State of Louisiana Comments in Response to the Federal Register Solicitation for Comments on Strategic Petroleum Reserve Policy

July 27, 1997

As one of the nation's primary petroleum producing, consuming, importing, and refining states, Louisiana is very much in tune with issues affecting the supply and distribution of petroleum and its products. Effective long term operation and management of the Strategic Petroleum Reserve (SPR) is an essential element in maintaining the security of the country's petroleum supply and in ensuring the public's confidence in the supply system. Though the U.S. cannot control the world price of oil or other forms of energy, nor can the U.S. control the production policies of foreign nations supplying oil to this country, utilization of the SPR provides the U.S. an element of control to induce a degree of stability in petroleum supply by reducing the impacts of external disruption or manipulation. The judicious application of such a tool can provide enormous benefits to this country over the long term.

Loss of public confidence in the supply system can create supply problems just as surely as an external physical disruption. If employed properly, the SPR can prevent perceived disruptions from turning into real shortages. Consider, for example, the two major oil supply interruptions the U.S. has experienced -- the 1973 Arab oil embargo and the 1979 Iranian revolution. The State of Louisiana and the nation both experienced a perceived petroleum product supply crisis that was far more profound than was warranted by reality. A 1983 analysis published in the Oil & Gas Journal reported that the two oil shocks could have been handled without supply disruptions by simply using petroleum stocks already in storage in major consuming countries.¹ For example, during the 1973 Arab embargo, the U.S. was denied a total of less than 400 million barrels of oil; whereas, the U.S. had 1,008 million barrels in private storage at the time of the embargo. The report goes on to state, "If one were to look only at the numbers representing physical conditions, then, there was no reason for an energy crisis. Yet a crisis occurred, with a broad set of disruptive consequences."

These patterns were repeated and reinforced during the Iranian disruption. During 1979, average Iranian production which fell by only a little more than 2 million barrels per day was offset by increased production from other OPEC nations of 3.5 million barrels per day.¹ Nevertheless, the cut in Iranian production was perceived to create or to threaten to create a shortage. The response was a rapid build up of storage stocks in anticipation of higher prices. As a result of the stockpiling, a scarcity mentality evolved, and oil demand actually exceeded consumption. Prices rose rapidly and actual spot shortages developed. Among the direct impacts in the state and nation were reduced supplies of diesel fuel and gasoline at fuel stations, station closings, reduced operating hours, and long lines at stations with fuel. Hoarding and storage at the state consumer level compounded problems created by stockpiling by the oil companies at the national and international level. The Department of Natural Resources Assistant Commissioner of Conservation, who managed most of the state's emergency fuel allocation measures during this period, reflecting on the Iranian disruption after it was over, stated that the state found that most of the gasoline shortage in Louisiana consisted of everybody driving around with full fuel tanks in their vehicles.²

In order to prevent this shortage mentality from developing again, the public must have confidence in the fuel supply system. Whether warranted or not, the public does not trust the petroleum companies when it comes to setting prices or allocating supplies in a crisis. As previously mentioned, some past actions by industry give credibility to this fear. Reassuring fuel consumers and providing third party or arms length oversight of national fuel supply in an emergency is a role that must be filled by the federal government working closely and cooperatively with the energy supply industry.

In any future energy supply disruption, it is essential that the federal government take effective action immediately. Without this, state action will be confined to reactive responses to inadequacies in the federal measures. In the case of an oil supply disruption, analysis of past events indicates that the following are three of the most important steps, that have to be implemented at the national level:

(1) The Strategic Petroleum Reserve and private oil stocks should be managed as a single national reserve by a joint government--industry allocation committee.

(2) Draw down of the national reserve should be begun before a fuel deliverability problem occurs to diffuse fears of shortages and panic buying to allow time for the detailed state and federal emergency management steps to be orderly put into action.

(3) The public should be informed on what is happening, what is being done about it, and why there is no need to panic. This includes coordinating government comments and news releases to prevent communicating conflicting messages to the public and to ensure that any exporting countries withholding supplies see that their actions are not creating the desired chaos.

Brief answers to the specific questions in your solicitation for comments are provided below. These brief answers should be considered along with context and comments of the preceding discussion.

1. Should the United States continue to maintain the Strategic Petroleum Reserve?
   Yes.
    
2. What should be the size and composition of the Reserve facilities and oil inventory?
   The Reserve should maintain petroleum stocks equal to a minimum of 90 days of net imports. Less than this is not likely to be enough to provide a significant deterrent to an intentional disruption by a foreign power or to be enough to make a meaningful cushioning effect on natural or artificial disruptions. The Reserve could conceivably be made up of a combination of crude oil and refined products, privately and publicly owned. Some arguments could be made to increase the ratio of light sweet crude to heavy sour crude in the Reserve because virtually any refiner could process the light sweet crude. This could be advantageous in the event of a significant loss of complex refinery capacity. With the sophisticated petroleum distribution infrastructure in this country, central storage of reserves is generally more economical than regional storage.
    
3. How should Reserve oil be distributed?
   The existing provisions of distributing oil by competitive bid with the option to direct sales of up to 10 percent by means other than competitive bid seems adequate.
    
4. What should be the draw down and distribution capability for the Reserve?
   A draw down and distribution capability equal to 60 percent of daily imports should be maintained.
    
5. What is an appropriate policy for revenue raising sales from the Reserve?
   Sales for revenue generation should not be allowed, as they undermine the purpose of having a strategic reserve and limit the ability of the reserve to be fully ready for its intended purpose, which is insurance from disruptions.
    
6. Should the Reserve's facilities be available for alternative uses?
   The flexibility to lease or sell underutilized or idle distribution pipelines, marine terminals, and other facilities for commercial operations should be allowed, as long as the federal government ensures that the facilities are fully maintained for operation and retains priority use of the facilities to distribute Reserve stocks in the event of a national emergency.
    
7. Should the Reserve attempt to raise funds through alternative financing, innovative financial instruments, or buying and selling inventory?
   Long term storage of non-government oil in the Reserve could be an effective option, as long as the government has access to the oil under acceptable provisions in the event of a national emergency. Use of financial options, futures, and other potentially risky instruments should not be used for such things as selling options for the purchase and sale of Reserve oil. This defeats the purpose of the Reserve which is for the Reserve to serve as insurance. If the federal government would like to pursue such financial instruments for increasing revenues or decreasing costs, then consider taking a portion of federal royalty production in-kind to experiment with these possibilities of revenue enhancement.

Jack C. Caldwell
Secretary of Natural Resources

Cited References

¹Kash, Don E., Edward J. Fox, and Thomas J. Wilbanks, World Economic Recovery Could Determine When the Next Energy Crises Will Occur, Oil & Gas Journal; December 19, 1983, pp. 82-91.

²Spencer, Fritz L. Jr., Assistant Commissioner of Conservation, Louisiana Department of Natural Resources, Baton Rouge, Louisiana, private communication; November 1989.

--------------------------------------------------------------------------------

Prepared by: T. Michael French, Director Technology Assessment
For: Jack C. Caldwell, Sect. of Natural Resources
Submitted to: Richard D. Furiga, Deputy Assistant Secretary
Strategic Petroleum Reserve, U.S. Department of Energy