GAO blasts DOE on SPR*
Posted by Evan Herrnstadt on February 28, 2008
As the fill of the SPR is debated by Congress and the DOE, the GAO threw its hat in the ring. The Office’s report is critical of the cost-effectiveness of fill protocol. It makes three very reasonable suggestions:
1. Include some heavy crude in the SPR.
This is a complete no-brainer as far as I’m concerned. According to the report, around half of disruption-vulnerable U.S. refineries are incompatible with the light and medium crude currently held in the SPR. Running the wrong type of crude would result in about a 5% reduction in U.S. refining throughput, a significant loss during a supply disruption. Five percent is pretty bad, and certainly blunts the impact of any SPR release, but that’s for total refinery throughput. One refiner cited in the study claims that using exclusively SPR oil in its heavy crude unit would result in 11 percent less gasoline and 35 percent less diesel. To be fair, refineries are probably not going to be relying entirely on SPR crude, but you get the point.
There’s also the little matter that heavy crude costs about 10% less than light. So current policy has us buying more expensive crude oil that is only efficiently compatible with about 55% of likely affected U.S. refineries. Gold star for the GAO.
2. Use dollar-cost averaging to determine a purchase path instead of a constant quantity path.
The government has basically set a quantity and, as Sen. Dorgan is learning, is largely intractable regardless of market conditions. This means that even as prices soar above that magical $100 mark, the DOE is stubbornly purchasing the same monthly quantity as before. By using dollar-cost averaging, DOE basically gives itself a monthly SPR allowance. Thus, like a normal consumer, the DOE buys more oil when it’s cheap, and less when it’s expensive. This sounds good, but markets are tricky, and the oil market is quite volatile. So I quote the GAO:
We also ran simulations to estimate potential future cost savings from using a dollar-cost-averaging approach over 5 years and found that DOE could save money regardless of the price of oil as long as there is price volatility, and that the savings would be generally greater if oil prices were more volatile.
100 points to the GAO.
3. Purchase oil on the market instead of through royalty-in-kind arrangements.
First, this adds an unnecessary level of red tape to the SPR fill process. Since not all oil from RIK arrangements goes to the SPR, there is clearly already bureaucracy in place to sell RIK crude. But maybe selling off RIK crude and using the revenues to purchase the same amount of oil on the world market sounds inefficient and circuitous.
Well, unfortunately, the way the bid evaluation process works is not equivalent for market purchases versus RIK exchanges. Straight market purchases are considered conditional on general market trends, as well as the prices of SPR-suitable crude grades relative to other grades. In contrast, the RIK oil is exchanged for other oil for the SPR. The evaluation process focuses on whether DOE will receive oil of at least the same value as the RIK oil it is giving up. Thus, it ignores market trends and is vulnerable to exchanging at questionable times. The GAO report gives an example in which simultaneous bidding processes resulted in opposite outcomes: the cash process rejected Light Louisiana Sweet (LLS) at $67/bbl, whereas the exchange process bought LLS at a similar price. As you might have just concluded yourself, the cash process is also considerably more transparent. A for the GAO.
This report is quite readable, and well worth a look. But at first glance, it certainly seems that if the SPR fill process is to go on, the DOE and Interior would do well to implement the GAO’s suggestions. They would save money, improve the SPR’s effectiveness in the event of a disruption, and increase transparency.
Note: for great analysis of the fill/no fill debate, check out this post at Energy Outlook. Also read the post’s comments for some discussion of dollar-cost averaging by people who actually seem to know something about investment.
* I kind of wanted to see if I could write a title in which over 50% of the letters are in acronyms. Yes I could.