Strategic Petroleum Reserves: Analysis of Alternative Financing Methods

Published by the Government Accountability Office on 1989-03-16.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

___.,._   “,.“_-    .-.._.__   ~.----.------

  Mw~It            1!)H!)
                                               Analysis of
                                               Alternative Financing
                     United States
GAO                  General Accounting Office
                     Washington, D.C. 20548

                     Resources, Community, and
                     Economic Development Division


                     March 16, 1989

                     The Honorable Philip R. Sharp
                     Chairman, Subcommittee on Energy and Power
                     Committee on Energy and Commerce
                     House of Representatives

                     Dear Mr. Chairman:

                     This report responds to your March 2,1988, request that we examine
                     alternative, nontraditional methods of acquiring oil for the Strategic
                     Petroleum Reserve (SPR). You were concerned with the budget deficit
                     and sought to reduce government outlays for the SPR. As agreed in sub-
                     sequent discussions with your office, our analysis summarizes and dis-
                     cusses a variety of nontraditional oil acquisition and financing methods.

                     We examined approximately                40 proposals in three broad categories that

                 .   increase government revenues by selling financial instruments such as
                     bonds, increasing taxes or user fees, selling government assets or using
                     receipts from revenue producing assets, or selling futures or option con-
                     tracts and dedicating these revenues to the acquisition of oil for the SPR;’
                     acquire oil by means other than outright purchase, such as renting/leas-
                     ing it, mandating that firms contribute oil to the SPR, or providing
                     inducements to encourage private SPR contributions;
                     set up a separate SPR entity to handle financing or acquire oil and man-
                     age the SPR.

                     We compared the alternatives that we identified to the current method
                     of acquiring and financing SPR oil through congressional appropriations
                     that are reported in the budget. Our comparison covered (1) short- and                                   b
                     long-term acquisition and financing costs to the government, (2) the
                     effect on the budget and national debt, and (3) other key considerations,
                     such as who would control the SPR oil.

                     When compared to the conventional method of financing oil for the SPR,
 ults in Brief       most of the proposals have certain benefits or advantages, but all of
                     them have economic or other disadvantages. Some proposals would
                     reduce the budget deficit by increasing government revenues (new taxes

                     ‘GAO is currently reviewing its position on dedicated funding and will be issuing a report on this
                     subject in the near future.

                     Page I                                          GAO/RCED-89-103      Alternative   Financing   Methods

or fees) but would, for example, raise prices to the consumer. Other pro-
posals could reduce short-term expenditures (asset sales, leasing oil or
indexed bonds). However, the proposals might increase long-term
expenditures by more than the initial reduction in outlays, We have con-
sistently recommended against proposals such as asset sales, which
would reduce outlays and the deficit in the short term but would
increase the long-term deficit. Furthermore, most asset sales are
excluded from the calculation of the deficit for purposes of the Balanced
Budget and Emergency Deficit Control Act of 1986 (Gramm-Rudman-

Some proposals involve exchanging future government “profits” on the
value of oil already in the SPR (should oil prices rise in the future) for
lower current expenditures (equity certificates, options). Some propos-
als would affect such concerns as government control of the oil, espe-
cially during drawdown in an oil supply disruption (leasing, equity
certificates). Some proposals would establish a separate SPR entity. If the
SPR entity is off-budget, its expenditures would not be reported in the
budget. However, if the government provides funding to the entity, that
funding would count against the deficit.

(P.L. 94-163, Dec. 22, 1976), as amended, is the nation’s first line of
defense in an oil supply disruption. By law it may not be drawn down
and the oil distributed unless the President determines that a severe
energy supply interruption has occurred or that drawdown is necessary
to fulfill U.S. obligations under the international energy program, which
under many oil disruption scenarios means sharing oil with other Inter-
national Energy Agency members.

The Department of Energy (DOE) is responsible for the SPR'S manage-
ment, maintenance, operation, and construction, including buying and
storing the oil. In the event of a drawdown, DOE would administer the
withdrawal and sale of the oil from the SPR. DOE currently plans to auc-
tion the oil to the highest bidders at drawdown.

As of September 30, 1988564.7 million barrels of the currently planned
760 million barrels of oil were stored in the SPR. As of November 30,
1988, DOE had spent about $17 billion to acquire the oil, store it, and
maintain the facilities. In fiscal year 1988, DOE disbursed $338 million
from the SPR petroleum account for the acquisition and transportation of
20,8 million barrels of oil that were added to the SPR inventory. On the

Page 2                             GAO/RCED-99-103   Alternative   Financing   Methods

                        basis of the amounts appropriated by Public Law loo-446 (Sept. 27,
                        1988), DOE plans an average fill rate of approximately 60,000 barrels per
                        day during fiscal year 1989. Assuming this fill rate continues, the SPR
                        will reach the 760-million-barrel level in about 10.7 years, in 1999. DOE
                        estimates a total expenditure of about $22.6 billion for costs associated
                        with filling the SPR to the 750-million-barrel level.

                        The SPR is funded through annual appropriations from the Congress,
                        The sources of these funds are general government revenues from, for
                        example, taxes, duties, or borrowing (the sale of debt instruments). Most
                        government expenditures are funded in this way, and SPR expenditures,
                        for most of the SPR'S history, were included in the annual budget. The
                        Omnibus Budget Reconciliation Act of 1981 (P.L. 97: 5, Aug. 13, 1981)
                        established the SPR Petroleum Account, the account tit at pays for SPR oil
                        acquisition and transportation, as an off-budget account. As part of the
                        effort to control government expenditures, the Gramm-Rudman-Hollings
                        act brought this account back on the budget. The SPR is now funded, as it
                        was before 1981, through annual appropriations with funds from the
                        U.S. Treasury, and oil is purchased at market prices.

                        Our analysis of alternative funding proposals compares those proposals
GAIO’sAnalysis of SPR   with the current method of financing the SPR, noting similarities and dif-
Funding Proposals       ferences. For clarity we have grouped these proposals into three catego-
                        ries: (1) revenue raising alternatives, such as bonds or taxes; (2)
                        different ways of acquiring oil, such as renting; and (3) establishing a
   /                    separate SPR entity.

R&9IW Raising           Revenue raising alternatives include special bonds and taxes, asset sales
                        and receipts, and futures and options contracts. (See app. II.) These pro-                b
Altltrnati .ves
                        posals generally address the means by which the government could raise
                        money for funding the SPR, but they do not directly affect the purchase
                        price of oil or other SPR costs. In practice, revenue raised in these ways
                        could be used to finance any government expenditure-not          just to pur-
                        chase SPR oil. However, these proposals dedicate the revenues to funding
                        the SPR.

                        The proceeds obtained from issuing special bonds to purchase SPR oil
                        would substitute for conventional debt (i.e., the issuance of Treasury
                        securities) that is normally used to finance government expenditures. If
                        these bonds can be sold at a lower interest rate than comparable Trea-
                        sury offerings by, for example, indexing the face value of the bonds to

                        Page 3                              GAO/RCED-89-103   Alternative   Financing   Methods

the price of oil, then the government’s interest cost might be reduced.
However, if the price of oil rises, the government will have to repay a
greater amount when the bonds come due. This additional amount may
or may not be more than the interest saved over the life of the bond on a
discounted present value basis.2

Additional revenues received from new or increased taxes or asset sales,
such as the sale of government land, would lower the current budget
deficit to the extent that they result in additional income, and budget
expenditures are not increased. However, the sale of a revenue produc-
ing asset, such as the Naval Petroleum Reserve (NPR), would result in the
loss of future revenue. The sale price of a revenue producing asset
would need to reflect the discounted present value of future revenues
for the government to avoid a loss. We have consistently recommended
against asset sales and other proposals that would reduce outlays and
the deficit in the short term but would lead to higher deficits in the long
run. Furthermore, the proceeds of most asset sales are excluded from
the calculation of the budget deficit for purposes of the Gramm-Rud-
man-Hollings procedure.

Raising revenue by selling futures contracts to purchase SPR oil does not
seem feasible. To preserve oil for use in an emergency, DOE'S selling price
would need to be set at a disruption market price; consequently, in nor-
mal circumstances no one would buy such a high priced oil futures con-
tract. (See app. II for details on futures contracts.)

The sale of options contracts on SPR oil, however, would raise revenues
for the purchase of additional SPR oil. An options contract would give
the purchaser the right (but not the obligation) to buy SPR oil at an
agreed-to price on an agreed-to date. Such contracts might be attractive
to firms that wish to ensure that they have access to oil should a disrup-
tion occur. To retain control of SPR oil, DOE could sell options contracts at
a price that reflects the expected price of oil during a disruption. The
per barrel selling price of such an options contract is likely to be low,
reflecting that under current market conditions the risk of a disruption
is also low. Therefore, this proposal is not likely to raise enough revenue
for the government to purchase meaningful quantities of oil for the SPR.

‘The discounted present value, also known as the net present value, is a concept that allows meaning
ful comparison of dollar flows, either money received or money spent, that occur at different times.
In general, revenues to be received in the future are worth less than equal revenues on hand today
because money on hand can be invested to yield a higher amount in the future or, in the case of the
federal government, it can reduce the amount borrowed in the future. The farther into the future the
expected revenues or costs are, the less value they have in today’s dollars.

Page 4                                         GAO/RCED-89-103     Alternative   Financing   Methods

                          Selling options contracts at a disruption price, however, may be desir-
                          able as an energy policy alternative to facilitate early distribution of SPH

Alikrnative Ways of       Alternative ways of acquiring oil (other than the current method of gov-
Acquiring Oil             ernment purchases) include rent and lease, and compulsory or induced
                          private contributions. (See app. III.) The government could rent or lease
                          oil at an initial cost less than outright purchase; but over several years,
                          this alternative is likely to prove more costly since the “rent” is likely to
                          reflect both the private sector’s higher cost to borrow money and its
                          desired profit. In addition, lease proposals might complicate drawdown
                          unless the question of whose oil (the government’s or the lessor’s) comes
                          out first is settled during negotiation of the lease. The government,
                          under existing provisions of SPR legislation, could require or induce the
                          private sector to store oil, to which the private sector retained title, in
                          the SPR. Mandatory oil contributions may be challenged by the industry,
                          which would probably assert that the government was taking firms’ oil
                          without compensation. However, the Congress, under its constitutional
                          authority over interstate commerce, can mandate private storage of oil
                          as a fee to industry for the right to do business. If oil suppliers are
                          required to store oil in or for the SPR, they would probably deduct the
                          cost of this oil as a necessary business expense against their taxable
                          profits. Any such reductions would have to be considered when estimat-
                          ing the proposal’s effect on the federal budget. On the other hand, the
                          private sector might be induced to store oil in the SPR in return for some
                          form of compensation, such as the receipt of government-owned SPR oil
                          at less than disruption prices at drawdown. Such an agreement would
                          allow the government to reduce its current costs in exchange for
                          reduced expected future revenue gains (profit) resulting from the sale of
                          SPR oil. Like leasing proposals, these alternatives might complicate                                      b

Establishing a Separate   Some proposals suggest the establishment of a separate SPR entity-a
SP’REntity                government corporation, such as the Tennessee Valley Authority, or a
                          trust.:’ (See app. IV.) Such an entity could obtain oil by using some of the
                          alternatives outlined in appendixes II and III. For example, it could use
                          funds from the sale of assets or debt to buy oil, or be the beneficiary of

                          “A trust, as used in this report, means an entity with the power to undertake financial transactions
                          on behalf of another person or institution, in this case, the SPR. The Treasury also maintains separate
                          receipt and expenditure accounts, usually called Trust Fund Accounts; these are not referred to here.

                          Page 5                                          GAO/RCED-99-103      Alternative   Financing   Methods

dedicated revenue. If the entity is off budget, its expenditures would not
be reported in the budget. However, if the government provides funding
to the entity, that funding would count against the deficit. If the public
participates in the SPR entity, depending upon how this participation is
structured (i.e., if the public owns stock in the “corporation”), some or
all of the benefits of any rise in the price of oil might be transferred to

Separate government entities have sometimes been established for busi-
ness-type activities that generate receipts from selling products or ser-
vices and finance their costs primarily by such receipts. The SPR is now
an integral part of DOE and generates no revenues.

report, we interviewed DOE and other federal officials, as well as private
sector authorities. We then reviewed DOE, Office of Management and
Budget (OMB), and congressional documents, and documents and studies
by other organizations. With one exception, the proposals reviewed date
from 1981, Appendix I describes in greater detail our methodology and
also defines certain terms and concepts used in our analysis.

The proposals are not mutually exclusive; they could be mixed and
matched in many ways. We did not consider combinations except under
our discussion of separate entities in appendix IV. For our analysis, we
assumed that a funding proposal has only those features that are speci-
fied in this report. We then evaluated the proposals against the normal
method of financing through appropriations on the basis of three crite-
ria: (1) the government’s oil acquisition and financing costs (that is,
whether the government could either acquire oil or raise money more
cheaply over both the short and long term); (2) the effect on the budget                 b
deficit and the national debt; and (3) other considerations, such as who
would pay for the oil and the effect on government control of SPR oil.

As agreed with your office, we did not attempt to precisely quantify
either the costs or benefits of specific proposals. Instead, we assessed
the likely impacts of each proposal on federal spending. Further, as
agreed, we did not include any proposals involving foreign contributions
to the SPR.

We discussed the information provided in this report with DOE and OMB
officials and incorporated their comments as appropriate; however, we
have not obtained official agency comments at your request.

Page 6                             GAO/RCED-89-103   Alternative   Financing   Methods

As arranged with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from
the date of this letter. At that time, we will provide copies to the Secre-
tary of Energy and other interested parties and make copies available to
others upon request. This report was prepared under the direction of
Flora H. Milans, Associate Director, Energy Issues. Other contributors
are listed in appendix V.

Sincerely yours,

Keith 0. Fultz
Director, Energy Issues

Page 7                             GAO/RCED-89-103   Alternative   Financing       Methods

                       :                                              .,
                      ..                                                   ‘,..,     8,

Letter                                                                                                          1

Abpendix I                                                                                                  10
Approach,                Approach
Methodology, and
Definition of Terms
Appendix II                                                                                                13
Revenue Raising          Bonds
                         Taxes and User Fees
Alternatives             Asset Sales and Receipts                                                          20
                         Futures and Options                                                               24

7L$pendix III                                                                                              27
PLIternative Ways of     Renting or Leasing
                         Compulsory or Induced Private Contributions
P$quiring Oil

2Appendix IV

E$tablishment of a       The Proposals                                                                     34
Sl+parate SPR Entity
 i pendix V                                                                                                37
 Pajor Contributors to
14                       Resources, Community, and Economic Development
                             Division, Washington, DC.
T‘his Report

                         Page 8                           GAO/RCED-99-103   Alternative   Financing   Methods


           Department of Energy
           Federal Financing Bank
           General Accounting Office
           Industrial Petroleum Reserve -
           Naval Petroleum Reserve
           Office of Management and Budget
           Strategic Petroleum Reserve

Page 9                           GAO/RCED-89-103   Alternative   Financing   Methods
Approach, Methodology, and Definition
of Terms

                  We identified approximately 40 proposals for alternative funding of the
4pproach          Strategic Petroleum Reserve (SPR). To do this we interviewed Depart-
                  ment of Energy (DOE)and other federal officials, as well as private sec-
                  tor authorities, and reviewed DOE and Office of Management and Budget
                  (OMB) documents and studies by various public and private parties. The
                  proposals came in various forms; some were fully developed while
                  others were mere suggestions. We combined those that contained essen-
                  tially similar features and eliminated some that were impractical as well
                  as any that involved foreign participation,

                  For analysis ‘we grouped the proposals into three categories:
              . revenue raising alternatives, such as bonds or taxes;
              . alternative ways of obtaining oil, such as renting; and
              l a separate SPRentity.

                  These categories are not mutually exclusive; for example, the revenue
                  from an indexed SPR bond could be used to lease as well as to buy oil.
                  Our analysis, however, starts from the current method of financing the
                  SI’R, in which oil is purchased with funds appropriated annually. We
                  have assumed, therefore, that a funding proposal has those features
                  that are specified in this report, but otherwise uses current methods of
                  funding and filling the SPR. To use the example cited above, for instance,
                  we assumed that funds raised from issuing an indexed bond would be
                  used to buy oil at market prices.

                  We evaluated the proposals in three ways. Our analysis covered (1) the
                  effects on the government’s oil acquisition and financing costs, (2) the
                  effects on the budget deficit and the national debt, and (3) other consid-
                  erations, such as who would pay for the oil and the proposal’s effect on                b
                  government control of SPR oil. How we applied these criteria is explained

                  In our analysis we did not attempt to precisely quantify our results.
                  Instead, we assessed the likely impacts of each proposal, for example,
                  whether it would tend to increase or decrease annual expenditures or
                  the national debt.

                  Page 10                            GAO/RCED-89103   Alternative   Financing   Methods
                               Appendix    I
                               Approach,       Methodology,   and Definition
                               of Terms

Goyernment’s Oil               The analysis considered both short- and long-term acquisition and
Ac@isition and Financing       financing costs. Where appropriate, we compared the present value of
                               additional long-term costs with current savings:
                           l   Acquisition costs are the government’s expenditures for oil over time.
                               These costs can change as a result of a change in either the amount of oil
                               purchased or the price of oil.
                           l   Financing costs are considered to be the government’s expenditures
                               associated with money borrowed to finance oil purchases. For instance,
                               the government pays interest when it borrows money and, with some
                               types of debt instruments, may also have to repay a principal amount
                               that exceeds the amount it has borrowed. The government’s financing
                               cost can change as a result of a change in either the interest rate the
                               government pays when borrowing money or the total amount borrowed.

Ef’ftects on the Budget        Our analyses, in subsequent appendixes under this heading, present the
Deficit and the National       effects on the budget deficit and the national debt from outlays (expend-
                               itures) for the SPR program. The deficit is the amount by which the gov-
                               ernment’s budget outlays exceed its budget receipts for a given fiscal
                               year. Certain nongovernment entities, such as the government-spon-
                               sored enterprises, are not included in the budget (off budget). However,
                               in the event that the government makes payments to these off-budget
                               entities, these amounts would be included in the deficit.

                               The following definitions are presented to facilitate an explanation of
                               how the terms budget deficit and national debt were used:

                               Gross national debt consists of public debt and agency debt and includes
                               all public and agency debt issues outstanding.
                               Public debt is that portion of the federal debt incurred when the Trea-                               h
                               sury or the Federal Financing Bank (FFB) borrows funds directly from
                               the public or another fund or account. To avoid double counting, the FFB
                               borrowing from the Treasury is not included in the public debt. (The
                               Treasury borrowing required to obtain the money to lend to the FFB is
                               already part of the public debt.)
                               Agency debt is that portion of the federal debt incurred when a federal
                               agency, other than the Treasury or the FFB, is authorized to borrow
                               funds directly from the public or other fund or account. To avoid double
                               counting, agency borrowing from the Treasury or the FFBand federal
                               fund advances to trust funds are not included in the federal debt. The
                               Treasury or FFE3borrowing required to obtain the money to lend to agen-
                               cies is already part of the public debt (i.e., shown as part of the federal

                               Page 11                                         GAO/RCED-89-103   Alternative   Financing   Methods
                     Appendix    I
                     Approach,       Methodology,   and Deflnltion
                     of Terms

                     deficit). Agency debt may be incurred by agencies within the federal
                     budget (such as the Tennessee Valley Authority) or by off-budget fed-
                     eral entities (such as the Postal Service). Debt of government-sponsored,
                     privately-owned enterprises (such as the Federal National Mortgage
                     Association) is not included in the federal debt.

Other Concerns       In subsequent appendixes under this heading, we identify some addi-
                     tional important effects that would follow adoption of a particular pro-
                     posal. Those include

                 . who pays for the oil (taxes, user charges);
                 . who controls oil in the SPR and whether the proposal would complicate
                   drawdown (rent/lease, mandated contributions);
                 l the feasibility of the proposal (options); and
                 l legal issues.

                     Our discussion may not include all possible impacts,

                     Page 12                                                    GAO/RCED-89-103   Alternative   Financing       Methods

                                                       ‘:’             ,
                                                      ‘b ;.’         “.    ,,                                               ,
Appendix 11


              Numerous revenue raising proposals offer ways to fund SPR oil
              purchases. The proposals include issuing bonds, assessing taxes and
              user fees, selling government assets, and using receipts from revenue
              producing assets. The proposals generally address the means by which
              the government could raise money and do not directly affect the pur-
              chase price of oil for the SPR. In practice, the revenue raised from these
              proposals could be used to fund any government expenditure. These
              proposals envision dedicating the revenues to fund SPR oil purchases.

              Several proposals have been made to issue various bonds to generate
              extra revenue for the government to purchase oil for the SPR. A bond is a
              debt instrument that generates funds, which must be repaid in the
              future, and is issued by the government or a corporation. The principal,
              or face value of the bond, represents the amount that the debtor will
              repay to redeem the bond on maturity.’ The value of the bond at any
              given time will vary in the market place from its redemption value. In
              addition to receiving the face value at maturity, bondholders usually
              receive specified interest payments on a fixed schedule over the life of
              the bond. The proposals for SPR financing generally use one of two types
              of bonds: (1) conventionally structured bonds and (2) indexed bonds.
              Bonds associated with the SPRmight be issued by the Treasury, DOE, or a
              government corporation.

              Conventionally Structured Bonds. Conventionally structured bonds have
              a fixed face value at maturity and the bond holders typically receive
              periodic interest payments during the life of the bonds representing a
              fixed percentage of the face value. Conventional, fixed-rate proposals
              include (1) borrowing from the FFB and (2) issuing mortgage bonds
              backed by SPR oil. The latter is a conditional pledge of the oil to a credi-                            I,
              tor as security against default.

              The FFB is an entity of the U.S. Treasury authorized to lend money to
              federal agencies or government-sponsored, privately-owned entities.
              The FFB buys bonds and notes issued or guaranteed by federal agencies
              or government-sponsored, privately-owned entities. The FFB in turn bor-
              rows from the Treasury, which issues Treasury debt instruments to
              obtain the funds needed.

              ‘Maturity is the date upon which the principal is payable unless otherwise specified.

              Page 13                                         GAO/RCED-89-103     Alternative   Financing   Methods
    Appendix II
    Revenue Raising Alternatives

    The SPR could borrow from (sell debt instruments to) the FFB and use the
    proceeds for oil acquisition. This approach would change only the
    financing mechanism- not how the oil purchases would be made. Such
    borrowings from the FFB would be offset by additional Treasury borrow-
    ing with the interest recorded as current expenditures (outlays) in the

    Indexed Bonds. An indexed bond differs from conventional financing in
    that the face value of the bond is tied to another unit of value, such as a
    foreign currency or a commodity. In the case of oil-indexed bonds, as oil
    prices change, the face value of the bonds changes as well. Investments
    in this type of debt instrument may offer a hedge against inflation. To
    the extent that the price of oil tracks inflation, the value of the bond’s
    principal (face value) does so as well. During the 1980s oil prices have
    fallen despite a rise in the overall price level. However, major economic
    forecasters’ expectations appear to be that in the future oil prices will at
    least keep pace with those of other goods and services; therefore, the
    bond’s principal may be protected from loss of purchasing power.
    Because the bonds’ face value is linked to oil prices, borrowers may be
    able to sell an indexed bond to investors while offering a lower interest
    rate than necessary to sell a conventional bond.

    Indexed bond proposals include the following:

. bond issues with a variable redemption value linked to the price of oil
  (30-year term) which may be sold with a lower interest rate,
. bond issues sold at a discount (zero coupon) with a minimum and maxi-
  mum redemption value (7- to 12-year term), and
l bond issues tied to an agreement with the government to purchase spe-
  cific amounts of oil at a minimum price, and financed at a lower rate of
  interest than conventional Treasury debt.

    In the first proposal, bonds would have a stated par value,’ such as
    $1,000, and could be converted into the dollar equivalent of a specified
    number of barrels of oil.” For example, if the specified conversion price
    is $20 per barrel, then at maturity the holder of a bond with a face value

    ?ar value is usually synonymous with face value. The term means that value for which the debt
    instrument can be redeemed from the seller.

    “Although these bonds are sometimes called convertible oil bonds, the bonds themselves would not be
    convertible into oil and they would be backed by the full faith and credit of the 1J.S.Treasury, not by
    the oil stored in the SPR.

    Page 14                                         GAO/RCED-89-103      Alternative   Financing   Methods
Appendix II
Revenue Raising Alternatives

of $1,000 could convert that bond into the dollar equivalent of 50 bar-
rels of oil ($1,000 divided by $20 per barrel conversion price). This bond
would have a value at maturity of at least $1,000. However, if the price
of oil increases, the bond would appreciate in value. For example, if the
price of oil rose to $100 a barrel in 30 years, the bond’s value would
become $6,000 (60 barrels times $lOO-the then current market price of
oil). Furthermore, throughout the life of this 30-year bond, the bond-
holder would receive a fixed annual interest payment. The originators of
this proposal believe that the government could successfully market
these bonds with an interest payment of 3 percent, or $30 per year on a
$1,000 bond. They also believe that these bonds could carry a conver-
sion price slightly higher than the price of oil at the time the bonds are
issued, such as $20 per barrel based on current oil prices.

The second proposal also calls for indexing the face value of the bonds
to the price of oil. However, this proposal limits the amount that inves-
tors receive if the bonds are redeemed at drawdown. The oil price used
to adjust the bonds’ face value is limited to the price in the month imme-
diately preceding disruption and drawdown plus 15 percent. Another
difference between this proposal and the first is that this proposal calls
for the issuance of bonds that require no periodic interest payments by
the borrower. Investors purchasing this type of bond (commonly called a
zero coupon bond because there are no explicit interest payments) earn
their return from the difference between their (lower) purchase price
and the bonds’ face value. These bonds would be sold by auction, with
the winning bids determining the implied yield to investors and cost to
the government.

Under the third proposal, DOE would agree to buy periodically, through
an intermediary, a certain amount of oil with a guaranteed floor price.
With this guarantee the intermediary would then sell options to sell the                                      b
agreed quantity of oi1.4The intermediary would also issue 5-year, gov-
ernment-guaranteed SPR bonds, the revenue from which DOE would use
to purchase oil. Although these bonds would be sold to the public at
market rates, the government’s interest cost would be lower than with

“An option is a contract that gives the buyer the right to buy or sell, and the seller the contingent
obligation to sell or buy a specified futures contract at a specific price on or before a specified expira-
tion date. The exercise price (sometimes referred to as “strike price”) is that price in an options
contract at which the holder of the option may either buy or sell the security or commodity covered
in the option. A futures contract is a standardized agreement to purchase or sell a commodity for
delivery in the future at a price that is determined at initiation of the contract. A futures contract is
traded on a board of trade, or exchange, by members of the exchange; is used to assume or shift price
risk; and obligates each party to the contract either to fulfill the contract’s terms or offset the con-
tract by entering into an opposite transaction.

Page 15                                           GAO/RCED-89-103       Alternative   Financing   Methods
                          Appendix II
                          Revenue Raising Alternatives

                          conventional securities because the intermediary would pay part of the
                          interest. The proposer is willing to be the intermediary because it antici-
                          pates receiving enough revenue from selling options (for the sale of oil
                          to the government) to reduce the government’s interest payments and
                          still earn a profit. Oil producers and sellers may be interested in buying
                          these options to protect themselves against a fall in the price of oil.
                          Under this proposal, the government can reduce its financing costs by
                          giving up the chance to buy cheaper oil should the price of oil fall below
                          the guaranteed floor price. The higher the floor price, the more the
                          intermediary will receive from selling options and, therefore, the larger
                          the reduction in interest rate the government might receive.

,ernment’s Oil            For the conventional bond proposals and the first two indexed bond pro-
,uisition and Financing   posals, there is no effect on oil acquisition costs because oil would con-
                          tinue to be purchased as it is now, The third indexed bond proposal,
w                         however, could result in higher oil acquisition costs if the market price
                          falls below the floor price that the government guarantees to sellers.

                          For conventional bonds, the government’s financing cost will be the
                          same as or possibly slightly higher than (e.g., in the case of agency
                          bonds) conventional Treasury debt because the interest rate will be the
                          same or slightly higher. For indexed bonds, the government’s financing
                          cost compared to the cost of conventional Treasury bonds will initially
                          be lower. However, the appreciation of principal that the Treasury must
                          pay at maturity will depend on how fast oil prices rise during the life of
                          the bonds. The net financing and acquisition cost of the third indexed-
                          bond proposal, obligating the government to pay a floor price for oil,
                          could be greater than the current approach only if oil prices are signifi-
                          cantly below the floor. If oil prices stay at or above the floor, the gov-
                          ernment’s net costs would be lower under this proposal.                                                b

                          Some proponents of indexed bonds believe that the government’s
                          expected financing costs will be smaller because investors would be will-
                          ing to accept a lower expected return to get the inflation protection
                          afforded by linking the bonds to oil prices. For example, if conventional
                          Treasury debt pays 9.6 percent, and oil prices are expected to rise at 4
                          percent, these proponents believe that investors would accept a 3 per-
                          cent interest rate on indexed bonds. If oil prices rise at 4 percent as they
                          expect, the government’s financing cost will be 7 percent-lower      than
                          the 9.5 percent paid on conventional Treasury debt in this example.

                          “The government’s acquisition and financing costs are defined in app. I.

                          Page 16                                         GAO/RCED-89-103     Altemative   Financing   Methods
                             Appendix II
                             Revenue Raising Alternatives

                             Large oil purchasers interested in a hedge against oil price inflation
                             (such as utilities or airlines) might accept this lower expected return.
                             Other experts we spoke with suggest that investors might not be willing
                             to accept a lower rate of return and instead might require a premium to
                             compensate for the uncertainties of oil price inflation. For example, such
                             investors might require an interest rate of 6 percent so that their
                             expected return is 10 percent, exceeding the return on riskless Treasury

Effects on the Budget        The issuance of special SPR bonds would affect annual expenditures and,
Deficit and the Nation .a1   therefore, the budget deficit through interest payments and expendi-
n-k+.                        tures for the oil. Interest rates below Treasury borrowing rates would
                             reduce net government interest outlays. Because these bonds would sub-
                             stitute for conventional Treasury borrowing, the interest cost paid on
                             these bonds is less than the amount saved from reducing conventional
                             borrowing. Under certain proposals the government could face
                             increased future costs, even if the bonds are issued at a lower rate of
                             interest than Treasury debt. The present value of these increased future
                             costs might exceed the reduction in interest expense.

                             These proposals do not affect the total national debt in the short term
                             because they substitute one form of debt for another, i.e., special SPR
                             bonds for Treasury bonds. Over the long term, indexed bonds could
                             either increase or decrease total U.S. government liabilities as a result of
                             differences in the required interest rate plus the increased principal due
                             at maturity, and in the case of the third indexed bond proposal, possible
                             changes in oil acquisition costs.

Ot ler Concerns              There is no effect on government ownership, control, or drawdown from                     b
  i                          these bond proposals.


                             Various types of taxes and user fees have been proposed as potential
T&es and User Fees           sources of additional revenues that could be dedicated to fund SPR oil
                             purchases. A tax is a broadly based revenue source to fund government
                             activities; a user fee is a revenue source that is collected from those who
                             directly benefit from a related government activity.

                             The proposals include

                             Page 17                             GAO/RCED439-103   Alternative   Financing   Methods

                    Appendix II
                    Revenue Wing       Ahrnativea

                l   a tax on gasoline and/or other petroleum products,
                l   a fixed or variable import tax on crude oil and imported petroleum
                l   a refiners’ tax on imported crude oil and imported petroleum products,
                l   a user fee on oil companies for the use of federally financed facilities
                    such as harbors and waterways.

The Proposals       A Tax on Gasoline and/or Other Petroleum Products. A dedicated gaso-
                    line tax has been proposed as a way to raise money to fund oil
                    purchases for the SPR." A per gallon tax would be imposed at the gas
                    pump. The tax rate could be structured so that it would rise and fall
                    with oil consumption and/or the price of oil. Some persons believe that
                    the revenue from a gasoline tax would be large, predictable, and adjust-
                    able. For example, the Congressional Budget Office estimated, on the
                    basis of a study of a gasoline tax of 12 cents per gallon, that each cent
                    per gallon of the tax would generate tax revenue of about $1 billion per
                    year. This tax could be used to cover annual SPR expenditures.
   ,                Another proposal is to tax other petroleum products in conjunction with
                    a tax on a selected product such as gasoline. A tax on other petroleum
                    products would decrease the amount needed to fund SPR oil purchases
                    from a gasoline tax alone.

                    Import Tax on Crude Oil and Petroleum Products. A per barrel tax on
                    imported oil and petroleum products has also been proposed as a way to
                    raise money to fund the SPR. The tax rate could be fixed or variable. A
                    fixed tax rate would remain constant on a per barrel basis; revenue
                    would reflect the number of barrels imported. A variable tax rate could                                 b
                    change on the basis of such factors as the import level or the price of oil
                    to produce a constant stream of revenue.

                    Refiners’ Tax on Crude Oil and Imported Petroleum Products. A tax on
                    each barrel of imported crude oil refined into petroleum products in the
                    United States, and an equivalent tax on each barrel of petroleum prod-
                    uct imported into the United States, could raise additional revenue to
                    fund the SPR.

                    “This tax would be in addition to the current gasoline tax that is earmarked for the highway trust

                    Page IS                                         GAO/RCED-89-103     Alternative   Financing   Methods
                             Appendix II
                             Revenue Raising Alternatives

                             User Fee for Use of Certain Federal Facilities. Another revenue raising
                             proposal is a user fee (tax) paid by oil companies that use certain feder-
                             ally financed facilities, such as harbors and waterways, to finance the
                             SPR. The fee could be seen as a way of compensating the government for
                             the use of the facilities.

Government’s Oil             There would be little change, if any, in the net cost to purchase oil
Acquisition and Financing    except for import taxes because the oil would be purchased from the
                             market as it is now. Under the import tax proposal the domestic price of
costs                        oil would rise, thereby increasing the government’s acquisition cost if it
                             purchases domestic oil. If the government continues to purchase
                             imported oil, however, it would bear the expense of the tax but it would
                             also receive these revenues elsewhere. In the latter case, there would be
                             no effect on the acquisition price of oil net of taxes, unless the import
                             tax reduces world oil prices.

                             Because SPR oil purchases would be paid for from the new taxes or user
                             fees, the government would be able to reduce its borrowing if there is no
                             increase in other expenditures. As a result, in the future the government
                             would incur smaller financing costs. The reduction in government bor-
                             rowing, however, is unlikely to be large enough to affect the interest
                             rate the government pays7

  fects on the Budget        If revenues are increased from dedicated taxes or user fees to fund SPR
  e ‘icit and the National   oil purchases, the budget deficit would be reduced provided there is no
                             offsetting increase in government expenditures.
  eb t

  t.?er Concerns             These proposals increase the cost of oil and petroleum products to con-
                             sumers and businesses. Furthermore, different segments of the economy
                             and population would bear different shares of these costs, depending on
                             how the tax or user fee was established. For example, a gasoline tax
                             would heavily affect consumers, while a user fee on imports would
                             affect consumers, industry, and-to the extent that it reduced world oil
                             prices-foreign    producers. Higher domestic oil prices can also be
                             expected from an import tax because domestic oil producers will proba-
                             bly increase their prices commensurate with the higher prices of oil

                             71f the government’s budget is balanced (or is in surplus) during the period when taxes or fees are
                             imposed, the additional taxes or fees would allow the government to retire debt, which would simi-
                             larly reduce its financing cost.

                             Page 19                                         GAO/RCED-89-103 Alternative      Financing Methods
                  Appendix II
                  Revenue Raising Alternatives

                  imports. Consequently, the import tax would benefit these producers
                  since they are not subject to the tax and can retain the additional

                  These proposals would not change the structure of the SPR because the
                  government would continue to own and control the oil and its
                  drawdown. However, structuring user fees for government facilities in
                  harbors and waterways in such a way that they fall on the petroleum
                  industry alone and are used for the SPR might raise equity issues about
                  the appropriate source and use of funds.

                  All of these proposals envision dedicating the new revenues to filling the

                  Various proposals have been made that involve the sale of government
setSalesand       assets, the use of receipts from revenue producing government assets, or
:eipts            the sale of an ownership interest in a government asset as ways of rais-
                  ing and dedicating money to fund the SPR. Assets owned by the govern-
                  ment include items of economic value, both those that are physical in
                  nature and rights to ownership, such as stock in a corporation.

                  Asset sale proposals include

              l   sale of Naval Petroleum Reserves (NPR),
              l   sale of non-revenue-producing government assets,
              .   crediting receipts from federal oil and gas leases to a revolving fund for
                  use in purchasing SPR oil,
              .   utilizing NPR revenues directly for SPR oil purchases,
              .   auctioning some SPR oil to pay for more oil while requiring that the auc-                b
                  tioned oil remain in the SPR for 5 years, and
              .   selling equity certificates (ownership interest) in SPR oil.

1Proposals        Sell the Naval Petroleum Reserves, The NPR is a group of oil fields owned
                  by and operated under the control of the government, The oil produced
                  is currently sold on the commercial market. The Department of Defense
                  is entitled to NPR production for defense purposes and has used NPR oil in
                  the past.

                  Page 20                            GAO/RCED-99-103   Alternative   Financing   Methods
Appendix II
Revenue Raising Alternatives

In December 1987, the Secretary of Energy submitted to the Congress a
legislative proposal to authorize the sale of the NPR.~ The President’s
January 1989 budget submission for fiscal year 1990 includes a propo-
sal to sell two of the three NPRS. This option would help fill the SPR while
meeting budget targets through non-tax revenue. Filling the SPR also
would upgrade and improve civilian and defense energy emergency

Among other things, the proposal in the January 1989 fiscal year 1990
budget submission provides that the buyer of the NPR deliver oil for the
SPR at an average rate of 50,000 barrels per day for 6 years and make a
bonus bid of at least $1 billion; i.e., the government would receive both
oil and money.

Sell Non-revenue-producing Government Assets, This proposal is to sell
non-revenue-generating assets, such as buildings or land, and use the
proceeds to fill the SPR.

Use Receipts From Federal Oil and Gas Leases. Under the proposal,
receipts from the sale of federal royalty oil, bonuses, and rents received
from the holders of federal oil and gas leases would be placed in a
revolving fund that would be available for the purchase of oil for the
SPR. The gross receipts from these sources total billions of dollars. The
government also receives some of the royalty oil. This oil could be dedi-
cated to the SPR. Some of the funds from federal royalties are currently
committed to fund other federal programs or are used to make required
payments to states in which the oil is produced. The remaining available
funds offset budget outlays.

Dedication of NPR Receipts to the SPR. The revenues from the sale of NPR
oil could be dedicated to purchase SPR oil. NPR revenues were used to                                  b
finance SPR oil in 1977. However, these revenues, like federal royalty oil
revenues, are already counted as Treasury receipts and are used to off-
set budget outlays.

Auction SPR Oil and Use Proceeds to Purchase Additional SPR Oil. It has
been proposed that the government auction 250 million barrels of
existing SPR oil over a 5-year period. The proceeds from the auction
would be used to purchase more oil for the SPR. The auctioned oil would

‘GAO has issued two reports that address this sale proposal: Naval Petroleum Reserve No.l:Efforts
to Sell the Reserve (GAO/RCED-88-198,July 28, 1988) and Naval Petroleum Reserve
No.l:Examination of DOE’s Report on Divestiture (GAO/R~-88-151,         Aug. 25,1988).

Page 2 1                                       GAO/RCED-39-103     Alternative   Financing   Methods
Appendix II
Revenue Rabing     Alternatives

remain in the SPR for 6 years. At the end of 6 years, the owners could
withdraw the oil or sell it back to the government.

However, under the proposal, if during the S-year period oil prices rose
by 26 percent or more during a 6-month period, the owner could take
possession of the oil. If oil prices rose by more than 100 percent over a
6-month period, the oil would have to be drawn down and sold, with the
government receiving the difference between the 100 percent increase
and the market price of the oil at the time of purchase. As long as the
auctioned oil remained in the SPR, the government would pay a rental fee
to the owners and bear all storage costs.

Sell Equity Certificates (Ownership Interest) in SPR Oil. Three proposals
would create SPR certificates with fixed maturity dates. These certifi-
cates give buyers beneficial ownership of SPR oil and provide a supple-
mentary means of financing the acquisition of additional SPR oil.” Under
the proposals, the certificates would be denominated in barrels of crude
oil. The proceeds from certificate sales would be used to acquire crude
oil for the SPR.

Under the first proposal, the issue price of the certificates would be no
less than the average weighted price of crude oil imported into the
United States for the quarter preceding the date of issue. The proceeds
from the certificates would be used to acquire oil for the SPR. Any excess
proceeds would be deposited in the general fund of the Treasury as mis-
cellaneous receipts. Further, the certificates would mature in 10 years,
at which time they could be redeemed for cash (not oil) or rolled over
(new certificates issued). The certificate’s cash redemption value would
fluctuate with the market price of imported crude oil, reduced by the
amount of certain storage and handling costs.

Prior to maturity, holders of certificates could transfer them, presuma-
bly through sale on a secondary market. Also, the Secretary of Energy
could call in the certificates (buy them back) in the event of an SPR
drawdown. The proposal is not clear, however, about whether the gov-
ernment must buy back the certificates at drawdown.

The second proposal is similar in that the certificates would have a fixed
maturity, although for a shorter period-not    more than 7 years-and a
similar redemption price.

“Each certificate entitles the buyer to the value of one barrel of SPR oil-i.e., beneficial ownership.

Page 22                                          GAO/RCEDSS-103       Alternative   Financing   Methods
                            Appendix II
                            Revenue Raising Alternatives

                            A third proposal would allow the sale of fixed-price 7-year certificates
                            at the current cost of SPRoil, Minimum and maximum limits would be set
                            on the redemption price.

                            The minimum return would be set by a bidding process when the certifi-
                            cate is issued and therefore would be subject to government approval
                            prior to issuance. The minimum return an investor would require would
                            presumably reflect at least the rate of return on Treasury notes of com-
                            parable maturity.

                            The maximum return would be indexed to the price of oil within limits
                            determined by the government. For example, the maximum could be a
                            15percent increase over the market price of oil for the month preceding
                            disruption. At maturity, the government would buy back the certificates
                            at the then-prevailing price of oil subject to previously specified limits,
                            At that time, the government would either receive the benefit of any
                            excess profit or bear the burden of any loss on the transaction.

Gobernment’s Oil            There is no effect on oil acquisition cost because the oil is purchased on
Ackpisition and Financing   the market as it is now.
co -ts                      Because SPRoil purchases are paid for from the new asset sale revenues,
                            the government would be able to reduce its borrowing unless it
                            increased other expenditures. As a result, the government would incur
                            in the future smaller financing costs, even though the reduction in gov-
                            ernment borrowing is unlikely to be large enough to affect the interest
                            rate the government pays.

                            However, for equity certificates, the financing costs (reflected in the
                            price at which the government repurchases certificates at drawdown)                      b
                            could be higher or lower than conventional financing depending on how
                            rapidly oil prices rise.

Ef ‘ects on the Budget      Use of non-revenue-generating assets and equity certificates could
I) ficit and the National   reduce the deficit. They would provide an alternate revenue source by
                            replacing some Treasury debt if there is no increase in other government
r)1bt                       expenditures. However, these sales represent reductions in capital
                            assets owned by the government.
  I                         In the short run, the deficit is reduced from selling revenue generating
                            assets. However, in the long run, the impact on the national debt

                            Page 23                            GAO/RCED-39-103   Alternative   Financing   Methods
                       Appmdlx II

                        depends on whether the sales price is higher, the same as, or lower than
                        the net present value of the income generated by the asset. (The defini-
                      , tion of net present value is provided as a footnote in the letter.) It
                        should be noted that the proceeds of asset sales are excluded in calculat-
                        ing the deficit for purposes of the Gramm-Rudman-Hollings procedure.
                        This is consistent with our view that actions should not be taken that
                        reduce the deficit in the short term but increase it over the long term.

                      Presuming no additional outlays, the short-term deficit would be
                      reduced when equity certificates are sold because selling this asset is an
                      alternate revenue source that would replace some Treasury debt. How-
                      ever, the government forgoes profits that it may otherwise receive from
                      oil price appreciation by selling ownership interest in SPR oil, thus poten-
                      tially increasing the long-term deficit.

Other Concerns        Asset sale proposals would not change the structure of the SPR, except
                      when an ownership interest in SPR oil is given in exchange for revenues
                      as in the sale of the proposed equity certificates. If drawdown occurs
                      before the specified redemption date, the government could pay the
                      market (disruption) price for the oil in order to retain control over its
                      distribution. If drawdown does not occur (depending upon how the pro-
                      posal is set up) at the end of the specified period, the government could
                      repurchase the oil at prevailing market prices.

                      A concern over asset sales is that the income stream from asset sales-
                      for example, royalty oil revenues- might not be sufficient to keep the
                      SPR oil fill rate constant or at the required level.

                      Proposals have been made to sell (1) futures contracts in SPR oil or (2)                  A
F$tures and Options   options contracts on SPR oil. Futures and options contracts are primarily
                      Ways to organize drawdown of the SPR, but they have financing implica-
                      tions also.

                      Futures contracts are standardized agreements to purchase or sell a
                      commodity for delivery in the future at a specific time and price deter-
                      mined at the initiation of the agreement. A futures contract obligates
                      each party to the contract to either fulfill the contract’s terms or offset
                      the contract by entering into an opposite transaction (an opposite kind
                      of futures contract). For example, the holder of a futures contract to
                      buy a commodity could offset it by obtaining an equivalent contract to

                      Page 24                             GAO/RCED-89-103   Alternative   Financing   Methods
                                Appendix II
          ’                     Revenue Raising Alternatives

                                sell the commodity. Futures contract prices generally represent the mar-
                                ket’s expectations of what spot market prices will be when the contract

                                Selling futures contracts on SPR oil makes the government liable to
                                deliver on expiring contracts. If the government wanted to structure
                                agreements such that contract buyers would want to take delivery of oil
                                only in the event of a disruption, the futures contract price would have
                                to be set at an expected disruption price. For example, the expected
                                futures price for oil to be delivered might be $15 per barrel; however, in
                                the event of a disruption, the price might be expected to rise to $30 per
                                barrel. Buyers are unlikely to be interested in entering into contracts
                                obligating them to pay $30 per barrel to receive oil in 6 months when
                                futures contracts are available on the open market to buy privately
                                owned oil at $15 per barrel. Thus, futures contracts on the SPR are
                                unlikely to work unless the government is prepared to treat the SPR as
                                part of the commercially available stock of oil and potentially make
                                delivery of the oil to futures contract buyers for prices at or near normal
                                market prices.

                                An option is a contract that gives the buyer the “right,” but not the obli-
                                gation, to buy or sell a security or commodity contract at a specific price
                                on or before a specified expiration date. For example, the government
                                could sell options to buy SPR oil in June 1989 at $30 per barrel. There
                                may be some buyers willing to pay a few cents per barrel for the right to
                                buy oil in 6 months at $30 per barrel because, if there is an oil market
                                disruption in that period, the market price for oil may rise even higher.
                                Some revenue could be raised from the sale of these options.

                                There is no impact on acquisition costs because these proposals do not                   b
      quisition and Financing   affect how the government acquires oil.

                                The government’s financing costs are reduced to the extent that the sale
                                of options produces new revenues and therefore reduces total govern-
                                ment borrowings.

Efifects on the Budget          As long as the market price of oil remains below the exercise price, this
Deficit and the National        proposal will reduce the budget deficit by the amount of option reve-
TLLt\c                          nues generated. However, in a disruption, the government forgoes reve-
LqUL                            nue to the extent that firms exercise options contracts with prices under
                                the disruption price. For example, if firms exercise $30 options and the

                                Page 26                            GAO/RCED-89-103   Alternative   Financing   Methods
                 Appendix II
                 Revenue Raising Altemativfs

                 market price of oil rises to $36, the government forgoes $5 per barrel
                 that it would have received had options not been sold.

O!her Concerns   Options would not raise enough money to be an adequate revenue source
                 for filling the SPR. Furthermore, options would have an impact on own-
                 ership, control, and drawdown. However, some authorities think that
                 options constitute good energy policy because they would make a
                 drawdown more automatic and perhaps quicker in the event of a disrup-
                 tion. But before selling options, the government would need to specify
                 the number of options to be sold and their exercise price.

                 Page 26                           GAO/RCED-89-103   Alternative   Financing   Methods
Aphendix ‘III

Alternative Ways of Acquiring Oil

                         These proposals address means of obtaining oil for the SPR rather than
                         raising revenue. We have identified two major categories of ways to
                         acquire oil other than through outright purchases. The proposals include
                         renting or leasing oil (usually from the private sector) and obtaining it
                         through compulsory or induced private contributions.

                         Several proposals would allow the government to obtain oil reserves
Renting or Leasing       through lease arrangements with private firms or a state government.

                         A lease is a contractual agreement that grants the use of property, such
                         as land, equipment, or facilities, for a specified period of time in
                         exchange for a specified monetary payment. Although the proposals
                         evaluated are all specifically lease proposals, rental agreements would
                         operate in a similar manner.

                         Under the proposals, the government would lease oil, or lease oil and
                         storage facilities. Each proposal would require the government to pay
                         an annual rent or lease fee in an amount that would be much smaller
                         than the cost of purchasing the same amount of oil outright. The propos-
                         als differ in terms of whether the oil would be stored on-site at the SPR
                         or off-site at private facilities, and the party from whom the govern-
  ,                      ment would lease the oil.

                         If the government is the lessor, it would control the oil during the lease
                         period. However, the government would not own the oil unless the oil
                         was purchased either at the end of the lease agreement period or at

                         The specific proposals are to lease

                     .   oil from private firms,
                     .   oil and storage facilities,
                     .   regional storage reserves, and/or
                     .   Alaskan state royalty oil.

TI/e Proposals           Oil from private firms. Under this proposal firms would lease oil to the
                         government for storage at the SPR. During a drawdown of the SPR, title to
                         the oil may be transferred to the government because it would have an
                         option to purchase the oil. Then the oil would be distributed as specified
                         in the SPR drawdown plan. The government would compensate the firms
                         for the oil at the prevailing market price for any oil so distributed.

                         page 27                             GAO/RCED-89-103   Alternative Financing Methods
                            Appendix III
                            Alternative  Ways of Acquiring   Ofl

                            Oil and Storage Facilities. A proposal has been made to allow the gov-
                            ernment to lease oil and storage space from the private sector. Under
                            this proposal, the government would request bids to lease oil and stor-
                            age space for a specific period of time. The government would have the
                            option to purchase some or all of the oil in subsequent years, This option
                            could be exercised either during an oil disruption or when the lease was
                            about to expire.

                            Regional Storage Reserves. This proposal would establish regional stor-
                            age reserves for the SPR by leasing stored crude oil and possibly other
                            petroleum products. The reserves would be geographically dispersed in
                            patterns similar to the demand for oil. This approach might better utilize
                            existing storage capability, encourage development of new oil storage
                            capacity, and facilitate distribution at the user level.

                            Alaskan State Royalty Oil. Under this proposal the state of Alaska
                            would provide oil to the SPR under a lease arrangement. The oil would
                            come from a portion of the royalty oil the state receives from North
                            Slope production. The lease agreement would allow the state to claim
                            the world market price for the oil from the federal government at some
                            specified future date or at SPR drawdown, whichever occurs first.

G{wernment’s Oil            The government’s oil acquisition costs would be lower in the short term
Akquisition and Financing   and higher in the long term using lease arrangements. Firms will charge
                            the government rent or lease rates that cover their costs and provide
c+sts                       them with an acceptable rate of return. Their costs include their cost of
  !                         capital, which is typically higher than that of the government. These
  /                         proposals would lead to the government paying disruption prices for the
                            oil if the government wishes to be the distributor of oil during a disrup-
                            tion. However, government purchase would not necessarily be needed                           b
                            since the oil could simply be returned to the owners, which could have
                            the same effect of getting the oil back on the market,

                            Costs of above-ground storage are usually higher than those of storage
                            in caverns, such as those used by the SPR. Estimates on the costs of the
                            regional storage proposal were not provided.

                            Government financing costs are reduced to the extent that expenditures
                            for SPR oil are avoided or postponed.

                            Page 29                                GAO/RCED-89-103   Alternative   Financing   Methods
                           Appendix J.II
                           Alternative Ways of Acquiring   Oil

Effects on the Budget      Leasing and rental arrangements would reduce the deficit initially
IMficit and the National   because rental costs are less than the purchase price of oil. In the long
                           term, however, the national debt would probably get larger than under
Debt                       the current funding process because private firms will probably incorpo-
                           rate their profit margin into the lease rates. Over time this would cause
                           the government to pay out more money than if the oil were purchased
                           outright. If the government purchases the oil during a disruption, this
                           could increase the budget deficit. However, government purchase of the
                           oil is not necessary for its distribution because the oil’s owners could
                           simply reclaim full control and make distribution themselves. Therefore,
                           there need not be a large increase in the budget deficit for the year in
                           which a disruption occurs.

Otper Concerns             Drawdown might be complicated by the question of whose oil-the gov-
                           ernment’s or the lessor’s -comes out first, unless this is decided at the
                           time of the lease or the government purchases the oil at drawdown.

                           In addition, frequent withdrawal of oil from SPR facilities, as suggested
                           under one proposal, was not contemplated when the SPR facilities were
                           designed. The SPR salt caverns (the present storage facilities) can handle
                           only a limited number of large withdrawals of oil without damaging the
                           caverns. Such damage could result in the contamination or loss of oil.

                           Another concern is the ready availability for sale and distribution of oil
                           stored off-site from the SPR. The government would have to assure itself
                           that private firms storing oil away from SPR sites did not regard the
                           leased oil as part of their normal operating stock. If this oil were, in
                           effect, part of normal operating stocks, total United States emergency
                           reserves would not be increased.
                           Various proposals have been made to either require or induce private
Compulsory or              companies (usually oil companies) to contribute oil to the SPR. These pro-
Induced Private            posals fall into two groups: mandatory contributions and induced
Cbntributions              contributions.


T{irt Proposals            Mandatory Contributions. Mandatory proposals are those that require
                           oil companies to store oil either in the SPR or in company facilities where
 /                         the government would control the oil. Three mandatory proposals have
                           been made, including one in the original SPR enabling legislation. Some

                           Page 29                               GAO/RCED-39-103   Alternative   Financing   Methods
     Appendix III
     Alternative  Ways of Acquiring   Oil

     argue that mandated contributions could be required by the Congress as
     a condition of doing business for oil companies, refineries, and

     The first proposal would require private oil importers that import more
     than 75,000 barrels of crude oil per day during a calendar year to con-
     tribute oil to the SPR. The specific contribution would be equal to about 5
     days of the company’s imports, to be computed by averaging its imports
     for the calendar year. Importers of petroleum products are not included.
     Under this proposal, the government would pay importers for 11 years
     an annual fee-equal to 10 percent of the oil’s purchase price. The pur-
     chase price cannot exceed the average world price at the time of pur-
     chase. If a drawdown occurs, the government would sell the oil and use
     the proceeds to pay each importer the then-current average world mar-
     ket price of oil minus whatever payments the importer has already
     received. But the total government payments could not exceed the aver-
     age world market price for the 3 months immediately preceding the date
     of distribution.

     A second proposal is to use the authority under the Energy Policy and
     Conservation Act of 1975 (section 156 (b)), to create an Industrial Petro-
     leum Reserve (IPR).’ The Secretary of Energy has authority to require
     petroleum refiners and importers to store up to 3 percent of the volume
     of oil they import or refine each year. The IPR is, in effect, an emergency
     private sector reserve-in excess of their normal operating require-
     ments-that     presumably would be segregated from normal operating
     stocks to facilitate monitoring. All firms would be required to provide
     evidence of sufficient storage to meet the requirements. The President
     would have the power to order that the IPR be drawn down, but title to
     the oil would be retained by the oil companies. Companies would bear
     the costs of this proposal and would presumably pass them on to                              b

     A third proposal is to require oil importers to provide petroleum prod-
     ucts, or the equivalent of petroleum products converted to crude, for
     storage in the SPR at a rate determined by the Secretary of Energy. The
     volume required would fill the SPR at an average rate of at least
     100,000 barrels per day during each fiscal year until the SPR has at least
     750 million barrels. Title to the oil is retained by the importer and, if
     drawdown occurs, the government is to pay each importer the amount
     received from the sale of the oil in the order that the oil is sold. The

     ‘42 17X 6236(b).

     Page 30                                GAO/RCED-99-103   Alternative   Financing   Methods
                            Alternative Ways of Acquiring   Oil

                            government would assess and collect storage charges from each
                            importer that stores oil in the SPR.

                            Induced Contributions. Our definition of an induced contribution is one
                            in which an incentive is given that will make either an oil company or
                            another investor want to store oil for/or in the SPR. We have limited this
                            category to noncash incentives. Inducements that involve cash pay-
                            ments, such as rent or lease proposals, are discussed above.

                            The first proposal is to trade existing government SPR oil and the right to
                            receive the government’s future sales price for that oil in exchange for
                            private investors filling the SPR. Under this proposal, individuals or com-
                            panies willing to store a barrel of oil in the SPR would receive vouchers
                            (or some kind of negotiable instrument) for government-owned oil. For
                            example, the investors could receive two barrels of existing SPR oil-
                            after a specific period or earlier in the event of drawdown-in     return
                            for every barrel they stored there. The number of barrels to which the
                            voucher holder would be entitled could be determined at auction. The
                            government would control the oil for a specified period, such as ‘25
                            years, or until drawdown. However, private parties would own the
                            voucher oil and any oil that they stored to obtain it.

                            Another proposal is to give oil companies, or other entities, tax incen-
                            tives in return for contributions of oil to the SPR. Tax incentives include
                            changes allowed in an oil company’s accounting system that will reduce
                            the taxable profits of the company, such as the method used to deter-
                            mine the value of a company’s inventory. Tax incentives also can be
      I                     structured so that reductions could be made directly to a company’s tax-
                            able income in return for oil stored in the SPR. Unless structured other-
                            wise, the company storing oil in the SPR would retain ownership, and the
                            government would control the oil through drawdown.                                            b

G( vernment’s Oil           Under the first mandatory proposal, the government’s oil acquisition
A quisition and Financing   costs are likely to be less, if drawdown does not occur, because the value
                            of the 11 annual payments discounted at the government’s borrowing
ccf sts                     cost is less than the market price for oil. Eleven annual payments of 10
                            percent amortize the oil purchased at an interest rate of about 1.6 per-
                            cent, while the government’s borrowing rate is about 9 percent. If a
                            drawdown occurs, the government may have to pay a higher price, if
                            world market prices during the period preceding the drawdown are
                            higher than those prevailing at the time the oil was acquired.

                            Page 31                                    GAO/RCED-89-103Alternative   Financing   Methods

                         Appendix IIl
                         Alternative  Waye of Acquiring   Oil

                         For the second and third mandatory proposals, the government’s oil
                         acquisition costs are zero because industry contributes oil directly to the
                         SPR. There may be tax revenue losses if companies are able to deduct
                         costs associated with their contributions.

                         Under the first induced proposal (the voucher proposal), the govern-
                         ment has no direct oil acquisition costs. However, it pays for oil by giv-
                         ing up its future revenues on oil already in the SPR.

                         Under the tax incentive proposal, the government will receive less tax
                         revenue from companies that contribute oil to the SPR. However, there
                         could be an even greater reduction in expenditures since the government
                         would not be purchasing the oil.

                         For all of these proposals, the government’s financing costs are reduced
                         to the extent that government expenditures for the acquisition of SPR oil
                         are avoided or postponed.

ects on the Budget and   For the first mandatory proposal, the deficit is reduced in the short term
 National Debt           because the annual payment to the importers is less than the cost of
                         direct payment for the oil in one year. Over the longer run, as pointed
                         out above, the impact depends upon the occurrence of a drawdown and
                         the price of oil at that time.

                         The deficit also is reduced for the second and third mandatory propos-
                         als. This is because the firms-not the government-would       bear the
                         costs of providing additional oil reserves. This could have an impact on
                         future deficits if these firms reduce their taxable income by the value of
                         oil they hold in the reserve. However, government revenues would not
                         be reduced by as much as the government would have spent in buying                           b
                         the same quantity of oil.

                         For the voucher proposal, the deficit is reduced by the amount the gov-
                         ernment would otherwise have had to spend to acquire the oil deposited
                         in the reserve. However, potential revenues from the sale of the govern-
                         ment’s oil that could be used to reduce future budget deficits are forgone
                         by the government. This would be a “loss” to the government in the
                         sense that, if the government owned the oil it would get the high price
                         at disruption.

                         For the tax incentive proposal, the deficit would be reduced to the
                         extent the tax incentives reduce the need for government oil purchases,

                         Page 32                                GAO/RCED-89-103   Alternative   Financing   Methods

                 Appendix III
                 Altematlve   Ways of Acquiring   Oil

                 but increased by the amount of the tax revenue forgone in encouraging
                 private firms to hold strategic stocks. The net effect is likely to be a
                 reduction in the deficit since the reduction against taxable income would
                 probably not be equal to costs avoided by the government’s not purchas-
                 ing the oil.

Other Concerns   Depending upon terms of the various agreements, there may be ques-
                 tions about whose oil comes out first when the oil in the reserve is not
                 wholly owned by the government. Agreement with the other parties
                 involved could be reached at the outset to avoid questions.

                 Mandatory proposals raise a legal issue about whether the Congress can
                 require oil contributions, One view is that mandatory contributions
                 could be instituted under the Congress’ powers over interstate com-
                 merce as set forth in article I, section 8, of the Constitution, and would
                 require no compensation, Another view regards mandatory contribu-
                 tions as a “taking,” which would require government payment for the

                 The private sector would retain title to any oil that they place in the SPR.
                 This creates a concern that private owners would realize large profits.
                 Such profits could be expected to result from the expected increase in oil
                 prices in the event of a disruption.

                 Page 33                                GAO/RCED-89-103   Alternative   Financing   Methods
Appendix IV

Establishmentof a SeparateSPREntity                                                                    ,6

                Proposals have been made to establish the SPR as a separate entity. Sep-
                arate entities are sometimes created when the government undertakes
                business-like activities that generate revenues by selling products or ser-
                vices and help finance their expenditures primarily by such receipts.
                Some such entities, the Tennessee Valley Authority, for example, are on
                budget; some, such as the Federal National Mortgage Association, are off
                budget. Whether or not an entity is on or off budget is established by
                law. Generally those entities not included in the federal budget (off
                budget) are government-sponsored, but privately owned and financed.
                An SPR entity could be either on budget or off budget.

                For the SPR, two types of separate entities have been proposed, a govern-
The Proposals   ment corporation and a trust.l For purposes of operating the SPR as a
                separate entity, the distinction between the two is slight. A government
                corporation could take over the operation and management of the SPR, as
                well as the financing of oil purchases. A trust would be primarily con-
                cerned with financing oil purchases by selling bonds or stock. Essen-
                tially, a separate SPR entity could pursue many of the alternatives
                discussed in appendixes II and III. Any alternative used by a separate,
                on-budget entity would affect the government in the same way as previ-
                ously described.

                An SPR entity could use a variety of ways to acquire additional SPR oil
                and facilities or to fund its operations. For example, if the entity owns
                the SPR facilities and the government retains title to the oil, the entity
                could charge the government an oil storage fee. Also, an entity could use
                additional Treasury debt if it borrowed through the FFB, as discussed in
                appendix II.

                Revenue for the operations of an SPR entity could come from any of the                                   b
                alternatives discussed in appendix II. For example, a separate entity
                could sell bonds, which would resemble agency bonds. Like most agency
                bonds, they would probably carry a higher rate of interest than Trea-
                sury debt. Also, an entity could sell equity certificates, that is beneficial
                ownership of SPR oil. In this case, the SPR entity might be exchanging
                future profits, which might occur when oil prices rise, for current reve-
                nue to buy oil.

                ‘A trust, as used here, means an entity with the power to undertake financial transactions on behalf
                of another person or institution, in this case, the SPR. The Treasury also maintains separate receipt,
                expenditure, and revolving fund accounts, usually called Trust Fund Accounts; these are not referred
                to here.

                Page 34                                         GAO/RCED-89-103      Alternative   Financing   Methods

                            Appendix IV
                            EetablWment     of a Separate   SPR Entity

                            The separate entity proposals that we analyzed did not discuss how the
                            entity would purchase oil. One natural method would be through
                            purchases at market prices. Other methods, such as those discussed in
                            appendix III, are possible. These include renting or leasing, or compul-
                            sory or induced private sector contributions.                            f’

Government’s Oil            The Congress could create an off budget SPK entity to purchase oil and
Acquisition and Financing   arrange financing.2 In theory, the entity might be able to operate more
                            efficiently than the government (that is, buy oil more cheaply). How-
Cot;ts                      ever, its financing costs, as mentioned above, would be higher than
                            those of the government.

Effects on the Budget and   If the expenditures of the SPR entity were off budget, this arrangement
the National Debt           would reduce reported government expenditures and, therefore, the
                            budget deficit, Even if the entity were off budget, the government could
                            incur on-budget expenses. As discussed before, these expenses could
                            include payments for storage services or additional interest as a result
                            of Treasury borrowing. Such expenditures are likely to be less in the
                            long term than those of outright purchases of SPR oil through appropria-
                            tion However, in the event of a disruption, the budget would not reflect
                            revenues from the sale of SPR oil.

                            Diverting revenues to the SPR entity from other on-budget uses would
                            increase the budget deficit unless those other uses were simultaneously
                            eliminated. Further, there would be a capital loss from transferring the
                            assets to the separate entity.

                            Bonds issued by an off-budget SPR entity would probably not count as
                            part of the national debt. But with the possible exception of indexed                                   b
                            bonds as described in appendix II, this debt would probably carry a
                            higher rate of interest than conventional Treasury debt of comparable
                            maturity. These bonds could be viewed as having less security than the
                            full faith and credit of the U.S. government. Nevertheless, when such an
                            SPR entity issued debt, the government would probably incur some sort
                            of contingent liability, whether the debt technically counted as part of
                            the national debt or not. As a result, the interest rate spread between
                            these bonds and comparable Treasury bonds would likely be small.

                            2The Balanced Budget and Emergency Deficit Control Act of 1986 prohibits most government outlays
                            from being off budget, i.e., excluded from the budget totals. The Congress could either amend the act
                            or pass other legislation allowing an SPR entity to be off budget.

                            Page 36                                        GAO/RCED-fB-103      Alternative   Financing   Methods
                 Appendix Iv
                 EstablUment   of a Separate   SPR Entity

Other Concerns    The formation of an SPR entity could raise issues of control in an emer-
                  gency if the entity is free to make decisions about the timing and quan-
                 tity of oil distribution. These issues could, of course, be addressed at the
                  time the entity is established. Also, if equity, either in the form of certif-
                  icates of beneficial ownership in SPR oil or stock in the entity itself, were
                  sold to the private sector, this action would transfer the financial bene-
                  fits of oil price escalation from the government to members of the

                 Page 36                                    GAO/RCED-89-103   Alternative   Financing   Methods

Appendix V

Major Contributors to This Report

R$sources,              Flora H. Milans, Associate Director, Energy Issues (202-376-9715)
@rununity, and          Richard A. Hale, Assistant Director
                        Ja.y R. Cherlow, Assistant Director, Economic Analysis
Edonomic                Donna M. Lucas, Evaluator-in-Charge
Development Division,   Carrie M. Stevens, Evaluator
Washington, DC.         Molly MacLeod, Reports Analyst

(001HOPi)               Page 37                           GAO/RCED-S9-103   Alternative   Financing   Methods