SPR Selloff Hits The Markets At The Worst Time Possible

Quick question, who has sold just over 11 million barrels of crude oil into the market since the beginning of March?

Answer: The United States Strategic Petroleum Reserve ("SPR").

Many people are aware of the United States Strategic Petroleum Reserve, established by President Gerald Ford in late 1975 in response to OPEC's oil embargo, and the economic damage it caused to the U.S. economy. Storage capacity is rated for 713.5 million barrels, with current inventory of just over 683 million barrels at an average cost of $29.70 per barrel.

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Source: Energy.gov

The SPR has been used several times as a price buffer over the years, providing a source of protection during times of global upheaval. In 1991, President George H.W. Bush ordered an emergency release of 21 million barrels ("MMbbls") to support Desert Storm. A 30 MMbbl drawdown was initiated during the Arab Spring (2011) in cooperation with an additional 30 MMbbls supplied from other global stockpiles. Smaller releases have taken place in response to hurricanes impacting the U.S. Gulf of Mexico (11 MMbbls were made available after Katrina).

The SPR has been used to ease economic pain as well. President Bill Clinton authorized the release of 30 MMbbls to provide economic relief from high gasoline prices and low heating oil supplies in 2000, after 28 MMbbls were sold in 1996-1997 for deficit reduction purposes.

Which brings us to today. Let's recap the genesis of why these sales are happening (and what it portends for the future). Legislative actions over the past two years are aimed at bringing 190 MMbbls of crude from the SPR into the market between 2017 and 2025. The Bipartisan Budget Act ("BBA") of 2015 directed the Secretary of Energy to conduct a strategic review of the SPR and to outline a schedule for crude oil sales for multiple purposes, ranging from deficit reduction to infrastructure spending, and upgrading the SPR itself.

To fund the modernization of the SPR, BBA Section 404 allocated $2 billion of crude oil sales proceeds from the reserve between 2017 and 2020. The first 8 MMbbls have been contracted to be sold in 2017, with physical deliveries having begun at the end of February. It is important to note that the sales proceeds are set, not the volumes. If the price of crude is lower, they will sell more barrels. This wasn't the only move by Congress to generate some income from the SPR. The 21st Century Cures Act, passed in December 2016, authorized an additional 25 MMbbls of crude sales from the SPR, beginning with the sale of 10 MMbbls in 2017. To put this in E&P terms, the SPR has added an E&P company to the market that is producing nearly 50,000 b/d in 2017.

Starting next year, BBA Section 403 sales will ramp up, with 5 MMbbls sold per year from 2018 - 2021, and increasing to an annual rate of 10 MMbbls per year thereafter. These sales proceeds will be deposited into the general fund of the U.S. Treasury. Moreover, the SPR is committed to sell an additional 66 MMbbls of crude, scheduled to be sold between 2023 and 2025. Proceeds are dedicated to financing transportation infrastructure through the FAST Act (Fixing America's Surface Transportation). Additional action may be taken as well. President Donald Trump has indicated there may be an opportunity to reduce the deficit further with additional SPR crude sales.

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Why is this important to today's prices? Because the SPR is conducting oil sales at the same time the market is trying to find a floor. In the month of May alone, the SPR added in excess of 140,000 b/d of crude into the market.

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As you can see from the table above, from February through May the SPR has pushed 10.6 million barrels into the market, including the first tranche of the 10 MMbbl 21st Century Cures Act sales. All told, the remainder of the deliveries for the 2017 Fiscal Year (September 30th - October 1st) should occur by the end of this June. October 1st will begin the 2018 Fiscal Year sales (9 MMbbls for 21st Century, 5 MMbbls for the general fund, and the next tranche for upgrading the SPR). When trading, timing is everything. This has happened during the same time period that crude oil prices have moved down from $54 to $43 (a 20 percent decrease). This isn't the reason prices have moved into bear market territory, but it sure hasn't helped.