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The Pentagon's Fuel Fiefdom

The front page of The Washington Post can be a heady brew, especially when it has words like "slush fund" in the headlines. But then add in the byline "Bob Woodward," and you may have a recipe for hearings, investigations, and new legislation. But is the May 21st Post article about the Pentagon's fuel purchases maybe more tempest in a teapot than teapot dome? You be the judge.

The Department of Defense is one of the single largest fuel consumers in the world, if not the largest. DoD slurps down about 4 billion gallons of fuel every year, comparable to the entire nation of Portugal. On the other hand, the word "single" in that first sentence is important: DoD accounts for 2% of domestic petroleum consumption, meaning someone else consumes the other 98%. That includes individual consumers -- you, if you drive a car -- as well as institutional consumers, such as agribusinesses, Fedex, Walmart, and airlines. Indeed, the the U.S. airline industry consumed 17 billion gallons in 2016. So, it's a great deal of fuel, for a single "company," but it's a small part of our overall national consumption.

The fuel bill for 4 billion gallons can run pretty high -- it ranges from $10 billion to $20 billion per year, depending on market prices. I know! That seems like a TON of money!  But keep in mind that the Pentagon's total base budget is $500 billion, and since 2001, there have also been supplemental appropriations to pay for military operations (that's right: $500 billion does not actually cover the cost of fighting a war, only being ready to fight). So, fuel accounts for about 3% of the base budget.

Now, the way government works, defense offices have to prepare their annual budgets 18 months or more before they actually get the money -- if they actually do get the money in this era of continuing resolutions. It is not easy guessing what oil prices are going to be two years in advance, and especially in the last decade, when prices have been especially volatile and unpredictable. The Office of Management and Budget does its best, however, to give the Pentagon an accurate guess to use in their budget proposal. Or at least, I think they do their best. I have filed two Freedom of Information Act requests asking for information as to how OMB estimates fuel prices, but they have denied both requests on what I consider specious grounds. I could sue for the information, but I don't want to know that badly. 

Each of the military departments is responsible for requesting the amount of fuel they think they're going to use. GAO has criticized these estimates, which DoD agreed to improve for this budget cycle, so we'll see. But the actual buying and moving of all that fuel is centrally managed. DoD's Comptroller runs a working capital fund, which pays for all the fuel for all the Department of Defense (and a few other governmental customers). Then the Comptroller sets a "standard price" for fuel, which it will charge all of the military departments, and the Defense Logistics Agency-Energy actually procures and moves the fuel. The intent is to insulate military customers from volatility within a given year or in different places (you may pay a different price for fuel in Kuwait or Korea) and to standardize the way the Department buys this jointly-used commodity. The price includes some other expenses, such as the cost of transporting fuel. I believe it may also include a premium to make up the difference between West Texas Intermediate and Brent prices -- those two market prices historically tracked closely, but at times in the last decade, they've spread as far as $23 apart. My understanding is that OMB uses WTI for their estimates (again, how would I know since OMB is secret fortress), but DoD buys most of its fuel at Brent prices.

Okay, here's the heart of the matter: DoD gets it wrong sometimes. Sometimes, the amount of money the Pentagon  requests for fuel is too much or too little because they haven't fully anticipated the volatility in the market, and sometimes the military departments don't anticipate well how much fuel they're going to consume. There is nothing nefarious about that -- no one does a perfect job of predicting the volatility of the oil market or what missions the President might ask the armed forces to undertake in any given year. For energy markets, there's an entire industry of prognosticators and risk hedges out there precisely for that reason. Theoretically, there should be enough money in the Working Capital Fund to cover volatility, but with really sharp spikes and dips, the Comptroller may need to either cover the gap by moving funds around from other defense accounts, or raise or lower the standard price for fuel and push the military departments to cover the gap. If the gap is really wide, or the adjustment comes late in the year when there's less flexibility, they may have to put fuel in a supplemental budget request. That's appropriate: much of the fuel DoD uses in any given year is going directly to warfighting, which is what the supplementals pay for. 

But let's be clear: the Comptroller can't just go into a back room and exchange sacks of money with shady guys in trenchcoats. These "reprogramming requests" to shift funds around have to be formally submitted to Congress, and they are heavily scrutinized (a friend on the Hill says four different committees have to approve reprogramming requests). The Post article says the Department has needed to move around $6 billion in the last 7 years -- it's actually more than that over a longer time period, though it's only in the last 7 years that prices have been lower than anticipated. Again, I know that sounds like a TON of money, but we are talking about a $10-$20 billion annual fuel bill and a $500-$700 billion total budget. Oh, and by the way, the global oil trade is 98 million barrels every day, which is about $5 trillion, just to give you a sense of how far outside the control of the Pentagon the price of oil is. There's a lot of scale, here. And it's not like this money is evaporating into thin air or being spent on building someone's private villa -- it's just being shifted between programs. Now, you may think some of those programs are a waste of money, or some of the missions that consumed the fuel are not things the United States should be doing, but that's very different from saying this is a slush fund.

Just one last thing... There have been many reports calling on the Department to improve the way it buys fuel, including a study from the Defense Business Board advising the Department to "price hedge" (i.e., basically buy an insurance policy against the risk of price volatility). Many companies price hedge -- it's a common strategy for managing uncertainty. But frankly, the Pentagon's risk exposure isn't all that high, here -- why should they pay a private bank tens of millions of dollars to hedge for them, when they have a big enough budget to absorb these price swings, the U.S. Treasury to back them up, and the U.S. Congress to approve supplemental appropriations if they're really in a pinch? For another view on this, Business Executives for National Security (BENS) did a study on how DoD could improve the way it buys fuel. They found, to their surprise, that DoD actually does a good job already. You don't see that finding every day. This teapot is for you, BENS.