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Client Alert

March 25, 2020

U.S. Produced Crude Oil Targeted for First Purchase for the Strategic Petroleum Reserves


Amid current low oil prices, there may be one bright spot for U.S. producers. On Friday, March 13, President Trump announced he has directed the U.S. Department of Energy (the “DOE”) to begin purchasing oil for the Strategic Petroleum Reserves (the “SPR”). The DOE immediately took action on March 19 by issuing a request for proposal (“RFP”) for thirty million barrels of crude oil with a requirement that all submissions must be received no later than 11:00 a.m. Central Time, Thursday, March 26.[i] While the funding for the RFP was excluded from Congress’s stimulus package, Trump’s administrator remains firm on proceeding with the announced purchases and will seek funding within the DOE’s budget.[ii] Based on the foregoing, further RFPs are expected in the coming months with the DOE projected to purchase a total of seventy-seven million barrels of crude oil produced in the U.S. For parties interested in submitting bids or producers supplying parties submitting bids, it is important they are aware of the additional risks related to certifications and compliance measures required of companies contracting with the government.

Overview of the SPR

The SPR was created as an emergency supply of crude oil in the 1970s following the 1973 – 1974 oil embargo. Its purpose is to reduce the impact of disruptions to the U.S. supply of oil in the event of other oil embargos, natural disasters, etc. It is also fundamental to the U.S. for meeting its International Energy Agency obligations, which requires member countries to maintain a supply of emergency oil stocks. The SPR is the world’s largest supply of emergency crude oil with an authorized capacity of 713.5 million barrels and is stored in underground salt caverns along the U.S. gulf coast at four sites – two in Texas and two in Louisiana. The crude oil stored in the SPR may be used in exchanges, which is a type of “loan” of crude oil, or in certain emergency circumstances as defined in the Energy Policy and Conservation Act. Previously, the DOE has acquired crude oil for the SPR from both domestic and international sources. For example, the DOE entered into four country to country contracts with Petroleos Mexicanos (PEMEX) beginning in 1981, under which the DOE procured approximately 220 million barrels of crude oil.[iii]

Overview of Initial RFP

The initial RFP is targeted at crude oil “produced in the United States by United States producers”.[iv] Qualifying producers are U.S. citizens or companies organized in the U.S., in each case, employing fewer than 5,000 employees among all of its affiliates.[v] The bidder, however, can be a regular crude seller or distributor so long as it provides certification that the crude oil is supplied by qualifying producers.[vi] Thus, qualifying U.S. producers can participate indirectly with a trader or major producer acting as the aggregator. Because the crude oil is sourced domestically, even marine deliveries must be made by U.S. flagged vessels pursuant to the Jones Act.[vii]

The delivery period is for the months of May and June of 2020, with the pricing to be based on the average of NYMEX WTI and Argus WTI index settlement prices for the May and June contract months over the three trading days starting on the award date. Submitted bids will be the delta (price difference) to these average settlement prices. The index mechanism appears to give the winning bidder a short window to hedge the prices.

Compliance Requirements

Because the government as a customer operates under extensive and complex procurement statutes, regulations and rules that are different than the commercial marketplace, selling to the government as a prime or subcontractor[viii] may pose significant financial risks, and even may result in administrative sanctions, or civil and criminal liability for noncompliance. For example, the requirements listed in the RFP cover ten pages of Federal Acquisition Regulation (FAR) clauses incorporated by reference.[ix] In addition, the one-week time period (March 19-26) to prepare and submit a bid for the RFP may be a challenge for companies unfamiliar with the required procedures and regulations involved. Companies that regularly sell to the government mitigate the risk by having well-developed internal systems and processes to ensure compliance with these government-unique requirements. Potential producers and suppliers at the prime and subcontract level would be well served to make sure they understand how their current compliance policies and procedures may need to be enhanced to mitigate the risk when selling to the government.

Takeaway

The initial RFP targeted at crude oil produced in the U.S. has likely piqued many domestic producers’ interest. However, understanding the additional regulatory requirements to contract with the government is important to mitigate the risks related to government-unique compliance requirements and to improve a bidder’s chance of preparing a winning bid. With additional RFPs likely in the near future, a producer interested in selling to the DOE for the SPR would be well advised to engage legal counsel early in the process to navigate regulatory compliance matters.

 

[i]               See https://www.spr.doe.gov/doeec/OilPurchase.htm for the full text of the current RFP.

[ii]              Timothy Gardner, Trump Admin Looks to Buy Oil for Reserve Out of Energy Dept Budget, Reuters (Mar. 25, 2020).

[iii]              See https://www.energy.gov/sites/prod/files/2013/04/f0/Acquisition_Final_Rule.pdf.

[iv]              See footnote 1, at Sec. B.1.a.

[v]              Id. at Sec. B.1.b.

[vi]              Id.

[vii]             Id. at Sec. F.1.i.

[viii]             The definition of “subcontractor” in the FAR at 48 C.F.R. § 44.101 is extremely broad and would include companies selling to the prime contractor under the RFP. In addition, the prime contractor must flow down mandatory FAR clauses that also subject subcontractors to the above-described risks.

[ix]              Id. at Sec. I.