Why the U.S. Government Is Tapping In to the Strategic Petroleum Reserve

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Hurricane Harvey did untold amounts of damage to Texas -- preliminary estimates for the cost of recovery are around $190 billion.

In this clip from Industry Focus, Motley Fool analysts Sarah Priestley and Taylor Muckerman explain why that total is so huge, and what it means for the oil industry that Energy Secretary Rick Perry announced it was lending 500,000 barrels of oil to producer Phillips 66 (NYSE: PSX). Find out what the Strategic Petroleum Reserve (SPR) is and how it functions, what investors need to be aware of about this loan, how this compares to other times the SPR has been tapped in the wake of a disaster, and more.

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A full transcript follows the video.

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This video was recorded on Sept. 7, 2017.

Sarah Priestley: Texan residents and business owners are left to survey the damage and long-term impact. Preliminary estimates for the cost of recovery are at $190 billion. That figure would make this the costliest natural disaster in U.S. history. Taylor, part of the reason for this, I think, is the concentration of U.S. oil producing and refining industry. Five of the largest U.S. oil refineries are on the Texas and Louisiana Gulf Coast. Two of the largest refineries are near Houston. What will be the aftermath of this? What are they going to be dealing with now?

Taylor Muckerman: You have the Lake Charles area, big for refining. The Corpus Christi area, big for refining. Corpus Christi is almost back to pre-Harvey levels. They expect that a few more days, they'll be able to be quite near fully online. You look at, about 20% of the nation's refining capacity was shut down, so that's a big deal. And as a result, you've seen gas prices spike the most since Hurricane Katrina. The average price for regular unleaded, up $0.33 nationwide, up to $2.65 for the average. So people are feeling it. And that's probably going to last for several weeks, especially as you see, like you mentioned, other hurricanes potentially on the way. BP is already evacuating some of its Gulf platforms ahead of Hurricane Irma. So certainly still some risk out there for higher prices. The chemical industry is still offline as well, out of the ethylene production that they need to produce plastics. That's offline. So not only gasoline -- oil and chemicals all impacted. It's going to take a while for the supply chains for these to kick back in.

Priestley: Yeah. I read somewhere that the flooding has been the biggest issue they're about to deal with. It's kind of dangerous sometimes, especially fracking, if they get water in the wells, to start up again. And the other thing that people have got to consider is, the EPA is investigating potentially hazardous carcinogens in the area as a result of some of the explosions that we saw that took a lot of the media that may not be a huge impact on those companies, but on the people around, they definitely will. The reason that we're touching on this is, at the end of last week, the 31st of August, Energy Secretary Rick Perry announced that the Department of Energy is releasing oil from its Strategic Petroleum Reserve in an attempt to mitigate some of this disruption that we're talking about. This authorized the release of 500,000 barrels to Phillips 66's refinery in Lake Charles. This is the first emergency release from the SPR since Hurricane Isaac hit Louisiana in 2012. We got a great question from a listener on Twitter asking, "What are the implications and impact of this?" But first, I thought it might be worth touching on what exactly the SPR is. So, Taylor?

Muckerman: Basically, it's our nation's fall-back plan, if oil imports either get disrupted or we necessarily have to cut off oil imports for any diplomatic reasons. So I think we have about 140-some days of technically U.S. demand for oil, which would then probably be used for gasoline and other things to keep the nation running for almost half a year. So tap this every now and then. It hasn't been tapped in a few years. I think President Obama did it at least once during his two terms as president. I don't think it's necessarily anything to get in an uproar about. It's only 500,000 barrels in this case out of a few hundred million, 700 million, I believe, just north of that. And we're at peak capacity right now in terms of how much oil is actually in the SPR. So it's not like we're starting from a position of weakness letting this out. And in this case, Phillips 66 is a company that tapped it for 500,000 barrels, and they do have to refill it and then some once the term of the agreement -- I haven't seen exactly how long they have to replace this, but I imagine it's not immediate.

Then, for the company itself, you look at it and the refinery that they're using this oil at, it's completely online, so we already talked about high gas prices, so maybe just try to take advantage of the fact that they still can refine some oil. This is in Lake Charles. They do have other refineries that aren't completely online. So maybe just trying to take advantage of some higher margins right now.

Priestley: Interesting. You mentioned this was to protect the U.S. from international issues. I think that's how they started the SPR. They became a founding member of the International Energy Agency after the oil embargo by OPEC in the '70s. Obviously, it's a very different environment now. So that raises a lot of questions that we'll touch on later.

Muckerman: Yeah, we're producing near-record oil in the United States. We were definitely producing oil back then as well, but I think there's a much clearer path to the U.S. sustaining its own oil production if need be.

Priestley: Yeah. You touched on this, but in this instance, this is an exchange, which basically means that the borrower -- in this case, Phillips -- is loaned the barrels. They then have to return the same amount back to the reserves, the same quality of oil, plus extra as interest. So Philips must have requested this exchange, as you said, because they're probably taking advantage of the greater crack spread.

Muckerman: Yes.

Priestley: Should investors be concerned about them servicing this loan? Is it an issue to make good on that loan?

Muckerman: No, I think it's a small enough amount to where, as an investor, maybe it's encouraging to see management trying all options to keep capacity and their inputs coming in, because a lot of pipelines in that area were disrupted. So not only have we seen production be impacted, but even the production in the oil fields that are still running, it's having a hard time making it to the endpoints here and refineries along the Gulf Coast, because not only were the refineries impacted, but the feeding pipelines were as well.

Priestley: Yeah. And a lot of the ports, I can't remember the term for it, but they're essentially filled with silt now, so they have to be excavated.

Muckerman: Yeah, they have to be dredged, probably. We'll wait to see that, because the Gulf area is the hub for all the oil exports that we've seen ramp up over the last couple of years since we released that limit on U.S. oil exportations.

Priestley: Yeah, which is incredible when you think about how vulnerable that area is. I know every area has its risks.

Muckerman: As far west as this one went, it was kind of a surprise to a lot of people. Mid- to eastern region of the Gulf usually gets hit almost on a yearly basis. But as far west as Houston, kind of a shock there.

Priestley: Yeah, it's new to me. We have a lot of rain, but not hurricanes. I think, you said this already, but talking about how serious this is and what the impact is, I think it's important to remember that the reserves are tapped during natural disasters. It's very usual. And, as you said, 500,000 is nothing compared to how it has been. 2008, Hurricane Gustav and Hurricane Ike, they reduced levels by 5.4 million barrels. 2005, Hurricane Katrina, 20.8 million barrels. So there is a precedent for this. We shouldn't be too concerned.

Muckerman: Yeah. When you look at 500,000 barrels, and we're producing 9 million barrels per day as a country, not exactly something to get in a fuss about.

Sarah Priestley has no position in any of the stocks mentioned. Taylor Muckerman owns shares of Twitter. The Motley Fool owns shares of and recommends Twitter. The Motley Fool has a disclosure policy.