Critiquing the SPR Swap Plan

This morning, I read an interesting editorial in the Wall Street Journal:

Obama Has a Plan To Manage Our Oil Reserve

The editorial was written by John Shages, a former deputy assistant secretary for petroleum reserves at the Department of Energy. The editorial essentially argues that the composition of the Strategic Petroleum Reserve (SPR) is lighter than the composition of oil that most refineries run. Since lighter crude is also more expensive than heavier crude, Shages is suggesting that we sell some of the light crude and buy back some of the heavy crude. His argument – echoing the argument from Obama and various other government officials – is that this would generate cash and help drive down oil prices.

Some excerpts from the editorial:

Sen. Barack Obama is proposing a simple maneuver — called an exchange, or swap — that will help lower the price of oil for consumers, increase the amount of oil in the SPR, increase energy security, and leave taxpayers better off by about $1 billion. His proposal deserves to be adopted.

Today, with historically high oil prices, it is time to debate using the SPR. Some argue that the reserve should only be used in emergencies. Others say that we should use all the tools at our disposal to help consumers.

OK, let’s debate. Regular readers know that I strongly object to using the SPR in an attempt to influence prices. That is not what it is for. High prices – which are incidentally well off of their highs – do not constitute an emergency. Further, that line about taxpayers being better off by $1 billion misses a very large point. I could also trade in my house for a mobile home, and be better off by a few hundred thousand dollars. But that few hundred thousand has costs associated with it: Less home, a home that isn’t as safe in bad weather conditions, and a home that has less value when I wish to sell it. Likewise, there are costs associated with downgrading the quality of the SPR.

Mr. Shages continues:

The oil in the reserve now is all light crude, which is easier and cheaper to refine into gasoline, a reflection of refining capability at the time the SPR was created. Over the past three decades, however, U.S. refining capacity has become increasingly sophisticated and complex, because the world’s oil is increasingly heavy and harder to refine. Today, about 40% of our refining capacity is configured to handle heavier crude oil.

We now confront a mismatch between U.S. refining capacity and the oil mix in the SPR. In a 2007 report, the Government Accountability Office (GAO) found that in an emergency this mismatch could reduce U.S. refinery capacity by 5% or over 735,000 barrels per day in total as some refineries scale back production to accommodate the SPR oil. The GAO recommended that the Energy Department change the reserve’s oil mix to at least 10% heavy oil, roughly 70 million barrels.

It struck me as very odd that having oil that is too light could reduce refinery capacity. After all, light oil is much simpler to process – as is alluded to above. Yields are also higher. Yet the claim is that we would be better off with heavier oil in the SPR? This didn’t add up, so I dug up that GAO report that was referenced:

Improving the Cost-Effectiveness of Filling the Reserve

Some excerpts from that report:

Our analysis of DOE’s Energy Information Administration (EIA) data shows that, of the approximately 5.6 billion barrels of oil that U.S. refiners accepted in 2006, approximately 40 percent was heavier than that stored in the SPR.10 Refineries that process heavy oil cannot operate at normal capacity if they run lighter oils. For instance, DOE’s December 2005 found that the types of oil currently stored in the SPR would not be fully compatible with 36 of the 74 refineries considered vulnerable to supply disruptions. DOE estimated that if these 36 refineries had to use SPR oil, U.S. refining throughput would decrease by 735,000 barrels per day, or 5 percent, substantially reducing the effectiveness of the SPR during an oil disruption, especially if the disruption involved heavy oil.

If you know what the assays look like for heavy oil versus light oil (See The Assay Essay), this looks like a very improbable claim. I suppose if you didn’t try to optimize your refinery for light oil, then that might be a true statement. But refiners optimize their refineries on a daily basis. I used to work in a heavy oil refinery. We could run heavy oil through, or we could run light oil through. If we don’t change the refinery settings at all, and run light oil through, then the above argument may be correct. But we would never do that. The overall yields are in fact higher with the lighter crudes, but you have to make the necessary adjustments. You may end up shutting down some units – like cokers – that are designed to handle heavy crudes.

But there is a more significant factor that seems to be overlooked. Refiners are configured to run heavy crudes because they are cheaper. Why are they cheaper? One, because they are more readily available. What does that suggest? That it is much less likely that there would be a disruption of heavy crude supplies. Thus, Mr. Shages (and Obama’s) argument is based solely on what refiners typically run, and ignores the question of typical availability of supply.

In conclusion, a heavy oil refinery can run light crudes with some adjustments. A light oil refinery can’t run heavy oils without severely impacting yields. Further, a light oil refinery is much more likely to see supply disruptions because there is simply less light oil available. This is why swapping heavy oil for light oil is a bad idea. It is a misguided attempt to influence oil prices, and that is not the purpose of the SPR. If it is allowed to be used for this purpose, then all we are doing is speculating with the reserve.

Footnote: Headed back to Europe today; offline for a couple of days.