until later--superpower. The other parties in the region understand the game, too, having participated before, and we might be surprised and disappointed at who lines up on which side. Nevertheless, we can do this, because we've done it before on a much larger scale. No matter how much Iran's leaders might think they've gone to school on that era, they didn't live through it with their fingers on the Button, as we did.

Perhaps the biggest challenge to the viability of a containment option for Iran is creating an enduring bi-partisan framework for it in Washington. We aren't living in the days of Truman and Vandenberg, who didn't have to contend with 24-hour news cycles, bloggers, or the complete breakdown of secrecy. It's worth trying, though, because the alternative to a mini-Cold War is another hot one, with victory neither quick nor certain, and consequences no one can predict.