Need You Now - The Strategic Petroleum Reserve's Muted Effect in the Shale Era

Fundamental changes in U.S. crude oil production, crude transportation patterns, refinery sourcing of oil, import volumes and other factors have undermined the ability of the Strategic Petroleum Reserve to mitigate the domestic impact of a world energy crisis. Worse yet, the Department of Energy’s planned fix for the SPR will take at least several years—assuming it’s allowed to proceed according to plan. Today we consider current shortfalls in the SPR’s crude-delivery network, the potential effect on U.S. refineries in the event of an emergency, and the DOE’s plan to fix things.

Few of us give much thought to the jack in the truck, the flashlight in the drawer, or the blue tarp in the garage until a tire goes flat, the lights go out, or a tree falls on the roof. Similarly, it’s easy to forget about the federal government’s Strategic Petroleum Reserve (SPR), which was set up more than 40 years ago after the 1973-74 oil embargo but whose emergency use has been only occasional (thankfully). As we said in our Save It For a Rainy Day series a couple of years back, the SPR, which currently stores about 695 million barrels (MMbbl) of sweet and sour crude at four underground salt dome storage facilities along the Gulf Coast, has been tapped for emergency drawdowns only three times since it was created. The first time was during the Persian Gulf War in 1991, when—at President H.W. Bush’s order—the Department of Energy (DOE) implemented a plan to sell 33.75 MMbbl to help stabilize world oil markets. In the end, only about half of that amount—17.3 MMbbl—needed to be sold to achieve the desired effect. Next, in the aftermath of Hurricane Katrina (and its damage to oil production facilities, terminal pipelines and refineries) in 2005, up to 30 MMbbl was authorized for sale. Again, much less was actually bought—about 11 MMbbl. Finally, in 2011, about 30 MMBbl of SPR crude was authorized for sale—and sold to 15 companies—because of supply disruptions in Libya and other countries. Technically, there was a fourth use of the SPR. In 2013, the SPR conducted an emergency exchange with Marathon Oil after Hurricane Isaac disrupted Gulf Coast oil production, refining and distribution systems. By contract, Marathon repaid the 1 MMbbl in three months.

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The initial purposes of the SPR were to help reduce the impact of severe energy supply interruptions (like the 1973-74 embargo) on U.S. refineries, and to meet the U.S.’s obligations under the International Energy Agency’s (IEA) International Energy Program (IEP), which requires IEA members that are net oil importers to maintain crude oil inventories equal to at least 90 days of domestic demand. These purposes remain, but the SPR also came to be used to minimize the price shocks that come with major supply interruptions, whether they be the result of far-away wars or major hurricanes in the Gulf of Mexico. The SPR consists of 60 underground salt caverns (with capacities totaling 714 MMbbl) at four sites: Bryan Mound in Freeport, TX (capacity, 247 MMbbl); Big Hill in Winnie, TX (170 MMbbl); West Hackberry in Hackberry, LA (220 MMbbl); and Bayou Choctaw in Plaquemines, LA. Each of the four is currently between 96% and 99% full.

Fortunately, there’s been no instance so far in which the SPR has needed to go into what you might call “full-bore” operation. The SPR system is designed for an initial maximum drawdown (or oil-withdrawal) rate of 4.415 million barrels a day (MMb/d) —that rate could be sustained for 90 days (by which time ~400 MMbbl would have been withdrawn), after which the maximum rate would gradually drop. It would take a total of more than 150 days to drain the system’s 695 MMbbl if the spigots were left wide open.  Figure 1 shows the maximum pace of withdrawals and how much crude (and which types—sweet or sour) would come from each SPR facility.

Figure 1; Source: DOE

The SPR’s ability to mitigate the effect of a severe supply interruption on refineries and on crude (and petroleum-product) prices has been compromised since the beginning of the Shale Era, though. The problem is this: Because of four major changes since 2011­­—a) how much oil is produced in the Lower 48, b) where that oil is produced, c) how it is transported to refineries, and d) where U.S. refineries source their oil from—full-bore withdrawal in today’s energy world is unlikely to  have nearly the impact (for refineries and for prices) that it would have 15 or 30 years ago. Why’s that? Because while there’s technically sufficient capacity on pipelines connected to the four SPR storage facilities to receive all the crude being pumped out (even at the 4.415-MMb/d maximum drawdown rate), new patterns of oil supply and demand among U.S. oil producers and refineries (among other things) now constrain the SPR’s ability to distribute incremental volumes of oil into the market during a major supply interruption. In other words, because of increased utilization of pipelines and marine terminals along the Gulf Coast in recent years—and a few pipeline reversals—it has become more difficult to move large volumes of SPR-stockpiled crude without disrupting the existing flow of domestic production and Canadian imports.

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As we’ll get to later, DOE has determined that adding dedicated marine terminal capacity near the SPR facilities would significantly improve the reserve’s distribution capability, and a financial mechanism (planned sales of some of the stockpiled crude—the first of which is taking place this month) has been put in place to pay for enhancements that will not only extend the life of existing underground salt caverns but allow that needed marine terminal capacity to be built in the early-to-mid 2020s. First though, to understand why the SPR would be less effective in dealing with a crude supply crisis in 2017 than it would have been pre-Shale Revolution, let’s look at how crude from the SPR sites is distributed into the Gulf Coast market and the more general domestic market in the event of a declared emergency. Then we’ll consider the very significant crude-production, midstream and refinery-sourcing changes since 2011 that have negatively impacted the SPR’s ability to distribute large volumes of crude.

After an emergency is declared, SPR crude is sold in a competitive auction to the highest bidder, and purchasers are responsible for making their own transportation arrangements via pipeline or marine vessel. Figure 2 shows the four SPR storage facilities (red circles), the pipeline systems that serve each of them (purple lines), and nearby refining centers (gray hexagons). The green boxes define the three major pipeline and refinery distribution systems: The Seaway system connects to SPR’s Bryan Mound facility and includes refinery centers in Houston and Texas City (TX), while the Texoma system connects to the Big Hill and West Hackberry SPR facilities and includes refineries at Beaumont (TX), Port Arthur (TX), and Lake Charles (LA). The Capline system connects to the SPR’s Bayou Choctaw facility and includes refineries in Baton Rouge, St. James and New Orleans, LA; Capline also runs north to refineries in the Midwest.

Figure 2; Source: DOE

Each of the three (green-boxed) distribution systems has connections to marine terminals (to allow waterborne deliveries to refineries and storage not directly connected by pipeline): The Seaway system ties into ship-loading docks at Freeport and Texas City (combined terminal capacity, ~700 Mb/d), while the Texoma system connects to Sunoco Logistics Partners’ Nederland terminal (capacity, ~1.2 MMb/d) and Phillips 66’s Beaumont terminal (capacity, ~200 Mb/d), and the Capline system links to ~400 Mb/d of marine-loading capacity at St. James.

This set-up made perfect sense when the SPR was being implemented in the late 1970s and in the 1980s—and everything was copacetic in the 1990s and 2000s too. During those years, U.S. refineries (most of them located along the Gulf Coast) were turning to imports for more of their crude oil needs, and pipeline systems were in place to move imports and domestically-produced Gulf Coast and Gulf of Mexico (GOM) crude to coastal and inland refineries (in the Midwest and the Midcontinent). In the event of a supply emergency (such as a Middle East war or a hurricane in the GOM), the thinking went, these same pipes would be filled with crude from the SPR, directly replacing crude that wasn’t coming in by ship or from offshore platforms. As for U.S. refineries not directly connected by pipe to the SPR facilities, they would receive SPR crude by ship or barge from SPR-connected marine terminals.

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But a lot has happened the past six years. In 2011 the combined use of horizontal drilling and hydraulic fracturing for oil production really took off, including in places like the Bakken, the Eagle Ford, the Permian and the Niobrara; oil sands production in Western Canada was also on the rise. These changes were welcomed, of course­­—finally, the U.S. was moving to energy independence! The problem was, the pipeline network that had worked well for decades all of a sudden needed to undergo a major re-plumbing and expansion. New pipelines were built to transport Bakken and Niobrara crude to Midwest and Gulf Coast markets (and new rail loading terminals constructed to move Bakken crude to East Coast and West Coast refineries). More pipelines were built (or existing pipelines reversed) to allow more Permian and Eagle Ford crude to find its way to Gulf Coast refineries and marine terminals, and to let more Western Canadian product move to refineries in the Midwest, to the Cushing (OK) hub and to Gulf Coast. Pipeline reversals along the Gulf Coast had a big impact too. For example, the 2013 reversal of Shell Midstream Partners’ Zydeco Pipeline (formerly the Ho-Ho) between Houston and St. James (see I Got Storage (I Feel Good) and Oh-Ho-Ho It’s Magic) made sense for the new order, but it eliminated pipeline connectivity from the SPR’s Big Hill and West Hackberry facilities and Houston area refineries. In a nutshell, the infrastructure premise on which the SPR was founded had been turned upside down.

That’s only the beginning of the tale. In an upcoming episode, we’ll discuss the breakdown of the old order (as it pertains to the SPR) in more detail, consider changes that Midwest and other refineries have made in their oil sourcing, and lay out the DOE’s plan for correcting the SPR’s current shortcomings (and how to pay for it).

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“Need You Now” was a #1 hit for country music trio Lady Antebellum in 2009. It topped the Billboard Hot Country Songs chart for five weeks and won four Grammys, including Record of the Year and Song of the Year.