U.S. MOVES TO START TAPPING FOUR STRATEGIC RESERVE SITES

Patrick Crow
Washington Editor

The U.S. Department of Energy is proceeding with its first crisis-related drawdown of the Strategic Petroleum Reserve.

It's a dual test of how the SPR sales and distribution system will function and how the oil will affect the marketplace.

Reacting to increasing political pressure to stop speculation in oil prices, President Bush ordered DOE to sell 5 million bbl of SPR crude (OGJ, Oct. 1, p. 37).

The withdrawal rate will be as much as 167,000 b/d in November--although it will fluctuate with delivery schedules--from four of the six SPR storage sites along the Texas-Louisiana Gulf Coast. That's well below the rated 3.5 million b/d initial drawdown capability.

The U.S. has stored nearly 590 million bbl of oil in the SPR. It has invested $3 billion in facilities and $16 billion in crude, paying an average $27.26/bbl.

Energy Sec. James Watkins asked Congress for authority to sell another 10 million bbl, simultaneously with the 5 million bbl sale, to "stress" the SPR system at its drawdown capacity for a short period.

The House of Representatives quickly approved the added sales. But in the Senate, energy committee Chairman Bennett Johnston (D-La.) opposed the legislation on the grounds the SPR should be used to offset oil shortages rather than restrain prices.

Industry's first response to Bush's Sept. 26 order came from Lodwrick M. Cook, ARCO chairman and chief executive, who voiced full support for the drawdown.

The next day Cook said, "In addition to increasing crude oil supplies, the president's action will give the Department of Energy valuable experience in drawing down and auctioning off crude oil from the SPR in a noncrisis situation."

TEST DRAWDOWN

For some time that had been the Bush administration's position, too. It had resisted a drawdown, saying the SPR was for supply disruptions, not price eruptions.

Bush ordered the SPR sale after crude futures prices approached $40/bbl and a group of congressmen urged him to sell oil to calm the market.

Bush's intent was clear. He said oil supplies are adequate for the market, and there is no justification for the "intensive, unwarranted" speculation in oil futures.

Henson Moore, deputy energy secretary, said the futures market is not reflecting the amount of oil available on the oil market. "What it's really reflecting is apprehension about the market."

Watkins could not be as blunt in testimony before the energy and power subcommittee in the House.

He guardedly avoided saying that a supply disruption could be on the horizon, explaining that such a statement would become a self-fulfilling prophesy.

The 5 million bbl sale is being conducted under an SPR law, enacted Sept. 15, that permits the president to conduct a test drawdown of that volume without a formal declaration that a supply disruption is imminent, the normal requirement for a drawdown.

So Watkins told legislators a successful SPR test sale would reassure the markets, proving the system could be relied on in a major disruption.

Watkins, who had argued for a drawdown in administration councils, then told the subcommittee a drawdown larger than 5 million bbl would be a better test.

Rep. Phil Sharp (D-Ind.), subcommittee chairman, invited Watkins to name a figure, and the energy secretary asked for a total of 15 million bbl, which would be a 500,000 b/d drawdown. Sharp had his aides draft a bill on the spot, and the House passed it the next day, Sept. 28.

Watkins considered delaying the announced 5 million bbl sale until legislation passed and a single 15 million bbl sale could be held. But he decided any delay would make the SPR sales process appear unresponsive and ordered the approved sale to proceed.

SALE PROCEDURES

DOE sent sale notices Sept. 28 to more than 300 refiners, traders, cooperatives, and state energy offices.

Prospective bidders had until Oct. 5 to submit offers at the SPR office in New Orleans. DOE will consider offers only from responsible bidders and will not accept any that are less than 90% of the market value of comparable crudes.

DOE planned to release an abstract of the offers Oct. 9. Apparently successful bidders will be notified about Oct. 10, and the first contracts could be awarded beginning Oct. 12.

DOE said crude deliveries could begin in the second half of this month. But because most pipeline and tanker/barge shipments are scheduled on a 30 day cycle, most of the deliveries likely will be in November.

DOE offered sweet and sour light crude in a ratio comparable to the mix of crude oil currently imported into the U.S., although all of the world's lost production from the Iraq-Kuwait crisis is sour crude. DOE said 56% of the crude, or 2.8 million bbl, will be sour crude.

DOE said selling sweet and sour crude is a way of ensuring that the test sale provides experience to the widest range of potential buyers.

It offered 600,000 bbl of sweet and 1 million bbl of sour from the Bryan Mound site near Texas City, Tex., 1 million bbl of sweet and 1 million bbl of sour from West Hackberry near Lake Charles, La., 600,000 bbl of sweet from Bayou Choctaw near Baton Rouge, and 800,000 bbl of sour from Weeks Island southwest of New Orleans.

The sale will not involve the Big Hill site near Beaumont, Tex., or the Sulphur Mines site near Lake Charles. Big Hill, the newest site, is just beginning to be filled. Sulfur Mines is the smallest site and is intended for only one drawdown.

SPR sites can be served by barges or tankers, but most production is expected to move via pipelines.

The Bryan Mound site, 3 miles west of Freeport, Tex., is linked to Houston and Texas City refineries through a 42 in. DOE pipeline that connects to the area pipeline grid. It is in DOE's distribution system designated "Seaway" because it formerly was served by Seaway Pipeline, now converted to gas.

DOE's "Texoma" system once was served by a pipeline of that name, also now in gas service. Pipeline interconnections enable SPR crude from the Texoma system sites to move to Upper Midwest refineries.

The third cluster of SPR sites is served by Capline Pipeline.

SALE TERMS

Offers must be for at least 200,000 bbl if delivery is to a tanker, 40,000 bbl to a barge, and 75,000 bbl through a pipeline.

Under DOE's standard sales provisions published in the June 3, 1988, Federal Register, bids must be accompanied by an "offer guarantee" in the form of a certified or cashier's check, a wired cash deposit, or a letter of credit equal to 5% of the total offer or $10 million, whichever is less.

DOE planned to index the bid prices against a set of reference crude oils and then adjust the final price at the time of delivery to reflect changes in the reference crudes.

That was a change refiners had sought from the initial sales procedures. It protects them against the possibility that the market price for crude might fall sharply between the time they successfully bid for SPR crude and the time the last of the oil is delivered, as long as 2 months later.

The indexing formula for sweet crudes will be based on a composite of West Texas intermediate, Alaskan North Slope, and Louisiana light. The index for sour crude will be based on West Texas sour, Alaskan North Slope, and Louisiana light sweet.

The test sale scuttled a previously planned "paper test" of the SPR sale process, originally scheduled for late October. The exercise, termed "Sprint-90," would have involved industry but would not have sold any crude (OGJ, July 16, p. 32).

EFFECT ON THE MARKET

Watkins tried to soften congressional expectations that the SPR sale announcement would calm the market.

"We're not going into the test with the idea it will bring the prices down $8/bbl or something," he said. "It won't necessarily decrease market speculation."

It did not.

Prices climbed to $40/bbl after former Saudi Oil Minister Ahmed Zaki Yamani said oil prices could hit $1 00/bbl if Saudi oil fields were damaged, then dropped to $34 after Bush told the United Nations he favors a peaceful solution to the Middle East crisis.

Watkins said, "The test will demonstrate the readiness of the SPR under real life conditions. This is not an emergency drawdown, but it will clearly show that our procedures and hardware for withdrawing oil from the reserve are sound, efficient, and effective.

"This test drawdown will not affect our ability to conduct an emergency drawdown during the test period should the situation warrant it.

" DOE is continuously analyzing the oil supply situation and consulting closely with U.S. allies. Should it become necessary, we stand ready for the possible coordinated use of the more than 1 billion bbl of strategic stocks held by the U.S. and its allies."

He was referring to members of the International Energy Agency (IEA).

Analysts had expected no effect on the market.

John Lichtblau, chairman of the Petroleum Industry Research Foundation, said, "A 5 million bbl drawdown wasn't intended to put a lid on things. It's a drop in the bucket."

Lichtblau said there is no shortage of oil pushing prices up. "The market is mathematically in balance, but psychologically it's in imbalance."

Edward Krapels of Energy Security Analysis, Washington, said, "This is a market that needs to be hit with a two by four."

Philip Verleger, another Washington analyst, said, "The administration did the right thing. It just didn't do enough."

Rep. Billy Tauzin (D-La.) said, "Nobody in the oil business believes these phony prices being paid by oil traders in New York City."

And Rep. Mary Rose Oakar (D-Ohio) wrote Bush, reminding him that the administration could close futures trading to cool speculation.

The Commodity Futures Trading Commission has no plans to restrict oil futures trading.

A spokesman said, "We feel the market is accurately reflecting the forces of supply and demand."

PROBLEMS DOWNPLAYED

The House energy and power subcommittee also was interested in potential problems in an SPR drawdown. Rep. John Dingell (D-Mich.) declared, "I have substantial doubts the system will work."

Watkins replied, "I can't say we won't have any problems. But to the best of our knowledge, we are ready to move oil."

If circumstances warrant, DOE said the SPR could offset the loss of 730,000 b/d of U.S. imports from Iraq and Kuwait for more than 800 days. It could cover a disruption of all U.S. imports for as long as 75 days.

In response to questions, DOE admitted no potential difficulties.

There is some concern the SPR contains too much sour crude, but Watkins said the mix of sweet and sour crude is sweeter than the mix U.S. refiners import today.

DOE said all equipment is in good shape. Reports of rusted pipes were only brine discharge pipes, and reports that the Sulfur Mines cavern might collapse if oil is withdrawn ignored the fact it is designed for only one drawdown and is being phased out.

The department said there should be an adequate supply of U.S. flag tankers to move SPR crude in al I but the most severe drawdowns, and then federal agencies would consult to waive Jones Act requirements.

Some small refiners are concerned about their ability to obtain SPR crude, but Watkins has authority to allocate 10% of the oil sold each month to specific buyers.

And DOE said since the Iraq-Kuwait crisis, security has been tightened at SPR sites. Nearby National Guard units have been placed on alert.

PIRINC'S VIEW

Larry Goldstein, Pirinc president, said last week his group still thinks the U.S. should begin a commercial sale of SPR reserves, with or without support from IEA members.

He noted that the SPR was created to minimize economic disruptions like the one created by the Iraq-Kuwait situation.

In August, Pirinc recommended a 22.5 million bbl drawdown, or 750,000 b/d for 30 days (OGJ, Aug. 27, p. 24).

Pirinc, a study group funded by the U.S. oil industry, said there is no doubt the loss of supplies from two major OPEC members is a severe interruption, permitting a drawdown under the SPR enabling legislation.

Last week Goldstein told a conference sponsored by Pirinc and DOE on the outlook for winter fuels the supply system is much more precariously balanced than is generally thought.

He said speculators have reason for concern about future supplies. "The shortfall is real," he said. "A substantial part of the price increases you've seen can be attributed to market economics."

Even if supplies are adequate for the winter, Goldstein said, a major concern is that refiners may not draw down stocks to normal levels, thus worsening the situation.

At the winter fuels conference, DOE and industry officials said natural gas, electricity, and heating oil supplies should be adequate for even a colder than normal winter.

However, they agreed the fit between U.S. propane supply and demand is very tight.

Jimmie Peterson, director of the oil and gas office in the Energy Information Administration, said, "If you have anything happen in the propane market, there will be a supply problem."