Common Tragedies

Thoughts on Environmental Economics

Should Canada build an SPR?

Posted by Evan Herrnstadt on February 6, 2008

A joint report released this week by two think tanks called for Canada to establish its own SPR. As a net exporter of oil, Canada is not obligated to hold a particular level of stocks under the IEA emergency reserve program. However, the report argues that:

The IEA exemption for Canada is not warranted. NAFTA’s energy “proportionality clause” undercuts the logic behind the IEA’s exemption. Proportionality requires Canada, and Canada alone, to maintain its current share of energy exports to the United States, even if Canadians experience shortages. Mexico refused to sign this clause. Thus, until Canada demands, and gets, a “Mexican exemption” from the proportionality clause, not much oil from Western Canada and offshore Newfoundland can be redirected to meet Eastern Canadians’ needs.

This is an interesting argument, as Canada is exempt from requirements, despite the fact that most of its pipelines run North-South, thus leaving Eastern Canada vulnerable in the face of a short-term supply disruption. However, it jumps from proclaiming energy insecurity to touting the need for government stocks with few intermediate steps.

Many nations have set up reserves maintained by the private sector or via a quasi-governmental agency/corporation. This is generally done by requiring that all importers and/or refiners be required to hold a certain proportion of annual purchases or production in emergency stocks. These stocks are bound by law for release in the case of a declared supply emergency. This method is perhaps more efficient than a monolithic SPR (though there perhaps are economies of scale in storage), as it cuts out one more step in the process and also means that each refiner or importer can hold stocks of various refined products somewhat proportionally to production or purchase.

The cost-benefit balance of an SPR must account for the structure of the oil market. Oil is largely a fungible commodity, and stockdraw by any nation will have the desired effect on the world price for oil. Hence, coordinated draw under IEA and EU regulations will probably reduce the necessary size of a Canadian SPR. In addition, public stockholding might crowd private stockholding out of the market to some extent. If the private sector knows that the government will quell major supply disruptions, it has less incentive to hold inventories. Thus, putting a barrel of oil in a government SPR would probably increase total oil inventories by less than a full barrel. Finally, the effectiveness of emergency stocks is contingent on a government’s willingness and ability to release the oil at the right time. The mere presence of stocks probably stabilizes prices to some extent, but a drawdown has to happen quickly and convincingly in the event of a disruption.

Finally, an SPR must have proper infrastructure. One reason the U.S. SPR is somewhat feasible is because it is stored in underground salt caverns along the Gulf Coast in Texas and Louisiana (as well as proposed sites in Mississippi), near much of American refining capacity:

SPR map

The report proposes a series of salt caverns in Lambdon County, Ontario, to cover that province’s allocation, but immediately notes that their excavation could be an environmental concern. In addition, any release from these caverns would probably not be able to travel far because of insufficient pipeline capacity and the costliness of shipping by rail. Also, due to political concerns, any SPR allocation for Quebec would likey have to be located within the province.

This is not to say that I think required Canadian emergency stocks are necessarily a bad idea. I just hope that if it comes to the planning stage, the government will take into account the factors I noted above. It’s easy to just fall into the meme of “energy security” without really thinking about how oil markets work. I appreciate that the purpose of this report is probably just to kickstart debate; however, a more thorough BCA should be undertaken before making any bold claims about a “need” for an SPR.

One Response to “Should Canada build an SPR?”

  1. Maybe the U.S. could offer to sell to Canada a fraction of our current SPR holdings sufficient for it to meet the NAFTA proportionality clause requirements for a reasonable period.

    No investment costs in building more storage and delivery infrastructure in Canada, so Canada could save money. The U.S. would benefit from the better deliverability of resources located in the Gulf states and from the sale of current SPR holdings at current world oil prices.

    Alternately, the U.S. could sell to Canada a one-year option on sufficient quantities to meet the NAFTA requirement, and then renew the option annually at mutually agreeable terms.

    I’ve long been a skeptic of the SPR approach, so in my view any money we can get back from the program is pure benefit, but even assuming the U.S. benefits from the SPR it seems like there may be an opportunity for mutual gains.

    Of course Canada may wish to pursue an SPR for its own reasons, perhaps so it can help Canadian oil companies make more money now in exchange for possibly making a little less during some future emergency, but that decision need not be entangled with NAFTA-related obligations.

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