The Strategic Petroleum Reserve Story

The Days Ahead:

• Fed’s Jackson Hole symposium; Fed minutes, new home sales

This Week:

• How the Strategic Petroleum Reserve got into a mess
• It’s been a long and bumpy road
• The Reserve is at its lowest in 40 years
• Everyone agrees it should be built up
• But can’t agree on how and when
• It may start affecting oil prices in 2025

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Why is the Strategic Petroleum Reserve (SPR) a thing?

Occasionally the SRP bursts onto the headlines. Usually, it’s quietly working in the background and no one pays it much mind. Then when there’s some upset in the oil market, we see comments like “The SRP is too high/low” or “We need more storage.” But strange things have happened at the SPR in the last few years, and unless there’s a policy change, we’ll see more headlines, and not in a good way.

Origin

From 1960 to 1973, U.S. oil imports grew from 0.8 million to 6.2 million barrels a day of which 47% came from OPEC. In 1973, the Arab members of OPEC, or OAPEC, embargoed exports to several countries, including the U.S., who supported Israel in the Yom-Kippur War from October 1973 to March 1974. U.S. monthly oil imports fell 40% from 115 million barrels in October to 80 million in February, when the embargo was lifted. Meanwhile, the price of oil climbed from $2.90 to $11.65 which helped put the U.S. into a 16-month recession ending only in March 1975.

Demand recovered so that by 1976, U.S. oil consumption was 17 million barrels a day and imports were back to 7.3 million barrels a day. By December 1976, the U.S. was importing 183 million barrels a month. OPEC increased its share from 47% to 70% of all imports.

The embargo, the price increase and the return of OPEC as a dominant import source, worried the public and lawmakers. Something that had been abundant and cheap was suddenly scarce and expensive. In December of 1975, the Energy Policy and Conservation Act of 1975 introduced mandates for auto gas mileage, a ban of crude oil exports (which were only 32,000 barrels a day but remained in place until 2015) and the creation of the SPR as an office within the Department of Energy (DOE).  

Which was what?

The SPR’s purpose was to have a supply of enough oil during “severe energy supply trade interruptions.” The original size was to be between 150 million to 1,000 million barrels of petroleum. Confusingly, petroleum is usually the refined product of crude oil that ends up in your car, but for the SPR, the “reserve” is only crude oil. Oil lasts indefinitely in the special salt caves built for the SPR, unlike above-ground storage which is good for about two years. The idea was that the SPR would sit there and be available when there was a critical shortage from imports, hurricanes, or conflicts. Hawaii had special access to the SPR…just in case.  

Where does all that oil go?

The first SPR storage facility was built in 1977 and took 412,000 barrels of oil. At that time, daily U.S. oil consumption was 16 million barrels. The plan was to have storage facilities in the Gulf of Mexico stretching 480 miles from Eastern Texas to Eastern Louisiana. The DOE built four sites from 1977 to 1991, all near major transportation and refining hubs. The storage facilities are not large tanks but salt domes, or wells, which are excavated caves up to 6,000 feet below ground. Think of the system as a giant empty cylinder in a vast block of salt. The cylinder is full of oil. The oil is pumped into the dome and the outer layers of salt prevent leakage or water seepage. Capital costs for storage costs in the salt caves are $3.50 per barrel compared to $15 for above-ground tanks.

Anyway, we’re big fans of engineering marvels here at Cerity Partners so we could not pass this up to show you what they look like:

We’ve added the capacity for each site, which you may notice, sums to 712 million barrels, well short of the 1,000 million required under the 1975 act.

Oil is removed by pumping water into the wells. Oil floats on water. The oil is then pumped to its next destination, usually a ship or a refinery.

How much is in there?

As previously mentioned, when the SPR started in 1977, the U.S. consumed around 16 million barrels daily for a GDP of $1,800 billion. A full-capacity SPR would have provided 62 days of use. Today, the U.S. consumes 20 million barrels a day for a GDP of $28,000 billion. U.S. energy use per dollar of GDP has improved by a factor of 15 times. Today’s SPR is 375 million or about 18 days of use.

On the above chart, the blue line shows the amount of oil in the SPR. We’ve added total private sector stocks in green. The private sector is seasonal, often rising in winter and drawing down in summer, but is unchanged from 2016 levels at 423 million barrels. The rise in 2016 in private stocks was because U.S. oil production jumped from 8 million barrels a day in 2016 to 12 million in 2019. As production rose, stocks rose and are at a stable 32 to 34 days of supply.

The SPR is a different story

For years, the SPR kept levels steady at 580 million from 1990 to 2001 and 700 million from 2005 to 2017. The Department of Energy (DOE) released reserves in response to natural disasters and wars in Kuwait and Iraq. The jump from 2002 to 2006 was because a change in the law from 2000 to 2009 allowed oil companies drilling in the Gulf of Mexico to pay royalties in kind (i.e. oil) instead of cash.

In 1997, the SPR attracted budget attention for all the wrong reasons. The value of the SPR was $12 billion and Federal government outlays were $1,600 billion. Neither the SPR level nor oil prices had changed in years. Suddenly, the amount of “idle” money looked like a windfall. In 1996, the Omnibus Consolidated Appropriations Act, authorized the sale of 28 million barrels to raise $580 billion for “deficit reduction” purposes. It seemed like such a good idea that the SPR was used as a revenue source under four more acts from 1996 to 2000.

There were emergency drawdowns following the invasion of Iraq in 2001 and 2002 and then a steady build up to 700 million barrels from 2002 to 2009 using the in-kind provision. The SPR sat at 700 million until 2017 when Congress instructed the DOE to sell oil to modernize its plants.

The idea of the SPR as a revenue source had started again.

From 2017 to 2023, Congress found more ways to fund the budget. The Bipartisan Budget Act of 2018 directed the DOE to sell 90 million barrels from 2022 to 2027. The Tax Cuts and Jobs Act of 2017 authorized the sale of 21 million barrels from 2026 to 2027. The Fixing America’s Surface Transportation Act of 2015, calls for selling 66 million barrels from 2023 to 2025. Some 50 million barrels of authorized sales were reversed with the Consolidated Appropriations Act of 2023, but the same act removed $10 billion of the SPR’s purchasing power or around 125 million barrels.

And still it went on. The America’s Water Infrastructure Act of 2018, legislated a drawdown of 5 million barrels in 2028  and the Infrastructure Investment and Jobs Act of 2022, a drawdown of 90 million from 2028 to 2031. Total mandated sales were over 322 million barrels.

Note that the mandated drawdowns were years after the bills passed. It was a classic case of kicking the can down the road.

In the three years to 2020, Congress mandated sales of 150 million barrels, raising over $10 billion of revenues. By the end of 2021, the SPR had fallen 15% from its 2017 peak, all of which was for budgetary reasons. The “strategic” part of the reserve had taken a back seat.

Another big drawdown in 2022

In 2022, the SPR level fell from 600 million to 400 million barrels. Most of that, or 180 million barrels, was a drawdown because of Russia’s invasion of Ukraine, which sent oil prices from $70 to $120 in a month. There was a provision to use the proceeds to restock the SPR “in future years” but, again, the SPR just seemed a great way to fill budget gaps.

It’s enough to make one’s head spin but the pattern seems to have been to use the SPR as a funding source for spending that had little to do with strategic petroleum. Congress also turned down requests to replenish the reserves. The result is that the SPR is now at the same level as it was in 1983. It’s scheduled to drop to 100 million barrels by 2028.

Now what?

In late 2022, one of the continuing resolutions canceled some mandated drawdowns from 2024 to 2027 and gave the DOE more flexibility to buy supplies to refill the reserve. Some 140 million of the 322 million mandated sales were canceled. Congress also granted money for the SPR to buy oil to restore the reserves.

But that came with a twist.

The DOE was authorized to buy oil in a two-week window starting December 28, 2022. The DOE asked for bids and would settle two weeks later on January 13, 2023. The DOE had the option to walk away from any bids if the oil price dropped in the intervening two weeks. Now, two weeks and a long holiday is a lifetime in the spot market and the optionality was all in the DOE’s favor. Unsurprisingly, no sellers stepped up.

In 2024, President Biden announced he wanted to replenish the SPR. Between 2017 and 2021, Congress authorized $0 to buy oil for the SPR. In 2022, it authorized $11 billion but that was the year of the big draw down so the SPR made no purchases.

In 2023 it authorized $4.4 billion but only used $0.3 billion because of the weird purchase terms imposed on the DOE. In 2024, Congress authorized $4.1 billion of which the DOE has spent $2.6 billion or about 30 million barrels so far this year (see the hook up in the blue line above). The DOE has around $1.5 billion or 18 million barrels left to buy oil between now and the end of October but, again, there are restrictions. The price of oil must be between $67 to $79. Today, it’s $78.

Where does that leave us?

Everyone agrees building up the SPR is a good thing. But it can’t be done unless Congress authorizes more money. The DOE’s remaining $1.5 billion could add another 18 million barrels bringing the SPR up to 393 million barrels, but that’s way short of its peak. To build up the SPR, Congress needs to authorize the spending.

SPR is now in a strange place. Everyone wants a higher level but no one wants to pay for it. Former President Trump said he’s all in favor of filling up the SPR, which is a reversal of his 2017 proposal to halve its storage capacity. The current administration wants to build it up too. Whoever takes the White House and Congress in 2025 will have to move fast because the mandated sales start up again in the same year. An additional problem is that drawdowns impair the structure of the salt domes so replacement capacity diminishes every year.

Nothing more will happen in 2024.

The DOE wants to buy but can’t unless Congress recapitalizes its spending account. SPR levels will stay where they are until the postponed mandated sales return.

We don’t think oil prices will move much in the short-term. The SPR is an opportunistic and marginal buyer at best. It would help if the SPR was bigger as it would dampen supply interruptions. But that doesn’t look likely. Something must give otherwise the SPR will start to sell significant levels of oil, disrupting the market.

We may hear more about the SPR in coming months especially because headline inflation is sensitive to oil prices and we’re heading into an election. The problem is fixable. The will to fix it, unfortunately, is absent.

The bottom Line

We saw two major inflation reports, Producer Price Inflation (PPI) and Consumer Price Inflation (CPI), that were in line with expectations. If that doesn’t sound too exciting, we’d note that core consumer price inflation (CPI) has come in well below 0.2% for the last three months and seems to have left the January to March upside surprises well behind. The annualized rate of headline and core inflation has been below the Fed’s target of 2% since April. Headline inflation was at its lowest since March 2021.

Housing inflation, the largest component of the index and the most stubborn to decline, was at 5.3%. While still 2% over pre-Covid-19 levels, this was its lowest annual increase in over two years. We expect housing inflation to continue to fall given the slowdown in new rent prices. Here we show a popular rent index from Zillow and advance it by 13 months. Rents started to drop off rapidly in mid-2023. We expect the main housing inflation, in blue, to continue to drop, albeit with a lag.

Auto insurance, which we wrote about here, remains high at nearly 19% and is now 3% of the total index up from 1.7% in 2020. But used car prices and auto repair costs fell, which is usually a good sign that insurance rates will drop.

Markets took the news in their stride with no big reactions. The S&P 500 was up 4% for the week, up 8% from recent lows just two weeks ago and is 2.3.% below its mid-July peak. The Nasdaq rose 5%.

The 10-year Treasury traded between 3.8% and 3.9% all week, well below the 4.2% to 4.6% range we saw from January to July. We fully expect the Fed to cut in September and there was nothing in this week’s data to deter them.

The Japan Nikkei 225 stock index rose 4.5%. It remains 5% below it’s all time high but it’s a good recovery from the 25% fall we saw after the Bank of Japan’s rate decision two weeks ago. We’re tempted to place the volatility squarely on thinly staffed summer trading desks.

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Art of the Week: Natalia Goncharova (1881-1962)