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Explained: What are Strategic Petroleum Reserves?

Editor, TRANSFIN.
Nov 25, 2021 3:41 AM 6 min read
Editorial

In an unprecedented development, six countries announced yesterday that they would be tapping into their individual strategic petroleum reserves (SPR) in a bid to tame soaring crude oil prices.

The move pits the coalition - India, USA, UK, China, Japan and South Korea - against OPEC+, whose refusal to boost crude production has infuriated major importers.

To quote GoI, yesterday's announcement was a response to crude prices “being artificially adjusted below demand levels by oil producing countries, leading to rising prices and negative attendant consequences”.

These “consequences” refer primarily to sky-high fuel prices. In India, for instance, retail petrol prices remain elevated despite the recent cuts in excise duties. This, in turn, has been accompanied by rising commodity prices and the looming threat of runaway inflation with demand picking up as the pandemic recedes. The retail inflation rate in the US, for instance, reached a three-decade high last month.

 

Why are Crude Oil Prices Rising?

Oil has jumped by more than 50% this year. The reason? OPEC.

2020 was a brutal year for the oil cartel. The pandemic decimated demand for the black gold, which translated to record-low prices. By April 2020, Brent had plummeted to below $20 per barrel. WTI even went negative. (It didn’t help that COVID struck at the same time as a brutal price war between Saudi Arabia and Russia, which had led to crude overproduction by almost 20 million bpd.)

Anyway, faced with lockdowns, a deadly virus and no vaccines in sight, OPEC and its allies found common ground and entered into a two-year agreement that entailed massive production cuts of 10 million bpd (this was over time whittled down to 5.8 million bpd).

This, in addition to surprisingly swift post-pandemic recovery across countries, led to a resurgence in oil prices. Brent and WTI are both currently averaging $80/barrel. With most economies reopened and business getting back on its feet, countries naturally expected OPEC+ to increase production again so that prices are stabilised.

But higher fuel prices = more revenue for petrostates to replenish their own pandemic-struck coffers. So the cartel has been reluctant to acquiesce to importers’ requests. (In fact, Riyadh even pledged in January to cut its production by an extra 1 million bpd.)

 

Importer Ire: Why is OPEC Not Increasing Production?

Needless to say, OPEC vacillating on production hikes has not gone down well with oil importers, especially India and China, whose economic recoveries stand to be hampered by high crude prices. For the US too, despite being the largest oil exporter, soaring crude prices mean consumers would have to pay more at petrol stations. At a time when the Fed’s stimulus programmes are still in place and Washington has big-bang infrastructure spending plans, a prolonged period of high inflation is the last thing Uncle Sam needs.

How have importers voiced their protests? One, by simply asking OPEC to reverse cuts. This hasn’t yielded much luck. Two, by diversifying oil operations beyond OPEC members, but this is a long-term strategy. And now three, playing the SPR card.

 

What are Strategic Petroleum Reserves?

As the term suggests, strategic petroleum reserves or strategic oil reserves are crude stockpiles stored by governments (or even private companies) for usage during national security or energy crises so as to avoid supply disruptions and extreme price fluctuations.

These inventories are stored in underground bunkers or caves (as along the southern coast of the US), in huge tankers (as in Japan) or on ships docked at sea (as in China). If the SPR option is exercised, the oil can be given to suppliers by the government by way of “exchange”, with the barrels leased and then returned with an interest payment, or “bidding” i.e. Outright selling.

The concept of emergency oil inventories can be traced back to the oil crises of the 1970s. The US, which was hit badly by the 1973 OPEC embargo, built its SPR in 1975. Other countries followed suit (India began developing its SPR infrastructure in 2003). Currently, each International Energy Agency (IEA) member-state has an obligation to hold emergency oil stocks equivalent to at least 90 days of net oil imports.

 

Tall Talk

Now, OPEC+ is slated to meet next week to decide whether to increase production or stick to its guns. It’s unclear what it will decide to do, but the underwhelming scale of importers’ supposed retribution might mean it still has the upper hand.

You see, the SPR is usually the road not taken, unless in objectively desperate solutions. Like the Gulf Wars in the 1990s or the Libyan crisis in 2011. By opting for it right now, the six countries probably hoped to send a strong message to OPEC that current oil price levels are unsustainable and they are willing to do whatever it takes to tame them.

The move, however, might easily backfire. The total SPR release could come up to less than 70 million barrels (and most of it from the US): analysts expected at least 100 million. India, for example, has said it will release 5 million barrels in the coming days - a quantity sufficient to cater to about only a day's consumption. At this point, the message is no longer about putting up a strong stand against the oil cartel’s tactics but an underlining of OPEC’s outsized sway.

Oil markets are decidedly unimpressed. After a brief fall yesterday, crude prices rebounded today. In fact, analysts expect, ceteris paribus, Brent could touch $100-levels soon.

 

India's Strategic Petroleum Reserves

India has three functional (underground) SPR sites at Visakhapatnam, Mangaluru and Padur. These have a combined capacity of 5.33 Million Metric Tonnes (MMT). The country’s SPR facilities are managed by the Indian Strategic Petroleum Reserves Ltd (ISPRL), an SPV under the Ministry of Petroleum and Natural Gas.

FYI: It's pertinent to note here that besides the oil stored in SPR facilities, state-run refiners also hold a lot of oil (65 days of crude storage). Industry players are also obligated to hold oil - 650 million barrels - which can be tapped by GoI under extreme circumstances. Also, these figures are for emergency reserves, which are different from the proven/yet-to-be-extracted oil reserves India holds (what’s that?).

FYI #2: If India stopped all crude imports tomorrow and only used its proven reserves and SPR, it would have enough oil for only about three years at the current rate of consumption.

Explained: What are Strategic Petroleum Reserves?India’s SPR saga is a tale of missed opportunities. Last year, for instance, when Brent was at decadal lows, importers like China and Japan went on a shopping spree, hoarding cheap oil for future usage. Beijing was particularly brisk - it bought so much extra oil that 73 million barrels (nearly 2x India's total storage capacity) had to be stored at sea.

While India has a storage capacity of 39 million barrels, China and Japan boast of total capacity of 550 million barrels and 528 million barrels respectively. This sinful asymmetry meant we were unable to exploit low prices last year even as we are the mercy of high prices this year.

Is India actively expanding its SPR facilities? Yes...and no.

Yes: Two more underground SPR sites are being set up at Chandikhol and Padur. Two more are expected to be set up in Bikaner and Rajkot.

The first two are under-construction and are expected to nearly double India’s SPR capacity once completed. Moreover, these new caverns are likely to be privately run (not by the ISPRL). And back in January, there were also reports of GoI considering viability gap funding (VGF) to attract private-sector bidders.

Commercialisation of assets is also underway. With ISPRL capacities saturated after filling them with cheap oil from 2020, GoI in July permitted the leasing of 30% of oil inventories to foreign companies. (That’s asset monetisation for you.) Having said that, the idea of getting foreign refiners to store oil in Indian caverns is not a new one. It was tried last year as well before being reversed.

No: The Chandikhol and Padur projects were approved in June 2018. Over three years later, they are still “under-construction”. As for the Bikaner and Rajkot facilities, news reports from 2019 and 2020 describe them as “expected to be initiated soon”. So...

Also, while exploring PPP models to accelerate SPR-building is all well and good, there is reportedly no clear revenue model to actually incentivise private sector investment. So all this talk of SPR reforms is like building castles in the air - castles that take ages to construct, evidently.

FIN.
 

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