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The limitations of U.S. petroleum reserve

A family observes the fire after an explosion at Amuay oil refinery in Punto Fijo in the Peninsula of Paraguana on Aug. 25, 2012. The explosion at Venezuela’s biggest oil refinery killed at least 26 people in the OPEC nation’s worst industrial accident in recent memory. The accident is having a big impact on global petroleum prices.

REUTERS

The U.S. strategic petroleum reserve provides a "powerful response option should a disruption" threaten the U.S. economy. Or so says the U.S. Department of Energy on its official website. In the real world, however, the SPR is showing its limitations.

The current market conditions are emblematic of the shortcomings of the SPR, which holds more than 700 million barrels of crude oil. The U.S. economy is battling tight supply and demand balance for refined products, including diesel, heating oil and gasoline. Crude oil supplies, on the other hand, are relatively plentiful.

While European countries hold reserves of crude oil and products, the U.S. largely stockpiles crude. Washington only has two million barrels reserve of ultra low sulphur heating oil, created as recently as July 2000 under former president Bill Clinton.

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The White House has been pondering the use of the SPR to bring supply and demand in line. But the SPR is of little use as it only contains crude oil, rather than products. Insiders say the Obama administration has concluded the use of the SPR will have little impact on oil prices as the problem lies elsewhere.

The surge in gasoline and middle distillates prices is linked to failures at several refineries, including an explosion at the 955,000 barrels a day Paraguana Refinery Complex in Venezuela - the world's second largest - in August, and more recently, a fire at the 300,000 b/d Irving Oil Refinery in Saint John, N.B.

True. Crude oil supplies have tightened, particularly due to the impact of U.S. and European sanctions on Iranian oil exports, but the big problem is refining output.

The U.S. has faced similar limitations of the SPR over the past decade. When hurricanes Katrina and Rita hit the energy-rich US Gulf of Mexico in 2005 the main problem was not oil production, but rather lack of refining capacity as several plants were flooded. The U.S. had to ask its European allies to release their gasoline and diesel-rich emergency reserves to make up for the shortage.

The U.S. could gain flexibility in its response to disruption in commercial supplies by changing the content of its reserves to contain both crude and refined products.

Washington, facing fiscal challenges, could pay for the change, reducing the size of the SPR, which will soon be much larger than necessary. Philip Verleger, a U.S.-based economist, recently argued in Petroleum Intelligence Weekly, the industry journal, that "rising U.S. production combined with falling use will make roughly 100 million barrels per year [of the SPR] superfluous every year until 2020". He added: "This means the U.S. government will be putting 200,000 b/d or more on the market."

If Mr. Verleger is right, the sales could help to pay for a more radical proposal mooted in private by some senior industry executives: sell even more oil and buy some products, changing its 40-year focus of the reserve from crude oil to a mix of crude and oil products to greatly increase its flexibility.

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