Optimal Strategic Petroleum Reserve Policies: A Steady State Analysis

Shmuel S. Oren and Shao Hong Wan
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Shmuel S. Oren: Department of Industrial Engineering and Operations Research, University of California, Berkeley, California 94720
Shao Hong Wan: Department of Engineering-Economic Systems, Stanford University, Stanford, California 94305

Management Science, 1986, vol. 32, issue 1, 14-29

Abstract: A simple model is presented which allows us to determine the optimal size, fillup, and drawdown rates for a Strategic Petroleum Reserve (SPR) under a variety of supply and demand conditions. The optimal policy variables are determined by minimizing an analytic expression which we derive for the expected insecurity cost rate to the U.S. due to uncertainty in supply of imported oil. The oil market is modeled in terms of an elastic demand curve and two levels of supply which alternate according to a stationary, continuous time Markov process. The SPR policy is characterized by a fixed fillup rate up to the reserve's capacity, when supply is at its normal level, and a fixed drawdown rate during shortages. The insecurity cost rate being minimized includes consumer welfare loss due to price hikes, reserve holding cost and capital appreciation of the reserve. Base case results and sensitivity analysis are presented and compared to results obtained by previous approaches. These comparisons suggest that the proposed model can reasonably approximate the more computationally demanding stochastic dynamic programming formulation. The main advantage of the new approach is that it permits extensive sensitivity analysis which is important given the quality of the data.

Keywords: inventory/production: stochastic models; applications; dynamic programming: approximation (search for similar items in EconPapers)
Date: 1986
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