ISSN 2330-717X

Strategic Petroleum Reserves: Stocking Oil For Rainy Days – Analysis

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By Shebonti Ray Dadwal*

India’s 2004 decision to construct a strategic petroleum reserve (SPR) in the wake of increasing demand, stagnating domestic production, rising international oil prices and dependence on the unstable West Asian region for imports, had come in for criticism. At that time, the decision was to create reserves for 15 days partly because it was reckoned that any supply disruption would not last longer and partly due to the huge costs it entailed. Yet, in June 2018, the government announced that it would increase the size of the SPR to 87 days’ worth of the country’s net crude oil imports by 2020. This includes 12 days’ worth of imports plus 67 days’ worth of commercial stocks held by refineries (apart from the armed forces stocks). There is also a plan to construct two additional reserves at Bikaner and Rajkot, taking the tally to 91 days’ worth of net imports, akin to those held by developed countries which are members of the International Energy Agency (IEA).

Surprisingly, the June 2018 decision to increase the size of the Indian SPR came at a time when the US has been debating whether its strategic stockpile should be cut to half the current size of 727 million barrels, driven by the shale revolution and the country’s dramatic resurgence as a net oil exporter. Moreover, globally, there are no perceived shortages envisaged in oil supplies, at least in the foreseeable future. Given that the global oil market is currently awash with oil, why has India decided to undertake such a huge capital investment, estimated at Rs. 4098.35 crore for the three original SPR sites alone,1 to enlarge its SPR?

SPRs were introduced by the International Energy Agency (IEA) in the aftermath of the 1973 oil shock when Arab countries cut production by around five million barrels a day (mbd) from 20.8 mbd to about 15.8 mbd, and OPEC raised prices by some 400 per cent. Subsequently, to ensure that OECD countries, which were the largest oil consumers at that time, would not be caught flatfooted in the event of any supply disruptions, the IEA was formed in 1974 and tasked to coordinate policies and advise member countries on protecting their energy interests. A core condition for the 30 member countries is for each to maintain 90 days’ worth of net oil imports, which would be used collectively in the event of a supply disruption. Oil could also be released under exchange arrangements with private firms, which, in turn, could be repaid in kind within a certain date with additional premium barrels. Originally, the stocks were meant to correct a shortage in the market caused by a supply disruption; however, over the last decade, the US has released oil from its SPR for a variety of reasons, including to finance policy initiatives and keep running domestic refineries hit by natural disasters, leading some analysts to caution against using the SPR as a “piggy bank”.2

So far, the IEA has coordinated a drawdown of its SPR only five times. The first was in 1991, during the first Gulf War, when IEA member states made up to 2.5 mbd of additional oil to the market for 30 days3 to ensure adequate supplies; the second and third instances occurred in 1996 and 1999-2000 with a view to countering rising oil prices; the fourth came in 2005 after Hurricane Katrina; and, the fifth in 2011 to counter the disruption of oil supplies from Libya.4 Thus, over time, SPRs have been used more as a cushion for price shocks rather than for dealing with supply disruptions and shortages.

Today, while shortages of oil due to conflict or embargoes are deemed unlikely, price volatility has become a regular feature due to global politics and the proclivity of some producers to manipulate production for influencing prices or protecting their market share. Given the global character of the oil market, production outages in any part of the world has a cascading impact on prices globally. For example, the 2016 drop in prices was the result of OPEC members pumping up production to prevent US shale from taking over market share. Similarly, the historic December 2016 agreement between OPEC and non-OPEC producers to curtail production was intended to shore up prices. Be that as it may, production manipulations by producers leaves countries like India, which are dependent on imports, vulnerable to such manoeuvres.

While India’s huge and growing thirst for energy, including oil, ensures that it is a premium market for producers, the pricing of oil is an issue that has major ramifications for the Indian economy as oil imports constitute the largest outflow of foreign exchange. Years of stagnating domestic production and the rising demand for crude (82 per cent is imported) have seen India’s crude oil import bill grow by 42 per cent to US$125 billion (Rs. 881,282 crore) in the current financial year ending March 2019.5 It is against this backdrop that the decision to speed up the process of enlarging the Indian SPR was taken.

Despite the government’s stated intention to reduce dependence on oil imports, oil will remain in demand for the next few decades. Therefore, the issue today is not so much whether oil will be available, but whether affordable oil will be available. A case in point is the most recent oil price spike triggered by geopolitical factors. With Iranian sanctions expected to take around one mbd off the market, spare oil capacity is around 1.5 to 2 mbd (the US Energy Information Administration puts it at 1.4 mbd, and predicts that it will come down further to 1.2 mbd by end-2019). Moreover, with production outages from other producers, an increase in US oil production may not be sufficient to prevent supplies from tightening, which, in turn, could send prices up. Under these circumstances, having an expanded SPR would provide some relief from price hikes. This is certainly more practical than the earlier plan to construct an SPR that would cater for only 15 to 45 days of imports.

Second, having a SPR option would offer India the leverage to be a serious player in the international oil market, as it will have the option to release supplies when prices spike and recharge the SPR when prices are low. Moreover, by maintaining adequate strategic stocks, India could use its SPR as an arm of energy diplomacy by providing joint stockpiling opportunities to friendly countries, both producers as well as net importers. India has signed an agreement with the UAE’s ADNOC to fill its SPR in Mangalore, scheduled to commence in November 2018. Two-thirds of the volume would be available for India, and ADNOC could store the remaining volumes or sell the oil in the domestic market.6 Alternatively, countries which cannot afford to maintain SPRs could purchase crude from India in the event of a disruption, which, in turn, could strengthen bilateral relations. With India now an associate member of the IEA, it could coordinate with the Agency in times of supply shortages as well as manage demand.

Finally, notwithstanding the current adequate supply condition, there is little certainty in oil markets, and there is a perception that a period of plenty could be followed by a supply crisis. Nor is the longevity of shale production certain over the long term. Hence, while an SPR may not suffice in the event of a long-term supply disruption, it could provide some relief from price spikes, albeit for a limited period, and allow the market time to adjust to price spikes and attain some balance.

Views expressed are of the author and do not necessarily reflect the views of the IDSA or of the Government of India.

About the author:
*Shebonti Ray Dadwal
is Senior Fellow at the Institute for Defence Studies and Analyses, New Delhi.

Source:
This article was published by IDSA

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IDSA

The Institute for Defence Studies and Analyses (IDSA) is a non-partisan, autonomous body dedicated to objective research and policy relevant studies on all aspects of defence and security. Its mission is to promote national and international security through the generation and dissemination of knowledge on defence and security-related issues. IDSA has been consistently ranked over the last few years as one of the top think tanks in Asia.

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