Saving Oil for a Rainy Day : Government’s Stockpiles of Crude Growing Despite Program’s Ongoing Controversy

From time to time, soldiers can be seen scampering around the fringes of an inconspicuous government complex south of here. When they’re not dodging the resident alligators, they are exchanging laser gunfire with Wackenhut guards and local police and sheriff’s deputies.

These are just games to prepare for real trouble, such as terrorists. James P. Davis, who manages the site for government contractor Boeing, declares: “I pity anybody who tries to invade here. It would be tougher than Fort Knox.”

That is arguable--the government itself concedes that the security could be beefed up--but the analogy to Fort Knox is fitting. There is gold here, too, only it’s black. This is the largest of a half-dozen underground salt domes in Texas and Louisiana into which the government has injected 537 million barrels of crude oil in the past 10 years.

The stockpiling continues, currently at a pace of 75,000 barrels a day. Most of it comes from Mexico, but oil from 18 nations has been stashed. More than 40 million barrels have been bought from Libya and Iran. Oil, after all, is oil.

The U.S. Strategic Petroleum Reserve, combined with smaller stockpiles in Germany, Japan and a few other Western nations, has made the world a different place from the one whose economy was rocked by disruptions in the output of oil in 1973-74 and again in 1979.

900-Million-Barrel Cushion

Today, the major oil importing nations enjoy several weeks’ worth of government-controlled reserves totaling about 900 million barrels of oil as a cushion against a cutoff. The non-communist world uses about 46 million barrels a day. The two energy shocks of the 1970s involved disruptions of less than 2.5 million barrels a day.

Some credit the mere existence of the public stockpiles, along with the world’s unused oil-producing capacity, for preventing a surge in the price of oil during the recent Middle East hostilities. And the reserves have clearly reduced the leverage of any hard-line Persian Gulf nation that would use oil as a weapon on the world scene.

“Anybody who argues against the Strategic Petroleum Reserve is either ignorant or illogical,” says John Lichtblau, president of the Petroleum Industry Research Foundation, a respected industry think tank.

But burying the oil in the ground is only one battle. The war over when and how to exhume the stuff and deliver it to the gasoline pumps has yet to be fought, and it is a political and economic free-for-all waiting to happen.

The SPR has been a politically charged issue from the start, and the bickering continues today as Democratic congressmen claim credit for straightening out a mismanaged agency and dragging the Reagan Administration kicking and screaming to the altar of strategic oil stockpiles.

“We have found it almost impossible to deal with this Administration on SPR. They’ve tried to kill the damn thing twice,” snipes Rep. Mike Synar (D-Okla.), chairman of a government operations subcommittee that overseas the reserve. “The Department of Energy came around as a Johnny-come-lately . . . it’s a classic example of this Administration’s failed leadership and lack of energy policy.”

Some economists, meanwhile, complain that as a line of defense against a cutoff of oil supplies and the attendant surge in price--the reserve’s primary purpose--its virtues have been overstated.

For example, Philip K. Verleger Jr. of the Institute for International Economics, author of an influential 1982 book, “Oil Markets in Turmoil,” says oil prices today respond so quickly to the barest hint of swings in supply or demand that the economic damage from an oil cutoff would be done long before the government was able to sell its cache of oil.

“In theory, (the SPR) has meant a major change in the way one views the world oil market at a time of crisis. In actuality,” Verleger says, “it may be of no use at all.”

Such attacks are dismissed by Energy Secretary John S. Herrington as partisan politics or bad economics. The very existence of the reserves will ease the psychological fears of a shortage that could ignite prices, he insists. As for who did what to whom, Herrington says:

“It’s one of the most successful programs in government today. Everyone wants to take credit for it.”

The reserve has assumed a heightened importance since the dramatic 1986 fall in the price of oil caused Americans to start using more oil but to begin producing less of it. This has reversed a several-year decline in the nation’s dependence on imported crude, which has risen to about 40% of our consumption from 30% in a year’s time.

Rocky Start

Most of the increased demand has been met with oil from the Middle East, whose leading producers have been holding a rocky meeting of the Organization of Petroleum Exporting Countries. Though the cartel appears deeply divided now, many oil authorities expect its clout--and this country’s vulnerability--to grow along with a rise in our reliance on imported oil to 50% of consumption by 1990.

Whatever its current weaknesses, the Strategic Petroleum Reserve deserves some sort of medal for being here at all. Borne of the oil disruption and price run-up that followed the 1973 Arab oil embargo, the SPR survived a rocky start, indeed.

Woefully behind its original timetable even today, it was ridiculed during the Carter years as a prototypical white elephant dogged by Pentagon-sized cost overruns. It was plagued by fraud, mismanagement, and charges--never proven--that the caverns didn’t contain as much oil as they were supposed to. Some of the oil was even said to be “bad.”

Today, the reserve contains enough crude to be a credible factor in the oil markets and most of the criticism of SPR management and operations has subsided. Synar, whose committee claims responsibility for some 170 operational changes in the reserve since 1984, says this has resulted in “massive improvements.”

Grew From Embargo

The reserve’s operators have persuaded at least some critics that they can get the oil out of the ground and into the nation’s commercial pipeline and tanker systems at a rate of about 3 million barrels of crude per day. While the target is 4.5 million barrels, many oil experts consider that large an import shortfall to be highly unlikely.

Created by the Energy Policy Conservation Act of 1975, the chief legislative result of the nation’s post-embargo energy frenzy, the reserve has been strongly backed by Congress. But it has received hot and cold signals from the White House over the years, depending on the energy or fiscal climate of the moment.

With oil plentiful and the budget deficit swelling, President Reagan twice declared moratoriums on the filling of the reserve to save money. He would have topped off the reserves at 500 million barrels--far short of the original mandate of 750 million barrels and merely half the 1-billion-barrel target during the Carter years.

Congress was fighting Reagan on that when prices took their historic 1986 tumble, oil imports began to climb again and $10- $20-per-barrel crude looked like a bargain. In what some described as a victory for Herrington, the White House changed directions and today endorses the 750-million-barrel goal at an accelerated 100,000 barrels per day.

A recent General Accounting Office report to Synar’s subcommittee questions the Administration’s commitment to the reserve, noting that the Department of Energy’s current budget contains no funds for cavern expansion needed to accommodate the 750 million barrels or to improve the rate at which the oil can be pumped out and distributed around the nation.

The government’s statements of support for the SPR have been hedged with language on the need to cut the budget deficit. But a senior Administration official said, “We are playing poker with the budget every day. Both sides know that SPR has to be filled at an aggressive rate.”

$18-Billion Price Tag

Herrington says emphatically, “President Reagan is absolutely dedicated to putting 750 million barrels in the ground by the early 1990s.”

But that would require 100,000 barrels per day. Synar, commenting on the budget climate in Washington, says, “If we get 75,000 barrels a day, I will be surprised. You’ve got to understand, we ain’t got the money. And off the front page, out of mind.”

The cost to date: $18 billion.

How much oil the nation needs in reserve depends on one’s optimism or pessimism. Under guidelines of the International Energy Agency, the West’s oil importing nations have agreed to maintain a 90-day emergency stockpile of oil, an amount deemed to be economically affordable yet large enough to cushion most likely oil shortages.

Analyst Lichtblau says a 90-day supply--that is, enough to fill the void created by a complete cutoff of imported oil for 90 days--would last much longer under the most plausible scenarios.

“The chance of 90 days of total import interruption is virtually zero,” says Lichtblau, noting that the nation’s biggest foreign suppliers continue to be friendly neighbors Canada, Mexico and Venezuela. “For all practical purposes, a 90-day supply would really last for 200 or 300 days of a one-million-barrel-a-day loss, which is more likely.”

The SPR holds about 118 days of supply at the moment, or 537 million barrels against today’s consumption of about 5 million barrels per day of imported crude oil. This is a moving target. Two years ago, with a smaller cache but far less imported oil entering the country, the supply was 133 days.

‘What’s an Emergency?’

But many energy experts are less worried about oil shortages than about panic-induced price run-ups caused by the threat of shortages, and some say that is the SPR’s weak link.

The issue centers on the Reagan Administration’s plan--or deliberate lack of one--for deciding when to distribute oil from the reserve in a crisis. The Department of Energy has refused to define in advance what constitutes an energy crisis that would warrant presidential action to unlock the subterranean oil vaults.

“What’s an energy emergency? Is it the lack of oil at any price, or the lack of oil below $30 a barrel?” asks a DOE official. “Somebody said it’s sort of like pornography. We’ll know it when we see it.”

The Administration says the President would order the release of large amounts of SPR oil early in an energy emergency. It would be sold at auction to the highest bidders--presumably oil companies--who would move the crude into the refinery and distribution network to meet demand. The free market would allocate the oil.

Test Went Smoothly

The government pumps oil out of the caverns from time to time but has tested its sales arrangement only once, in November, 1985, when it actually sold about 1.1 million barrels of SPR crude to private bidders. Many in and out of Congress want more testing--Synar says the government spent a leisurely month getting the 1.1 million barrels out of the ground--but DOE’s Furiga says no more are needed.

The government and oil companies had several weeks to prepare for the test. Because there were plentiful supplies of oil on the market at the time, only 17 out of 136 invited firms made bids. Several oil companies contacted said it went smoothly.

In fact, it was an unintended windfall. The government sold the oil at about $28 per barrel just days before the world price collapse. Weeks later, Uncle Sam bought replacement oil at $13 a barrel.

A DOE spokesman says that, between the time production would be interrupted in the oil fields of the Middle East and the appearance of actual shortages here, “We would have a fairly lengthy period of time” in which to act. “If the tanker line stopped, we’d know that several weeks beforehand.”

But in a world where oil prices can spurt within hours of a modest New England blizzard, economist Verleger and others consider the DOE approach to be a laid-back system that would be left behind in the snow in the case of an announcement of a sizable cutback in production by a Middle East producer, such as occurred in Iran in early 1979.

Today’s rapid-fire oil trading system is fairly recent, dating to the 1983 introduction of crude-oil futures contracts on the New York Mercantile Exchange. The sale of so-called “paper barrels” has played an increasingly influential role in the price of oil and the speed at which transactions are made, introducing great volatility to the markets.

Thus, analysts say a price run-up would be immediate, far in advance of any physical shortage of oil.

Indeed, the spike in prices is the main concern because a minor shortage can be turned into a serious one if panic touches off hoarding of oil by governments and consumers alike.

“The threat that exists is of rapid price increases as opposed to real shortages,” says G. Henry M. Schuler, energy-security fellow at the Center for Strategic International Studies and a former Middle East-based oil executive. “The SPR will meet the shortage situation very nicely, but I can’t imagine it working to dampen prices.”

Verleger says the DOE must be able to inject oil into the market as instantly as the Federal Reserve Bank injected money into the economy the day after the recent stock market crash. An auction, he said, is “insane.”

“You’re not selling Aunt Agatha’s heirlooms here, you’re trying to provide liquidity to the economy. An auction ain’t the way to do it. The market doesn’t wait for the shortage to appear. The DOE is nowhere near this point. It almost has to be run off a trading desk. The central banking system has recognized this for years.”

Never mind that the Fed has an inexhaustible supply of money while the SPR has only 534 million barrels of oil. DOE’s Herrington says the very existence of the Western nations’ stockpiles assures the market that there is a guaranteed supply of crude. He maintains that it won’t be necessary to trade the SPR oil instantly to prevent a damaging price spike.

Premium Price

“What’s changed since ’73 and ’79 is SPR, the psychological fact of knowing it’s there,” he says.

Skepticism on this point has prompted many economists to propose the sale of options on SPR oil, giving buyers the right to take oil from the reserve at a predetermined price. That would automatically trigger the release of SPR oil when market prices reached that level.

Similarly, Amoco Corp. says the government oil should be on the market today, but at a premium “so that nobody would want it,” according to Allen Davies, manager of crude supply, planning and economics for the Chicago-based oil company. “That price would become a trigger, a means for releasing the oil to a free market.”

One problem, of course, would be agreeing on a trigger price. It might also require amendments to current law, which says SPR oil can only be released by a presidential finding that the oil is needed because of “a severe energy supply interruption” or overseas obligations.

“The SPR was not to be used as a market device,” says the DOE’s Furiga.

In addition to the question of a speedy response, some economists warn that the lack of a formula to automatically release SPR oil will lead to government paralysis in the face of tremendous contradictory pressures--foreign versus national and regional demands, for example--to either sit on the oil or distribute it.

California and Hawaii worry that Alaskan crude might be diverted to Japan during a worldwide crisis, gumming up their normal supplies long enough to cause an explosion in local prices. Like New England, they have debated a need for regional oil reserves. Meanwhile, Texas--enjoying a rise in oil prices--would take a far different view than Massachusetts on the market’s need for an injection of government oil.

No Improvements

Thomas Burns, manager of the economic staff at Chevron, credits the reserve’s existence with keeping a lid on world prices through such events as the Iraqi attack on the U.S. guided missile frigate Stark. But he agrees that the mechanism for drawing down the stockpiles is “a valid cause for concern” because the President will feel pressure not to deplete the reserves unnecessarily--but to move quickly enough to head off a devastating world price run-up.

Indeed, the issue of SPR’s role in a crisis has provided a field day for energy strategists who like to simulate such events on computers. The Rand Corp. think tank conducted such a “crisis” for the California Energy Commission in 1982, and the government’s hypothetical failure to act caused oil prices to hit $100 a barrel.

“Frankly, there’s not an easy answer,” Burns says.

However quickly or equitably the stockpiles are handed out in a crisis, skeptics point out that there has been no improvement this decade in the amount of oil the world has to handle an oil crisis--just a transfer of some oil stocks from private to public hands.

When commercial inventories of crude oil are taken into account, the Western world has only a tiny fraction more days’ supplies of oil today than it had in 1980--99 days today versus 98 then. The reason is a sharp decline in stocks held by private companies.

Then, 92 of the 98 days were in private hands. Now, with the growth of public stockpiles, only 76 of the 99 days are held by private concerns. In effect, part of the cost of maintaining the world’s oil inventories has been shifted to the taxpayer.

Naval Sales

Industry officials say they have trimmed inventories over the past several years for purely commercial reasons, notably for economic efficiency in the face of lowered demand for oil and the high cost of money. But some say the existence of the federal reserves has encouraged this trend.

“We are no better off than we were before, and I would argue that we are worse off,” said Bijan Mossavar-Rahmani, assistant director for international studies at Harvard’s Energy and Environmental Policy Center. “With the growth of these stockpiles, commercial inventories have fallen off. We think there is a relationship. The existence of the reserves has lulled us into complacency.”

Mossavar-Rahmani also sees irony in the government’s ongoing sale of oil from its Naval Petroleum Reserves in California and Wyoming. Since 1976, the government has sold roughly the same amount of crude oil--550 million barrels--from its naval reserve at Elk Hills, Calif., as it has bought for the Strategic Petroleum Reserve.

It hasn’t been an even swap, either: Uncle Sam has sold the Elk Hills oil to private refiners for an average of $21 a barrel, while buying crude for the SPR for an average of $28 a barrel.

Herrington and others call this an apples and oranges dispute, because Naval Petroleum Reserves are conventional oil fields with limited strategic value. The Elk Hills field near Bakersfield is remote from the nation’s pipeline system and can only be produced at a rate of 120,000 barrels a day, not enough to be a major factor in alleviating a crisis. The SPR can be emptied 30 times as fast.

Nonetheless, Mossavar-Rahmani says, “The overall issue is how much oil does the government have under its control. No one envisioned in the 1970s that the SPR would simply back out the NPR in a game of musical chairs.”

Like the reserve’s strongest boosters, however, Mossavar-Rahmani agrees that it has had an important positive effect on the West’s energy security--presuming we only have five more energy crises.

The subterranean oil can theoretically last forever in the salt domes. But each time oil is withdrawn, water must be pumped into the caverns--and the water dissolves the salt walls. After five complete turnovers of oil, engineers say that the caverns would grow so large that they would collapse.

1

A storage cavern begins when a well is drilled into a salt formation, one of 350 along the Gulf Coast. Fresh water from a nearby lake or river is pumped through a steel tube inserted into the well.

2

The process, known as solution mining, dissolves the rock-hard salt and leaves a cylindrical, brine-filled chamber large enough to hold about 10 million barrels of crude oil. Creating a chamber can take up to several years. A single storage facility typically consists of several chambers.

3

Crude oil is pumped into the cavern, where it floats on top of the brine. The displaced brine is pumped to the surface and discharged into the Gulf of Mexico or deep wells. To recover the oil, engineers pump water back into the cavern, forcing the oil out. The process can be repeated no more than five times, because the caverns become enlarged and are prone to collapse.