August 31, 2017
Hurricane Resilience and the Role of Oil Product Reserves
By Philip Cornell
Since making landfall on August 25, Harvey has knocked out nearly one quarter of national refining capacity at the time of writing, including the nation’s largest refinery at Port Arthur. A number of refineries could be out for as long as a month if their storm drainage pumps remain submerged.
While Harvey’s rainfall may be unprecedented and the situation quite serious, this is not entirely new territory for a Gulf Coast refining sector with experience of major storms. Hurricane Katrina left refinery complexes inoperative for months in 2005 due to flooding and power outages. While many existing facilities were successfully reinforced before the arrival of Hurricane Ike three years later, new facilities built to accommodate the US shale oil boom are only now being tested. The aftermath of Harvey will surely call for an assessment of the resilience of installations, but also of the tools at hand to mitigate the effects of disruption.
In 2005 those tools seemed to work, at least with respect to the international market. After Katrina, damaged crude production in an environment of tight global production and runaway Asian demand prompted a timely release of international strategic oil stocks. In this way, the government-owned US Strategic Petroleum Reserve (SPR) of crude oil in Texas and Louisiana, and the wider coordinated stockholding regime of the International Energy Agency (IEA) proved effective at stabilizing the global oil market in the face of natural disaster.
However, the US oil landscape has changed dramatically over the past decade, with the rise of shale oil and the perception of a global oil glut. High oil inventories, along with increased domestic production that is more responsive to market conditions, has led some to question the value of the SPR in its current form. International stockholding obligations, as imposed by the IEA, are measured in days of net import coverage. Reduced import dependence means that the number of days of coverage provided by a similar volume of SPR supplies has nearly tripled since Katrina. This has created a 240-million-barrel surplus in US publicly held stocks above the IEA requirements.
That surplus offers a tempting piggy bank to break for policy makers looking to pad budgets without raising taxes. As part of the 2015 budget deal, the administration of former US President Barack Obama agreed to sell 58 million barrels of oil in the SPR, while US President Donald J. Trump’s recent budget proposal seeks to sell 270 million barrels in an effort to bridge gaping holes in its own fiscal math. While Trump’s proposal is unlikely to pass, it reflects a growing comfort with lower strategic stockholding (even among Department of Energy officials), and a heightened disdain for global market management in an era of “America First.”
Indeed, the SPR today is really about the global market, and not directly helpful to storm-stricken areas. That was the case during Katrina when SPR installations were knocked out along with commercial storage sites. Even if they had remained operable, the crude stocks in the SPR cannot help consumers without access to refineries. The SPR is also geographically concentrated in one place—amidst the Gulf Coast refinery cluster in Texas and Louisiana. While a useful location for flexibly providing oil to the global market, it is less effective in terms of addressing local shortages of specific products, particularly if Gulf refineries are down. Limited SPR releases to specific refineries may ameliorate commercial crude bottlenecks brought on by the storm (as in the case of the decision to supply the Phillips 66’s refinery in Lake Charles), but crude is not generally in short supply.
The distinction between impacts to crude supply versus the availability of refined products is an important one. So far, crude production in Texas and offshore remains relatively unharmed, and West Texas Intermediate (WTI) crude oil prices have actually dropped due to expectations of lower US refining demand as a result of closures and an ongoing glut in crude inventory and pipelines leading to the Gulf. Goldman Sachs has speculated that Harvey could lead to an additional 1.4 million barrels per day in domestic crude availability because the oil cannot be refined. However, the product side of the equation tells a different story, with Goldman expecting up to 785,000 barrels of gasoline to come off the market. With less than 10 million barrels of commercial finished gasoline stocks in the region as of last week (and many of those installations likely damaged as well), many areas in Texas are quickly drying up.
Gasoline futures spiked nearly 12 percent on August 31, and shortages were already being felt as far away as Austin and Dallas, where gas stations were turning away customers. Those disruptions could begin to reach far beyond Texas due to oil product infrastructure bottlenecks in the eastern United States. Houston is the point of origin for the Colonial Pipeline, which transports more than 100 million gallons of gasoline, heating oil, and aviation fuel daily to key demand centers in the southeast and as far north as New York harbor. Power outages temporarily reduced throughput along the Colonial Pipeline after Katrina, and Harvey closed the line at its point of origin soon after landfall. Product continued to flow from further up the line until August 31 when the line was shut altogether due to damage and insufficient supply.
If Colonial deliveries are stopped for several days and commercial product stocks around New York begin to dip, the northeast would benefit from the Northeast Gasoline Supply Reserve (NGSR)—the result of another recent hurricane experience.
When Hurricane Sandy wreaked havoc on New York in 2012, gasoline shortages were triggered by the resulting power outages as commercial gasoline stocks could not be delivered because the pumps relied on power from the local grid. In the storm’s aftermath, the Department of Energy established the NGSR to hold stocks in New York (700,000 barrels), Boston (200,000 barrels), and Maine (100,000 barrels). While one million barrels may not be much help in a region that consumes 50 percent more than that each day—and even though commercial stocks are now equipped with independent power—it is a start. However, it is also one the Trump budget proposal intends to scrap.
Ultimately, what Harvey demonstrates is that US strategic oil storage is not designed for the kind of shortages caused by hurricanes. Yet local disruptions to the oil supply chain and to product availability can be a real problem, especially in large countries with infrastructure bottlenecks. This is why most IEA members hold strategic oil stocks at least partly in the form of refined oil products, and often more evenly distributed near demand centers around the country. However, the United States has followed the opposite approach, building a centralized government-owned all-crude SPR designed for global events like the 1973 embargo that sparked its creation. That mindset is written into the law, as release authority is predicated on nationwide economic impact.
It is too soon to tell whether market forces will adequately make up for the marked shortfall in oil product barrels resulting from storm damage, and shippers are scrambling to import oil products from abroad. But Harvey has put the efficacy of the SPR and US strategic reserve policy once again in the spotlight. Later this year, the Atlantic Council’s Global Energy Center will publish a review of international models of oil product stockholding, and draw lessons for US strategic oil storage. The aftermath of Harvey will undoubtedly lead to new questions about how the United States holds strategic oil stocks, and whether they are more useful for supplying crisis-stricken US citizens, for managing global markets… or for padding unrealistic budget proposals from the White House.
Phillip Cornell is a nonresident senior fellow at the Atlantic Council’s Global Energy Center.