THE SPR SELLOFF: RIGHT ACTION FOR WRONG REASON

May 29, 2017 § 1 Comment

The Trump administration’s decision to sell half the holdings in the Strategic Petroleum Reserve (SPR) is the right step.  The SPR was created following the Arab Oil Embargo in the early seventies. It is currently near capacity at about 685 million barrels. The intent had been primarily to guard against a disruption of imports.

The President of the US has the authority to add to, or subtract from, the Reserve without Congressional approval.  But the stated reason for this draw down, revenue for the treasury, is debatable, not the least because this is not a piggy bank; withdrawals must serve a strategic purpose.  Also, such a massive draw down is likely not in the spirit of the authority given, so Congressional approval may be prudent.

Not debatable is that the US is increasingly importing less oil and it is progressively traveling shorter distances to get to the US.  Domestic oil is light and sweet.  It is, by and large, not desirable to most of the domestic refineries, which make better profits from discounted heavy oil from Canada, Mexico and Venezuela.  Consequently, imports from these neighbors combined with some export of domestic crude is a benefit to the nation.  Certainly, light oil from the Middle East and Nigeria, is scarcely required.  Our navy does not need to police the Strait of Hormuz, at least not for oil or gas supply reasons (ample shale gas has rendered import of LNG passé).  Supply disruptions are much less likely from the close neighbors.  About the only real risk is Venezuelan unrest.  This combination of reasons justifies a smaller SPR.

But the best reason for a smaller SPR is the rapid response ability of shale oil production.  Conventional offshore wells will produce oil 4 or more years after a decision to drill.  For shale wells, that figure is a few weeks if the lease is on hand.  This nimbleness of shale oil production is a reason why the industry has weathered the saw tooth price behavior of oil.  Furthermore, a threatened shale oil industry, run largely by entrepreneurial independent producers, has responded with innovation to drive down the cost to produce.  These reasons have conspired to defeat the Saudi gambit of leaving oil price down to freeze out shale oil.

In another twist, unique to shale oil, thousands of wells are drilled but not stimulated, known as DUC (drilled and uncompleted) wells.  They wait for better prices.   Around 5000 of these exist today.  A DUC well can be stimulated and produced in a week in response to even short duration shifts in the price of oil.  In fact, their very existence is a bearish influence on commodity traders.  These act as buffers and a surrogate for the SPR.  In fact, given the short time to production of even regular shale oil wells, all of shale oil still in the ground is the SPR.  In my view the SPR could serve its purpose by being only a third of the current 685 million barrels.

I have previously opined that, in the face of the SPR not being needed at current levels, it could be accessed to exert political will or influence.  A friendly, strategic, net importing nation could be provided the necessary technology to create the reserve (usually in salt caverns).  Oil could be supplied from the SPR to fill this country’s new reserve.  India, for example, could be enabled with a strategic reserve of 200 million barrels, more than enough for their purposes.  The US would be paid for this in one form or the other.  At today’s oil price, just north of USD 50, we even net a profit; the average acquisition cost of our SPR is close to USD 30.  We get our treasury funds, and we potentially slow down India/Iran coziness in energy.

Vikram Rao

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§ One Response to THE SPR SELLOFF: RIGHT ACTION FOR WRONG REASON

  • Gallo, Greg says:

    Very interest article Vikram

    Thanks for keeping us on you list

    Best to Susan

    Greg Gallo 650 269 4144

    Sent from my iPhone

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