Chapter 2. Oil Stockpiling Overview

1. Definition and Types of Oil Stockpiling

○ The purpose of the strategic petroleum reserve is to secure stable oil supply in advance to prevent severe social, economic, and political turmoils in the future that may be caused by various types of temporary oil supply disruptions.

○ Oil supply shock or oil supply disruption is defined as sudden reduction of oil supply that causes temporary shortage of oil imports. Oil supply disruptions can be triggered by political embargo that can be provoked by instability in oil-producing countries, especially Middle East countries; by natural disasters, such as Katrina in 2005, oil field accidents or oil tanker accidents;

by wars or disputes in a territory.

○ There are two types of oil stockpiling. One is the strategic

petroleum reserve (SPR) or compulsory stocks related national security and the other is the commercial oil stockpile to maintain normal business activities.

- The SPR consists of government stockpile (or public stockpile) and mandatory industrial stockpile that is strategically provided for emergency prevention purposes by laws.

- Commercial oil stockpile is the inventory that oil related business entities, such as refineries and oil importers, hold to make business go without a hitch during the time of unbalanced oil supply and demand.

○ Strategic stockpiling (or compulsory stockpiling) has three types, company stocks, government stocks, and agency stocks.

○ Generally speaking, it is a common trend that the government or public entities take responsibilities for management and operation of SPR directly of indirectly, instead of giving entire responsibilities to private sectors. The reasons are:¹⁸⁾

- First, because the social welfare loss reduction effect of stockpiling is not reflected in private stockpiling companies for profit, while it is reflected in public stockpiling entities like the government, the marginal benefits and the marginal costs of stockpiling for the private stockpiling companies are equalized at the lower stockpile level than the public stockpiling entities.

- Second, usually the government intervenes the market to stabilize the prices and it discourages speculative stockpiling of private sectors.

18) Refer page 1203 of Toman(1993).

- Third, at the time of oil supply disruption, private stockpiling companies have incentives to wait until the price rises sufficiently to maximize profits. When private stockpiling companies expect that the duration of the disruption is long, but actual duration is short, the social welfare of having stockpile may not be materialized by missing appropriate timing of release.

2. Types of Strategic Petroleum Reserve System

○ As mentioned above, there are three types of the SPR systems; the government stockpiling system, the agency stockpiling system, and the company stockpiling system.

○ The government stockpiling system is the system that stockpiling is financec by tax or public budgets and managed and operated by a government organizations or organizations entrusted by the government. Its advantages are following;

- It has the most clear and certain effects of stockpile release in increasing oil supply in a market in emergency situation.

- In addition, announcement effect of the government is an effective tool to calm the market.

- The government stockpile is sharply separated from business activities of private sector.

○ The agency stockpiling system is the system that stockpiling is managed and operated by the agency and financed by members of the agency who are usually oil-related business entities.

- The advantages of the agency stockpiling system:

stockpiling system Advantages Disadvantages Government

stockpiling

․Maximum government control

․The most stockpile release effect

․Easy to check and monitor stockpile level

․Financed by taxpayers

Agency stockpiling

․Cost sharing be members

․Separation from commercial stockpile or inventories

․Easy quality maintenance of stockpile

․Secure market neutrality

․Reduction of stockpiling costs

․Hard to Secure market neutrality at normal time

․Needs for continuous study for cost reduction

Company stockpiling

․Efficient quality maintenance of stockpile

․Concise stockpile release procedure at the time of emergency

․Hard to check and monitor stockpile level

․Hard to guarantee strict security

․Uncertain stockpile release at the time of emergency

․Burdensome cost burden of oil related companies

<Table 2-1> Advantages and disadvantages of stockpiling systems

․ Easy stockpiling level check and monitor,

․ Separation from commercial stockpile or inventories,

․ Easy stockpile quality maintenance,

․ Secure market neutrality,

․ Clear stockpile release procedure,

․ Hard to Secure market neutrality at normal time,

․ Needs for continuous study for cost reduction.

○ The company stockpiling system is the system that all costs of stockpiling is borne by oil related companies and construction of storage and stockpiling facilities and management and operation of

stockpile are all responsibilities of the companies.

- During emergency situation, stockpile release can be promptly and efficiently executed and reached to consumers in the markets.

- The government are allowed to direct the companies to reduce the stockpile level, but, in principle, it cannot step in to the actual release procedure.

- The advantages of the company stockpiling:

․ Efficient stockpile quality maintenance,

․ Concise stockpile release procedure at the time of emergency, - The disadvantages of the company stockpiling:

․ Hard to check and monitor stockpile level

․ Hard to guarantee strict security

․ Uncertain stockpile release at the time of emergency

․ Burdensome cost on oil related companies

3. Types of Storage

○ There are four types of storage; above-ground tanks, in-ground tanks, under-ground caverns, and floating tanks.

○ Under-ground caverns consist of under-ground rock caverns and under-ground salt caverns.

4. Characteristics of SPR

○ SPR is a public good.

○ SPR has positive externality.

○ The costs of stockpiling is borne by countries that hold stockpile, but the benefits of stockpiling is for every countries. As a result, it creates free-rider problems.