Statement of
Richard D. Furiga
Deputy Assistant Secretary
Strategic Petroleum Reserve
Office of Fossil Energy
U.S. Department of Energy
Before the
Subcommittee on Energy and Mineral Resources
Committee on Resources
U.S. House of Representatives
April 15, 1999

Madam Chairman and Members of the Subcommittee:

I am pleased to represent the Department of Energy and to appear with my colleague from the Department of the Interior to testify on the resumption of oil acquisition for the Strategic Petroleum Reserve.

A joint DOE/DOI team has been putting this initiative together quickly and effectively. The efforts of the staff from our Office of Fossil Energy and from Interior's Minerals Management Service have allowed us to take advantage of low oil prices and begin adding to our Nation's energy security.

In fact, I am pleased to report that beginning this coming weekend the first crude oil will be delivered to the Strategic Petroleum Reserve under an expedited delivery request from Equiva Trading Company in exchange for royalty volumes from Shell and Texaco. [NOTE: In his opening remarks, Mr. Furiga said that deliveries were now scheduled to commence on Monday, April 19, 1999.]

Before I go into more detail on the progress made to date and our plans for the immediate future, let me describe briefly the significance of the Strategic Petroleum Reserve to the energy and economic health of this Nation.

The Strategic Petroleum Reserve - An Investment in Energy Security

The Strategic Petroleum Reserve is the cornerstone of our capability to respond to an energy supply emergency.

Numerous times in the past three decades the world has experienced disruptions in the supply of oil exports. In 1973 the first energy crisis made most Americans aware that our economy is highly dependent upon the availability of imported oil, and that crude oil prices were, for the most part, no longer within our control. That price shock led to passage of the Energy Policy and Conservation Act in December 1975. Among other things, the Act authorized the creation of a petroleum reserve of up to one billion barrels.

Today, the Strategic Petroleum Reserve consists of four sites, two in Texas and two in Louisiana, with a capacity of 700 million barrels. All of the storage capacity is in 62 huge caverns that have been leached from salt domes thousands of feet below the surface.

The first crude oil was added to the Reserve on July 21, 1977. In the early 1980s, in the aftermath of the 1979 Iranian revolution and accompanying oil disruption, the Reserve was filled as fast as the facilities could accept crude oil; by the end of 1985, it contained 489 million barrels of oil. In the late 1980's and early 1990's, constrained by tightening budgets, fill continued albeit at a slower pace. In 1994, fill stopped completely at a peak inventory of 592 million barrels.

The Reserve has been used once under Presidential direction in response to oil supply concerns. In January 1991, at the onset of Operation Desert Storm and in conjunction with our allies in the International Energy Agency, the Department of Energy activated a drawdown of the Reserve, ultimately awarding competitive contracts for the sale of 17.3 million barrels. The Desert Storm sale, and other test sales, successfully demonstrated the Reserve's ability to function efficiently in a real world emergency situation.

In fiscal years 1996-97, driven by fiscal requirements, three non-emergency oil sales totaling 28 million barrels were carried out, leaving the Reserve at its current inventory of 561 million barrels.

Transfer of Royalty Oil to Restore SPR Inventory

The downturn in oil prices that began in late 1997 and intensified in 1998 and early 1999 continues to pose a serious threat to our domestic production capacity and, consequently, to our long-term energy security. At the same time, however, it has provided an unprecedented opportunity to begin re-acquiring crude oil for the Reserve at relatively low prices.

Secretary Richardson brought this issue before the Administration in late 1998. After a series of meetings with the Department of the Interior, the Office of Management and Budget, and the National Economic Council, it was agreed the Administration would move as quickly as possible to transfer 28 million barrels of Federal royalty oil - the same amount sold during 1996 and 1997 largely for deficit reduction purposes - to the Department of Energy for use in refilling the Strategic Petroleum Reserve. The oil to be transferred would be royalty oil from the Gulf of Mexico Outer Continental Shelf.

This approach to acquiring oil for the Reserve while prices are relatively low offers several advantages:

• The acquisition price would be below the price for which the Government had sold oil in FY 1996-97 and significantly below the Reserve's historic average oil acquisition cost.
• By resuming oil fill, we would help improve the ratio between the Reserve's inventory and the daily rate of oil imports which had begun to escalate in recent years.
• Finally, the royalty transfer plan would enable the Federal Government to add oil to the Reserve without requiring new appropriations, particularly important since funding has not been appropriated to purchase oil for the Reserve since 1990.

As Secretary Richardson said in announcing the initiative on February 11, 1999, "By putting royalty oil in the Strategic Petroleum Reserve today, we will get a high rate of return tomorrow - enhanced national energy security, increased strategic assets, and a very good deal for the American taxpayer."

Working together, the Department's Strategic Petroleum Reserve Office and the Minerals Management Service decided to transfer the oil in two phases.

In Phase 1 the Government negotiated with a small number of the largest producers on Federal lease tracts with a target of transferring up to 50,000 barrels of oil per day, starting no later than May 1, and ending on July 31, 1999. Phase 2 will take the remainder of the 28 million barrels from eligible producers who respond to a competitive solicitation. Deliveries are expected to start on August 1, 1999, at a rate of approximately 100,000 barrels per day and end in March or April 2000.

In both phases, the Strategic Petroleum Reserve will require that the oil delivered to the Reserve meet our standard quality specifications. In addition, the Strategic Petroleum Reserve is requiring that bids provide for delivering the oil directly to Reserve sites rather than to the normal transfer points at which the value of the royalty share is calculated for payment in cash.

Due to the complexity of gathering and transporting royalty oil with varying qualities produced from more than 1000 Federal leases in the Gulf of Mexico, we do not expect to transport royalty barrels directly to the Reserve. Instead, we will arrange for exchanges of crude oil to meet the Reserve's storage specification and provide for efficient delivery.

Under these exchange agreements, the volume of oil received by the Strategic Petroleum Reserve will differ from and could be somewhat less than the volumes accepted by the Minerals Management Service. This is because the oil delivered to the Reserve is expected to be of a higher quality than the oil produced at the lease and additionally, the producer in Phase 1 or the contractor in Phase 2 will pay the transportation expenses.

For example, in the recently negotiated contracts, the crude oil to be received by the Strategic Petroleum Reserve will be a light, low-sulfur oil, significantly higher in quality than the oil produced from the Federal leases. This grade of crude oil is suitable for the "sweet" oil storage capacity available at our Bayou Choctaw site. Because the oil to be delivered is of higher quality than the royalty crude, the exchange ratio is somewhat less than 1:1 due to adjustments for crude quality.⁽¹⁾

In the upcoming Phase 2, we expect to continue the exchange practice. When the Reserve receives a barrel of crude oil in exchange for an equivalent quality royalty crude, the total volume delivered will be close to the quantity transferred by the Minerals Management Service, adjusted only for gathering and transportation expenses.

Recent Actions and Current Plans

On March 31, 1999, we announced our contracts under the first phase of the royalty in kind program. Shell, Texaco, and BP-Amoco have agreed to deliver 38,600 barrels per day of very light, low-sulphur crude oil to our Bayou Choctaw, Louisiana, site in lieu of making a royalty payment to the Minerals Management Service. The 3-month contracts will result in approximately 3.5 million barrels being added to the Reserve.

Because these companies are all potential bidders during Phase 2 of this royalty-in-kind transfer, they have asked us to treat the exchange ratios for the royalty versus delivered oil as procurement sensitive information, and we therefore, have not included in our public testimony the exact volumes of royalty oil included in the contract.

Phase 2 of the royalty-in-kind program will begin with a solicitation that we plan to issue in late April or early May. Unlike the first phase, Phase 2 will be open to all bidders for 100,000 barrels per day of royalty oil from the Gulf of Mexico. We anticipate awarding contracts in June and beginning deliveries on August 1, 1999. Deliveries will continue until the total 28 million barrels of royalty oil is transferred to the Department of Energy.

Our success in Phase I of this program, and our continued close working relationship with the Department of the Interior, gives us every reason to believe the second phase will also proceed smoothly. We expect that the Department of Energy will add inventory to the Reserve, lower the average cost of oil acquisition, receive fair value during the exchange portion of the contract, and conduct its acquisition in a manner to counter balance the extremes of the supply and demand cycles rather than exacerbating their peaks and valleys.

This concludes my prepared statement, I will be happy to answer any questions Members may have.

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