Statement of
Ernest Moniz
Under Secretary for Energy, Science and Environment
U.S. Department of Energy
to the
Committee on Energy and Natural Resources
United States Senate
on
October 19, 2000

Mr. Chairman and Members of the Committee:

When Secretary of Energy Bill Richardson directed the exchange of crude oil from the Strategic Petroleum Reserve (SPR), he did it to increase critically needed fuel supplies, especially heating oil in the Northeast, and to help consumers make it through a cold winter. In addition, this action will ultimately add oil to the SPR, increasing our overall energy security.

We are already moving 23 million barrels of crude oil into an extremely tight market. The first crude oil from the Reserve started moving last Friday, and more is scheduled for delivery today. Refineries are maintaining high levels of product output, and in a separate action, we now have in place a fully stocked and ready-to-use emergency reserve of heating oil in the Northeast.

In short, Mr. Chairman, while we are not yet out of the woods, Americans are significantly more protected today from a possible energy shortfall this winter than they were a month ago.

Rationale for the Exchange

The President made the decision to carry out the oil exchange because of concerns that lagging petroleum product inventories could create potentially severe hardships for many American families this winter. Across the country today, distillate inventories, which include heating oil, are 21 percent lower than they were a year ago. In the Northeast, where 37 percent of families use heating oil to stay warm, distillate inventories are lower still: 49 percent less than last year's levels. In New England, heating oil inventories are closer to 70 percent lower than last year.

While global oil production increases have added three-and-a-half million barrels of oil per day to the world market, due in part to the Administration's diplomatic efforts, demand continues to siphon off most of the extra barrels before they move into inventories. Thus, world and U.S. crude stocks remain very low, and stocks of heating oil and other distillate fuels are at critically low levels.

Stock builds are critical to the Northeast; during the course of winter up to 17 percent of the region's heating oil will come from inventories. During cold snaps, drawdowns of inventories can constitute an even greater percentage of local supplies.

Why do we believe that a temporary infusion of crude oil into the market will lead to additional heating oil supplies this winter? There are complicated and detailed answers involving world energy market interactions, refining yields, and seasonal market shifts that could be provided, but let me focus on the basic issues:

• The crude oil was needed in the market: Crude oil inventories worldwide have been low and did not appear likely to increase in the near future unless action was taken;
• Refineries could increase heating oil output at this time: U.S. refineries were about to enter the fall season when their configurations change to increase distillate yield relative to gasoline yield, and gasoline output can be maintained by use of more volatile blendstocks than in the summer. This is also a time when refineries do maintenance, both discretionary and non-discretionary. Discretionary maintenance can be delayed when market conditions offer appropriate incentives.
• Middle distillates (diesel fuel, heating oil, jet fuel, and other transportation fuels) account for about 25 percent of the total refined output: Heating oil is usually about 10 percent of the total output (40 percent of the distillate yield) but the other distillate products can be used for heating fuel when demand requires. Having an increased output of all middle distillates would increase the cushion for cold spells.
• Most of the crude oil we are exchanging from the SPR is light, sweet crude oil (25 million of the 30 million barrels initially awarded; 18 million of the 23 million barrels currently under contract). In the refining process, this type of crude oil offers the highest yields of critically needed distillate products.

Considering all these factors, the Energy Information Administration estimated that an additional 3-5 million barrels could be added to distillate fuel inventories as a result of the SPR exchange.

Statutory Authorities for Exchanging Reserve Oil

There is clear legislative authority in the Energy Policy and Conservation Act (EPCA) 42 U.S.C. 6201 et seq., that authorizes the Secretary of Energy to exchange oil from the Strategic Petroleum Reserve.

Section 160(a) states that:

The Secretary is authorized, for purposes of implementing the Strategic Petroleum Reserve Plan - to place in storage, transport, or exchange:

(1) crude oil produced from Federal lands, including crude oil produced from the Naval Petroleum Reserve to the extent that such production is authorized by law;

(2) crude oil which the United States is entitled to receive in kind as royalities from production on Federal lands, and

(3) petroleum products acquired by purchase, exchange, or otherwise. [emphasis added]

One of the primary "purposes of implementing the Strategic Petroleum Reserve Plan" is to acquire additional crude oil for the Reserve. The exchange solicitations issued by the Department on September 25, and in modified form on October 16, explicitly state that the companies awarded contracts must return more crude oil of comparable or higher quality than they received. Contracts were awarded on the basis of offers that would return the highest value of additional specification-grade crude oil to the Reserve. Therefore, the requirement of Section 160(a) will be met, and the exchange is being carried out within the Department's existing legal authorities.

Crude oil exchanges from the Reserve have been used before. On two occasions, including one instance this summer, Reserve crude oil has been exchanged with companies facing disruptions in crude oil deliveries because of transportation problems (a pipeline blockage in 1996; a shipping channel blockage this past June).

In 1998, the Department exchanged a lower-quality crude oil for a higher quality crude that better matched the Reserve's specifications.

Currently, exchanges are being used to supply the Reserve with specification-quality crude oil in the Royalty-in-Kind initiative (where a portion of federal royalty oil from production in the Central Gulf of Mexico is being used to re-fill the SPR). Because of market conditions, it was advantageous for both the government and the companies to renegotiate delivery dates for several of these contracts, allowing the contractors to have more time in exchange for more oil later. The department effectively exchanged 16 million barrels of oil due in 1999 and 2000 for 18 million barrels of oil due in 2000 and 2001.

The Ongoing Process for Exchanging Crude Oil

The solicitation, bidding, and contract award process was developed by staff in the Department's Strategic Petroleum Reserve Office. It was designed to meet two overarching goals: (1) to move Strategic Reserve crude oil into the market as quickly as possible, and (2) to acquire the most crude oil for the Reserve while assuring adequate protection to the government and the taxpayer for the value of the SPR oil.

To encourage as many bidders as possible - including both large and small companies that might be able to take delivery of the oil or arrange trades that could move the oil quickly into the market - the SPR office elected to forego an upfront bid bond requirement and instead required necessary financial protections to be in place prior to delivering the SPR crude oil. Past experience had indicated that a requirement to provide a bid bond or earnest money could add to the time and expense and make it difficult for many companies, especially small businesses, to prepare responsive bids.

As protection for the taxpayer, a letter-of-credit from a certified financial institution for the full value of the crude oil was required within 5 working days after a contract was awarded.

This is an important point, Mr. Chairman. At no time in the process was the government at risk of losing the value of any oil in the Reserve. No oil would be delivered without the protection of an irrevocable letter-of-credit.

On September 25, 2000, the Department released its exchange solicitation. In addition to the letter-of-credit requirement, the SPR contracting office also required other certifications from each offeror. These certifications attested to the independent nature of the exchange offer along with the disclosure of certain possible prior criminal or civil judgements. While the exchange process is not a procurement action under Federal acquisition guidelines, the SPR office also consulted the listing of companies debarred or suspended from Federal procurements prior to making contract awards.

The SPR office also reviewed all publicly available information on those bidders who were unfamiliar to the contracting office. In the case of two offerors who did not appear to have prior experience in energy trading, the SPR office, prior to awarding contracts, had discussions with third-party companies involved with each offeror to ascertain whether the offerors had legitimate opportunities to move the SPR crude oil into the market. Only after the SPR contracting office was convinced that each offer represented a reasonable opportunity to meet the exchange objectives were contracts awarded.

On October 4, the Department announced that 11 companies had submitted the highest value exchange offers. By the end of five working days, eight of the 11 companies, representing 20 million of the 30 million barrels of crude oil offered, had submitted the necessary letters-of-credit.

Three companies requested a time extension to secure their letters-of-credit. The SPR contracting officer has the discretion to grant a time extension if it is determined to be in the best interest of the government. In all three cases, evidence was presented that serious negotiations were underway with reputable energy companies, and the contracting officer granted each of the three offerors a one-day extension.

Two of the offerors did not secure the necessary financial guarantees by the time the extension had expired, and the SPR office terminated both contracts. Both offerors agreed to a no-cost termination. The third company was able to arrange a transfer of title to the oil it had been awarded to another energy company which, in turn, supplied the necessary letter-of-credit. The successful completion of this transaction enabled the government to secure a favorable deal for the taxpayer and to move an additional 3 million barrels of SPR oil into the market with the necessary financial guarantees. It also enabled a small minority-owned business to be included in the pool of successful bidders.

Consequently, of the original 30 million barrels of Strategic Reserve offered for exchange, 23 million barrels are now under firm contract with financial assurances. In return, the Department will receive 23.8 million barrels for the Reserve during August-November of next year.

To put this exchange in perspective, it is important to note that the 23 million barrels of oil exceeds the 17 million barrels sold (from 34 million barrels offered) during the 1991 Desert Storm drawdown. Proceeds from that sale were deposited in a special Treasury account established for replenishing the Reserve, however because of budget constraints, it took until1994 for the Reserve to be restocked. Under the current SPR exchange, all of the crude oil plus a premium will be returned to the Reserve within a year after deliveries.

Deliveries of the crude oil have begun. Although the Department specified that crude oil was being offered for delivery during the month of November, we also indicated that earlier deliveries could be made if companies could make the necessary transportation arrangements.

Last Thursday, October 12, Morgan Stanley Dean Witter - one of the companies receiving an exchange contract - requested an early delivery of crude oil from the Reserve's Bryan Mound site near Freeport, Texas. Site operators were able to complete the necessary preparations, and 500,000 barrels of oil began moving into the Seaway interstate pipeline on October 13.

A second delivery of 250,000 barrels of oil is scheduled to begin moving today from the West Hackberry site in Louisiana at the request of Marathon Ashland Petroleum LLC, another of the successful offerors.

This shows, Mr. Chairman, that the Strategic Petroleum Reserve is capable of responding literally overnight to the need to move crude oil quickly into the nation's distribution system. We are especially proud of the operational personnel at our Reserve for their ability to respond quickly and efficiently in delivering crude oil to the market.

The October 16 Solicitation

Because two of the initial winning bidders could not secure the necessary letters-of-credit, seven million barrels of crude oil were offered for exchange on October 16 when the Department reissued its solicitation. Offers will be due on Monday, October 23, and deliveries will be scheduled for December with earlier deliveries again possible.

In addition to the amount of crude oil, the Department made the following changes to the solicitation:

• Companies must take delivery of crude oil from the Reserve before the end of December although earlier deliveries could be arranged. The original solicitation specified the month of November for oil deliveries from the Reserve.

• Given the concerns expressed by Members of Congress and others regarding the qualifications of the initial bidders, the Department decided to reinstitute a financial guaranty requirement for the bid. A bid bond must accompany all offers due on Monday. The bond must guarantee that, in the event the Department selects an offer but the offeror cannot produce the required letter-of-credit, the offeror must pay either 5 percent of the value of the offer or $3 million whichever is less. This upfront requirement had been waived in the initial solicitation. To ensure that small businesses continue to have the opportunity to participate, the Department reduced the dollar threshold from $10 million, the amount it would require in an actual emergency drawdown and sale of Reserve crude oil.
• The irrevocable letter of credit which the offeror must provide prior to actually acquiring crude oil from the Reserve is now set at 110% of the value of the Reserve crude oil on the day of the contract award (rather than the previous 100%). This will provide protection to the Government for the crude oil delivered from the Reserve plus the bonus percentage the offeror commits to return next year.

We continue to believe that the objective of moving oil quickly into the marketplace can be met by encouraging the widest range of possible qualified participants in the bidding process. We do not want to unfairly bias the bidding process against small or minority businesses.

The Heating Oil Reserve

Although the Chairman's letter did not ask about the status of the Northeast Heating Oil Reserve, it is also a very important component of the Administration's energy preparedness efforts for this winter and has been established through the use of crude oil exchanges from the Strategic Petroleum Reserve.

On October 13, 2000, almost simultaneously with the first crude oil delivery out of the Strategic Reserve in Texas, the final shipment of heating oil was received for the government's reserve in the Northeast. The federal government now has a fully stocked, 2 million barrel inventory of emergency heating oil ready at three commercial terminals in the New Jersey and Connecticut as a supply cushion for consumers this winter.

To acquire the storage capacity for the heating oil for this winter, the Department is exchanging just over 117,000 barrels of Strategic Reserve crude oil. Another 2.7 million barrels of Strategic Reserve crude oil is being exchanged in return for the heating oil.

The Importance of Reauthorizing EPCA

With the heating oil reserve now fully stocked, we urge Congress to complete legislation that would set an appropriate trigger for releasing the emergency supplies if necessary. The President can order the heating oil to be released under broad national authorities, but more regionally-specific authorities would be appropriate to address possibly supply problems in the Northeast this winter.

We continue to call on Congress to pass a renewal of the Energy Policy and Conservation Act with the inclusion of an appropriate regionally-specific trigger for the heating oil reserve. The Act provides direct authority that underpins the Department's full emergency oil response capability. There should be no ambiguity about the President's ability to use this important energy response tool.

EPCA reauthorization is also important because the Act provides limited antitrust protection for U.S. oil companies assisting us and the International Energy Agency plan for and respond to an oil emergency in a coordinated manner.

Hopefully, the Senate will take action before Congress adjourns.

This completes my prepared statement. I will be pleased to answer any questions Members may have.