Today, the Department of Energy (DOE) announced that it will conduct a “pilot” acquisition of three million barrels of crude oil using the SPR’s new authority to engage in fixed-price contracts. It’s a good start to make sure that the DOE is ready to fulfill the President’s commitment to “repurchase crude oil for the SPR when prices are at or below about $67-$72 per barrel.” The SPR has unique challenges, from scheduled maintenance, intake limits, and the looming possibility of a Congressionally-mandated sale. This pilot acquisition will enable the DOE to work around these and other challenges and support readiness to engage in tactical purchases if/when the price of crude oil is firmly within the specified range. Operational readiness is critical for DOE to stabilize the price of oil and ensure future demand such that producers invest sufficiently today.
This is the President’s vision for strengthening energy security, but implementing that vision requires market participants to take his commitment seriously. As we’ve seen over the past few weeks, prices can drop precipitously, leaving the possibility that the DOE has to quickly engage in tactical purchases to stabilize the price of oil. Engaging in a pilot is an excellent way to demonstrate that ability to market participants.
We’ve previously written that government agencies can be better about interfacing with modern financial and commodity markets. The Federal Reserve offers some analogous lessons in this regard. Because the Fed must be ready to respond to a variety of circumstances, it must ensure that it has the operational readiness to respond to swift developments in financial markets. One way it builds that capacity is by conducting pilots. Just last month, the New York Fed conducted a “small value overnight reverse repo operation with Primary Dealers and Reverse Repo Counterparties to test its contingency operation infrastructure.” As the New York Fed states, these exercises “are relatively small in size,” “involve end-to-end processes (from trading through settlement),” and are conducted to maintain “operational readiness, rather than to fulfill a policy directive.”
Because the DOE is attempting a new type of acquisition that centers on market realities, it’s important that it is taking the steps to ensure the operational capacity to do so. If the SPR’s logistical frictions stand in the way of immediate refill but spot crude oil prices otherwise enter the President’s preferred refill range, the DOE can and should use its newfound fixed-price contracting capacity to contract for refilling the SPR at a slightly later date. That would still give credible service to the form and substance of the President’s commitment.
Looking ahead, DOE should conduct similar pilots for the longer-term fixed-price contracts intended to boost domestic production. We’ve been advocating for DOE to engage in “market-contingent acquisition” explicitly tied to new production (such as put options) through a Dutch auction facility. A similarly structured test exercise early next year for these types of acquisition contracts would help the DOE understand how to credibly engage in a variety of acquisition contracts. By doing so, the DOE would also be building credibility with market participants in terms of its capacity to help stabilize prices and supply conditions.
In any case, as the DOE aims to use SPR acquisition in a manner better aligned with its full statutory intent, the announcement of this pilot is an encouraging start. The DOE should apply this approach to its longer-term fixed-price acquisition contracts as well.
