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Do We Still Need the Strategic Petroleum Reserve?

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Last week T. Boone Pickens put out a video blog post questioning whether we really needed to keep our vast Strategic Petroleum Reserves, or SPR, stocked with oil. According to Pickens, we have about 750 million barrels of crude oil just sitting in storage. Given the massive oil production growth we're seeing here in the U.S., he thinks that we should start trimming these reserves. My question is whether that's really a good enough reason to end this insurance policy.

Before we get to that question, let's get a quick refresher on the SPR. It was established in the aftermath of the 1973-1974 oil embargo to provide the U.S. economy with a temporary solution to alleviate future oil shocks. Currently, we have just shy of 700 million barrels of oil in the SPR and its current capacity is 727 million barrels of oil. The oil is stored in salt domes at four different sites along the Gulf Coast.

Salt domes are also widely used to store natural gas. These vast underground storage facilities offer both security and are a much cheaper storage option than aboveground storage tanks. When these reserves are needed we can draw down about 4.4 million barrels of per day for about five months.

The reserves, which are owned by the U.S. Government, cost us an average of $29.76 per barrel, which means that Uncle Sam is sitting on quite the paper profit. Boone thinks the reserves are no longer necessary and that its time to start cashing out and sell our stockpile.

The crux of his argument is that the SPR was designed to protect us from an interruption of oil imports from OPEC. He notes that we import about 4 million barrels per day from OPEC, though only about 2 million barrels per day come from the Middle East. According to Boone, with the growth of our oil production we don't need to protect ourselves from these Middle Eastern supply shocks.

That begs the question: Are we really on pace to produce enough oil to eliminate the need for the SPR? Consider the Bakken: In January of 2011 the shale was producing about 275,000 barrels of oil per day. By last December, production had skyrocketed to 700,000 barrels of oil per day. The Bakken is probably pumping more than 800,000 barrels of oil per day now, and it has an inventory of more than 30,000 future wells that can be drilled.

It's possible that North Dakota eventually tops Texas as the nation's leading oil-producing state. Leading Bakken oil producer Continental Resources (NYSE: CLR  ) sees its production and proven reserves tripling between 2012 and 2017. That's truly breathtaking growth. It's even more remarkable when you consider that exploration and production companies with a global profile like ExxonMobil (NYSE: XOM  ) and ConocoPhillips (NYSE: COP  ) only expect production growth to hit around 2%-5% annually over the same time frame. The truth of the matter is that both companies would face a production decline if it wasn't for the growth opportunities in their North American properties.

This production growth isn't just seen in the Bakken. ConocoPhillips just announced two major deepwater discoveries in the Gulf of Mexico. ExxonMobil is about to begin production at its massive Kearl Project in the Canadian oil sands. When you begin to add it up, you get the feeling that North America really could be energy independent.

In fact, when you consider the potential of the Monterey Shale, the country really could see that dream become a reality. If you're not familiar with the Monterey, it holds an estimated 15 billion barrels of oil. That equates to an estimated two-thirds of the country's shale oil reserves. The 1,750 square-mile formation is in central California which could make it a bit more difficult to recover, given that it would require hydraulic fracturing to extract the oil. With all of the environmental concerns surrounding fracking, and considering California's environmental leanings, you can see how this could be a problem. That being said, just the fact that the formation exists is reason to hope that energy independence is within our grasp.

With that as context, let's take a step back for a moment and again ponder Pickens' advice that we scrap the SPR. We know that the SPR was designed to prevent another oil shock, specifically from the Middle East. However, do you know when we've made some of our most significant draws out of the reserve? If you guessed hurricanes then you'd be correct. Sure, we did draw down more than 30 million barrels in 2011 during the unrest in the Middle East; however, we've had large draws surrounding almost every major hurricane, including 21 million barrels of sales and exchanges surrounding Katrina and more than 5 million barrels that were exchanged when Gustav and Ike hit.

A final consideration before we begin to rethink the SPR is the environmental consequences of energy extraction. Fracking as you well know isn't a favored technology by the environmental community. The concerns run from the fluids used in the process, to the massive amounts of water required, to the possible gas seepage into drinking water. Those concerns are typically localized. What's not so localized are the major risks of deepwater drilling.

I'm sure you remember when the Deepwater Horizon drilling rig owned by Transocean (NYSE: RIG  ) and leased to BP (NYSE: BP  ) exploded and sank into the Gulf. The well spewed oil for months before it could be plugged. Because of that a moratorium was placed on drilling in the Gulf, and we're just recently beginning to get back to production levels seen before the event.

I like Pickens a lot, and I agree with him on almost every issue; however, I have to completely disagree with him on the SPR. It's a valuable insurance policy not only against future geopolitical supply shocks but also against shocks from Mother Nature. While we have no national energy policy, some of the stop-gap measures that we do have in place actually do make some sense no matter how much oil we are able to produce in the future. Topping the list is the SPR, it's a great insurance policy and should only be touched when a true emergency arises.

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