The Strategic Petroleum Reserve (SPR) is in play. The 695 million barrel inventory, stored in four storage locations in Texas and Louisiana with a capacity of 713.5 million barrels, never found its purpose; it is still waiting for the third oil crisis (after the 1973/74 Arab Embargo and the 1979 Iranian Revolution). Not surprisingly, the SPR is on the verge of becoming a piggy-bank offset for lawmakers. At $50 per barrel, SPR inventory is worth about $35 billion.
This week, MasterResource reviews the history of state and federal oil (and natural gas) storage regulation and ownership. Part I today is early (pre-SPR) regulation. Part II tomorrow will review the prehistory and beginnings of the SPR.
Part III will examine early problems with the federal storage program; Part IV early fill and financing controversies.
Part V concludes with an overall critical examination of the SPR from the vantage point of its first decade (mid-1980s).
These posts are adapted from my Oil, Gas, and Government: The U.S. Experience, published by the Cato Institute in conjunction with Rowman & Littlefield, in 1996.
Petroleum
Surface storage of crude oil in the early era of the petroleum industry has been criticized as wasteful. “Perhaps the most unfortunate feature of Pennsylvania oil history,” remarked John Ise, “was the waste of oil . . . running on the ground for lack of storage facilities.” [1]
Anti-pollution statutes focused on well plugging and casing to keep the water table separate from the oil table as described in Oil, Gas, and Government (chapters 3 and 4); surface regulation to arrest inventory leakage and overflows that contaminated creeks, rivers and vegetation came later.
In the 1870s and 1880s, municipalities and states set storage regulations for refined oils deemed hazardous. Licenses were often required for large holders of petroleum with limits on the amount that could be stored in one place. Chicago, Illinois restricted storage to 5 barrels, and Galveston, Texas limited above-ground storage to 40 barrels, for example. [2] The same family of regulations set flash point standards and inspection procedures for illuminants, described in chapter 22 of Oil, Gas, and Government. [3]
In the next century, regulation by major southwest producing states discouraged surface inventory in favor of retaining oil in the reservoir. Surface mishandling and waste prevention were in the language of many market-demand proration statutes, but the primary intent was to restrain output to stabilize crude oil prices. By reducing surface inventory, less “distress” oil was available to drive down prices.
Wellhead proration was a form of enforced storage that transferred present consumption to future consumption. [4] In the same vein, withdrawals of public land from petroleum activity and the set aside of prime oil lands as Naval Petroleum Reserves were forms of storage/inventory intervention.
States also included storage requirements with oil pipeline regulation. A 1905 common carrier law in Kansas aimed at Standard Oil Trust required oil pipelines to provide storage at the receipt point until shipped. [5] Other common carrier laws typically prohibited storage discrimination such as a Michigan statute in 1929 and Oklahoma statute in 1931. [6]
A 1925 Texas law declared oil storage facilities open to general business as public utilities and put the Texas Railroad Commission in charge of rates and “inspection, grading, measurement, deductions for waste or deterioration, [and] the delivery of such products.” [7] Common-purchaser oil pipeline statutes often included ratable storage along with ratable purchase such as Michigan’s 1929 law. [8]
The federal government directly regulated oil storage for the first time in 1933. The Code of Fair Competition for the Oil Industry for the Production Division, established pursuant to the National Recovery Act, declared that excess oil was presently in storage and prohibited drawdowns over 100,000 barrels per day for the entire industry. The President was also empowered to regulate storage withdrawals to prevent “injurious” effects on interstate or foreign commerce. [9]
Direct federal regulation of oil storage reappeared in the 1975 Environmental Policy and Conservation Act of 1975. In conjunction with other broad powers to deal with energy shortages, the President was given the authority to require adjustments in the amounts of crude oil, residual fuel oil or any refined petroleum product which are held in inventory by persons who are engaged in the business of importing, producing, refining, marketing, or distributing such oils or products. [10]
Inventory accumulation rates could be set, and inventory withdrawals at specified rates could be required. Another section of the Act banned “willfully accumulating” oil and products “in excess of . . . reasonable needs” during a supply disruption. [11]
In the 1970s, states and the federal government regulated storage in conjunction with pollution control laws. As described in chapter 28 of Oil, Gas, and Government, underground gasoline storage tanks were not allowed to leak, and above ground tanks were required to have special tops to prevent evaporation. [12]
Natural Gas
Storage regulation of natural gas began in the 1950s with the rapid growth of the natural gas transmission and distribution industry. Once gas service was in place, the challenge became how to satisfy peak demand short of expensive new pipeline capacity. The other side of the coin was excess capacity during times of slack demand. The solution was to establish storage facilities. The Federal Power Commission in a 1975 proposed rulemaking summarized the advantages of storage for all segments of the industry:
(1) storage tends to assure to independent producers a year-round cash flow which makes funds available for further exploration and development;
(2) storage reduces the need for more expensive pipeline capacity and makes possible more efficient utilization of existing pipeline facilities,
(3) storage benefits the high priority customers through the availability of natural gas during peak demand periods at the lowest reasonable costs; and (4) storage reduces the requirement for higher priced peak shaving SNG, LNG, and other substitutes. [13]
Gas cannot be economically stored above ground. The most viable option has been to utilize depleted oil and gas reservoirs -often near major markets. Eligible reservoirs had to be sealed to avoid leakage, porous to hold large quantities, and permeable to expeditiously extract the gas. Qualifying reservoirs, however, required unanimous consent from surface owners pursuant to the common law doctrine of ownership to the center of the earth.
This magnified the transaction cost problem of capture-rule production: whereas extraction holdouts from a unitization agreement had to incur the expense of drilling a well or face drainage, any surface owner over the reservoir could veto an entire project. A Kentucky court decision affirmed the absolute right of even the smallest surface owner to veto a project when it was ruled that injected gas without total consent of the surface owners lost its property title and once again was subject to the rule of capture. [14]
The practical difficulty of unanimity led to sentiment, primarily from gas pipeline and utility companies, to force holdouts into agreement. To this end, eminent domain laws were passed in West Virginia (1949); Kansas, Oklahoma, and Illinois (1951); Ohio and Missouri (1953); Montana and Pennsylvania (1955); Arkansas (1957); Indiana (1959); Kentucky (1962); Iowa, Nebraska, Louisiana, Colorado, New Mexico, Michigan, and New York (1963); Washington (1964); Georgia (1965); and Texas (1977). [15]
Condemnation typically requires a high percentage of voluntary agreement and cannot involve active oil or gas fields. A showing of “public purpose” is required to condemn not only underground storage space but associated surface areas. [16]
A federal eminent domain law for underground gas storage reservoirs has not been passed. The Natural Gas Act was amended in 1947 to allow condemnation of pipeline right-of-way and associated property, but attempts in 1951 and 1953 to include underground reservoirs failed. Coal companies led the opposition against legislative favor for gas. [17]
Consequently, state laws, if any, had to be used by interstate pipelines where voluntary agreement with reservoir landowners fell short. This changed in 1974 when a Federal District Court included acquisition and construction of gas storage facilities within condemnation rights under Section 7(h) of the NGA. [18] Condemnation aside, all storage projects associated with interstate gas transmission required certification along with the pipeline itself under Section 7(c) of the Natural Gas Act.
Eminent Domain Reconsidered
The rationale for eminent domain cannot claim to be within the conservation-law ethic of waste prevention and correlative rights protection. Condemnation statutes are a “second-best” solution to a property rights problem that substitutes a “tyranny of the majority” for a “tyranny of the minority.”
Reliance is placed on arbitrary court determinations of fair value instead of true value as revealed by voluntary transactions. In one eminent domain proceeding, a condemned party was awarded nothing because the court ruled that the storage easement across his property was “valueless.” [19] Confiscatory verdicts are always potentially present when coercion is resorted to.
Given the separability of subsurface storage and surface activities, surface owners should have no more interest in the innocuous workings of a gas reservoir beneath them than the movement of a satellite above their land – so long as no material influence, real or potential, is present.
If reservoir use requires surface use, arrangement must be made with the landowners to avoid trespass. If damage or irritation occurs to the surface area from reservoir mismanagement, whether in the form of destroyed vegetation, noxious fumes, or hazards, tort liability and retribution should apply.
Homestead Theory of First Ownership
With the surface owner justly considered, a homestead theory of oil and gas property law can be applied to reservoir ownership and use. The first finder of the oil and gas reservoir would continue to own the depleted formation unless sold or bequeathed to another party. Any use of the storage facility would require a lease between the owner(s) and the parties seeking storage.
In cases where the depleted reservoir is abandoned – the owner failing to keep proper legal documentation and not demonstrating intent to use – the reservoir would revert to a “state of nature” for a new first claimant to possess. In such cases, only a surface lease to operate the underground facility would be required.
Short of a homestead resolution to the transaction cost problem, the “solution” of condemnation over unanimous agreement can be questioned. In recent decades, lease agreements have included provisions for reservoir rentals upon depletion to avoid the holdout problem.
The large number of storage agreements made without condemnation suggests that pecuniary motives have made the transaction cost problem surmountable. In Texas prior to the Underground Gas Storage Act of 1977, for example, over a dozen reservoirs storing more than 150 million cubic feet each were in operation. [20]
[1] John Ise, The United States Oil Policy (New Haven: Yale University Press, 1926), p. 25.
[2] Boverton Redwood, A Treatise On Petroleum (London: Charles Griffin and Company, 1926), pp. 1052, 1061.
[3] See Bradley, Oil, Gas, and Government, pp. 1290–1293.
[4] Market-demand laws are discussed in Ibid., pp. 162–65.
[5] Kansas Laws of 1905, Chapter 315, Sec. 2.
[6] See Northcutt Ely, The Oil and Gas Conservation Statutes (Washington, D.C.: Government Printing Office, 1933), pp. 212, 286.
[7] Texas Revised Statutes, 1925, Title 102, Article 6049a, Section 1.
[8] Ely, The Oil and Gas Conservation Statutes, p. 211.
[9] Article III, “The Code of Fair Competition for the Petroleum Industry,” (1933).
[10] Public Law 94-163, 89 Stat. 871 at 954 (1975).
[12] See Bradley, Oil, Gas, and Government, pp. 1752–56.
[13] Quoted in American Gas Association, Regulation of the Gas Industry, 4 vols. (New York: Matthew Bender, 1982), vol. 1, p. 12-39. Gas is typically injected during the April through October “shoulder” months and withdrawn from November through March. Seasonal variations and market characteristics change this cycle.
[14] Hammonds v. Central Kentucky Natural Gas Co., 255 Ky. 685, 75 S.W. 2d 205 (1934).
[15] See Stephen McDonald, Petroleum Conservation in the United States (Baltimore: Johns Hopkins University Press, 1971), pp. 255-70; Robert McGinnis, “Some Legal Problems in Underground Gas Storage,” 17 Oil and Gas Institute (New York: Matthew Bender, 1966), p. 53.
[18] Natural Gas Pipeline Co. of America v. Iowa State Commerce Commission, 369 F. Supp. 156 (D.C., S.D. Iowa, 1974). Section 7(h) gave eminent domain rights to pipelines and “the necessary land for . . . the location of compressor stations, pressure apparatus, or other stations or equipment necessary to the proper operation of such pipe line.” 61 Stat. 450 (1947).
[19] Midwestern Gas Transmission Company v. Mason, 31 Ill. 2d 340, 201 N.E. 2d 379 (1964).
[20] Texas Railroad Commission, Annual Reports for 1977 and 1978.