Pentagon Oil Spending May Snarl Efforts to Trim $490 Billion

The U.S. military’s appetite for oil may snarl efforts to pare defense spending by about $490 billion in the next decade.

The Pentagon (USBODEFN), the world’s single largest consumer of energy excluding countries, spent $17.3 billion on petroleum in fiscal 2011, a 26 percent increase from $13.7 billion the previous year, according to Department of Defense data provided to Bloomberg Government.

World oil prices will average an estimated $145 a barrel in 2035 in 2010 dollars, up from between roughly $85 and $110, according to Energy Department statistics. Such an increase might force the military to dedicate more of its budget to fuel while still trying to cut total spending, said Russell Rumbaugh, a defense budget analyst.

“The oil prices will further exacerbate the defense spending cap,” said Rumbaugh, a co-director of the Stimson Center’s program on budgeting for foreign affairs and defense in Washington. “They’ll be in competition with other defense priorities, including procurement and paying soldiers.”

Rising oil prices accounted for the bulk of the Defense Department’s increased petroleum costs last year. The spending was the highest since at least fiscal 2005, the last year for which comparable data is available, according to the Pentagon. The costs represent about 2.5 percent of the department’s budget in fiscal 2011, which ended Sept. 30.

Source: U.S. Navy

Sailors aboard the Ticonderoga-class guided-missile cruiser USS Cowpens stand by after refueling at sea. Close

Sailors aboard the Ticonderoga-class guided-missile cruiser USS Cowpens stand by after refueling at sea.

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Source: U.S. Navy

Sailors aboard the Ticonderoga-class guided-missile cruiser USS Cowpens stand by after refueling at sea.

BP Plc (BP/), Europe’s second-largest oil company, was the top supplier of fuel to the Pentagon last year. The London company had defense contracts valued at $1.35 billion. The No. 2 supplier was Valero Energy Corp. (VLO) of San Antonio, with $905 million.

More With Less

The physical amount of petroleum purchased by the military rose 0.4 percent to about 117.0 million barrels from about 116.5 million barrels the previous year. That equates to an average price of about $148 a barrel in fiscal 2011 and about $118 a barrel in fiscal 2010.

“This is obviously at a time when the military is already making budget cuts,” Phil Flynn, an analyst at PFGBest in Chicago, said in an interview. “You’re asking the military to do more with less, and higher fuel costs are going to make that more difficult.”

In a budget proposal presented last month, Defense Secretary Leon Panetta said the department would try to cut $487 billion, or 8.5 percent, from the $5.62 trillion in spending that had been planned for 2012 to 2021.

Flynn said it was encouraging that the amount of petroleum purchased by the Defense Department didn’t rise materially last year.

Average Prices

“The growth was not significant,” he said. “Remember they were fighting two wars. They were fighting in Iraq and Afghanistan and, of course, we have troops all over the world. As we see a reduction in these troop levels, one would hope the demand would drop naturally.”

The military’s petroleum consumption is tied to its operations, Lieutenant Colonel Melinda Morgan, a Pentagon spokeswoman, said in an e-mail.

“The department’s efforts to improve our energy use are focused on increased military capabilities and effectiveness, not solely decreasing consumption through arbitrary targets at an enterprise level,” she said.

Average crude oil prices rose 19 percent to $95.11 a barrel on the New York Mercantile Exchange last year. Brent crude, the European benchmark, climbed 38 percent to an average of $110.91 a barrel on the London-based ICE Futures Europe exchange.

Oil for March delivery rose $1.50 to settle at $98.41 a barrel in New York yesterday.

Alternative Fuels

The Pentagon’s petroleum costs, mainly for jet fuel and diesel products, have tracked more closely with Brent crude prices because some of the petroleum is imported at European prices, said Tim Evans, an energy analyst at Citi Futures Perspective in New York.

While the Pentagon has been looking for other energy sources to reduce its vulnerability to petroleum prices, its spending for alternative fuels is dwarfed by the outlay for oil.

The military spent $21.6 million on alternative fuels, including biodiesel and fuel ethanol, last fiscal year, up 36 percent from $15.9 million in fiscal 2010. The Pentagon also is looking at animal fats, algae and seed oils.

‘Addicted to Oil’

“They are addicted to oil,” William Hartung, an analyst at the Center for International Policy, a Washington-based non- profit research group, said in an interview. There’s also a “substantial price premium” to move to alternatives, he said.

The Navy in December signed a $12 million contract to buy 450,000 gallons of fuel made from algae and used cooking oil. It was the largest biofuel purchase in U.S. government history, according to the Navy.

The Navy wants to derive 50 percent of its total energy from alternative sources by 2020, according to an agency website. The Air Force hopes by 2016 to get half of the fuel it uses for domestic flights from alternative sources.

The Defense Logistics Agency buys petroleum for the Defense Department. It then transfers or “sells” the fuel to military services at a price negotiated in advance, according to a 2009 Congressional Research Service report. This allows the Pentagon to take advantage of discounts for bulk purchases and usually provides the services with a stable price for that fiscal year, according to the report.

Price Fluctuations

Even so, this doesn’t shield the Defense Logistics Agency from oil price fluctuations, retired Air Force General Charles Wald, a director at New York-based Deloitte Services LP, said in an interview.

“It still pays the market price for oil,” said Wald, co- author of a 2009 Deloitte study on energy security and leader of the company’s Department of Defense practice.

The military pays for fuel from its operations and maintenance budget. If oil prices are higher than expected, the military may account for the increase by first cutting items within that budget, the Stimson Center’s Rumbaugh said. Those reductions might include limiting training hours for pilots or turning off the lights in gyms for a few extra hours each night, he said.

“There is a policy choice hidden behind those gas prices,” Rumbaugh said. “What’s more important to us -- having guys who are trained up or having stuff to use? If these fuel prices rise, we, as Americans, are going to face that choice more and more clearly.”

To contact the reporter on this story: Danielle Ivory in Washington at divory@bloomberg.net

To contact the editor responsible for this story: Stephanie Stoughton at sstoughton@bloomberg.net

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