Verleger : Reserve gives U.S. options over Russia
Editor’s note: The following article was originally published in Petroleum Intelligence Weekly on Monday.
President Barack Obama has warned Russia that any aggression in Ukraine will bring “consequences.” But many of the world’s international experts believe little can be done. There are no realistic military options, and the economic and energy interdependence between Europe and Russia makes tough sanctions extremely difficult to implement effectively.
However, the U.S. has a tool that could impose grave costs on Russia, particularly if the rest of the world went along. What’s more, the U.S. can act without jeopardizing its own security. The tool is its Strategic Petroleum Reserve. The U.S. now has approximately 700 million barrels of oil in the reserve. Almost all of it is no longer needed for national security. In fact, much of the oil has been made useless by changes in the domestic oil-industry structure (Petroleum Intelligence Weekly, Sept. 17, 2012). What this means is the U.S. can drive oil prices down and impose significant harm on Russia by selling oil from the reserve. In short, this approach would constitute a meaningful “consequence” for Russian President Vladimir Putin and his country. The U.S. could sell its Strategic Petroleum Reserve crude for two or three years if it had to, creating real pain in the Russian economy. What’s more, this is something the U.S. can do from a distance.
For this response to work, the world’s other principal oil producer, Saudi Arabia, would have to cooperate. Specifically, the Saudis would need to continue their present pricing strategy, allowing buyers to take as much oil as they want. Thus, before announcing a Strategic Petroleum Reserve sale, Obama would need to get the support of King Abdullah. Given the current Middle East situation, and especially Russia’s strong support of Syria and Iran, the Saudis would likely agree. Indeed, they may even applaud the action as long as the U.S. moved to push oil prices down by “just” 20 to 30 percent rather than 50 to 60 percent.
The president would likely need authorization from Congress, as well. Legislation that allowed, say, 500,000 barrels per day to be sold from Strategic Petroleum Reserve facilities to buyers from the U.S., Europe or Asia would smooth the process. One can be sure that conservative Republicans such as Sens. Lindsey Graham and John McCain would lead the charge to pass such a law.
The U.S. created the Strategic Petroleum Reserve following the 1973 Arab oil embargo. Over the years, the U.S. has accumulated nearly 700 million barrels of Strategic Petroleum Reserve oil, which is held in facilities in Texas and Louisiana. The U.S. Strategic Petroleum Reserve was essential to the country for the past 30 years. Today, though, this reserve is not essential because of the shale revolution, which boosted U.S. crude production, and declining domestic oil consumption. At the end of 2013, the reserve accounted for 112 days of imports. This coverage ratio has increased steadily since February 2011, first passing the 90-day International Energy Agency threshold in August 2012. On the basis of this first calculation, the U.S. has had surplus stocks in the amount of 136 million barrels for a year and a half.
However, the picture changes when we exclude trade with Mexico and Canada. One can argue from an economic and logistical standpoint that imports and exports from these two countries should be removed from the calculation for four reasons. First, Canada, Mexico and the U.S. are tied together in a trade agreement. Second, Mexico owns half a refinery in Houston that is specifically designed to process its heavy crude. Third, Canada must ship oil through the U.S. to get it to market. Fourth, both Canada and Mexico import substantial volumes of oil from the U.S.
The import coverage of the Strategic Petroleum Reserve is much higher if we exclude trade with Mexico and Canada. In this case, U.S. strategic reserves cover more than 300 days. If we calculate U.S. import dependence on this basis, the country could sell more than 600 million barrels from the Strategic Petroleum Reserve, leaving it plenty of oil to spare.
There is a further reason to contemplate selling Strategic Petroleum Reserve oil. Today, much of the crude held in our reserve cannot be distributed to U.S. refiners during a crisis. The Strategic Petroleum Reserve facilities along the Gulf Coast are connected to pipelines that once moved oil from the Gulf to refineries in the Midwest and around Houston. The system was designed to transport the oil using pipelines that in normal times moved imported crude to these refineries.
Today, the facilities mostly process domestic crude. Many pipelines that once moved oil north and west have been reversed to bring oil south and east. Thus, in an emergency, the Strategic Petroleum Reserve oil cannot be shipped to its intended destinations. Thus, this crude is not only no longer required by treaty — it cannot be used as intended. It could be sold, however.
Relatively modest sales of U.S. strategic stocks would affect world crude prices substantially. Our price-forecasting model predicts the Dated Brent price based on global commercial stocks. The model’s predictions show that releasing 500,000 barrels of crude per day beginning Jan. 1, 2013, would have lowered the Dated Brent price gradually to $98 per barrel by the end of 2013, $12 per barrel lower than the actual price on Dec. 31. The price decline would cut Russia’s income substantially. For example, a decrease of $10 a barrel would reduce Russia’s export revenue by around $40 billion. This is approximately 10 percent of its 2012 income from exporting fuels as reported to the World Trade Organization. The country’s gross domestic product might drop 4 percent, which certainly would count as a “consequence.”
Roughly half of the income loss would come from the decline in oil prices and the other half from the lower oil-indexed natural-gas price buyers would pay. Russia could offset roughly half of its loss by decreasing its exports barrel for barrel to the volumes sold by the U.S. Doing this, however, would impose long-term costs on the country because arbitrary export bans harm relationships between suppliers and buyers.
Sales of 500,000 barrels per day from the U.S. Strategic Petroleum Reserve are feasible. The facilities and the organization at the Department of Energy have been designed to put oil on the market quickly. Thus, crude from the reserve would likely flow within 30 days of an announcement.
Obama has informed Russia that it will face serious penalties over Ukraine. The U.S. has other alternatives than economic sanctions or military action. The sale of unneeded Strategic Petroleum Reserve crude oil would, by depressing world crude and natural-gas prices, significantly cut Russia’s income from energy sales and reduce its GDP.
Philip K. Verleger Jr. retired from the University of Calgary, where he was the David Mitchell-EnCana professor, and now heads PKVerleger LLC. He was director of the Office of Energy Policy at the U.S. Treasury in the Carter administration. He currently lives in Carbondale.
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