The case for exporting crude oil

Looking over the numbers, and knowing the way the North American oil market works, it’s becoming increasingly apparent to me that current US crude oil production cannot be sustained unless the Department of Commerce begins to permit exports beyond Canada.

The surge in US crude oil production, led by Texas and North Dakota, which account for more than 45% of all domestic production, can only be sustained if there are new processing facilities — refining capacity or possibly condensate splitters to take care of the higher-gravity oil — a change in US refiners’ crude slate, or the final option, exports.

There is some new refining and splitting capacity being added which will consume about 750,000 b/d of light sweet crudes and condensates, according to industry estimates. (OPEC & IEA estimates are at 500,00 b/d but US sources say this excludes condensate splitting capacity, so if you add condensate splitting capacity, it would add another 250,000 b/d.) But this is not sufficient to meet the rapid growth of production of tight oil in Texas, North Dakota and in other parts of the US.

The crude slate for US refiners for the most part has been remained relative stable: medium sour crudes are the preferred grade. EIA data shows that the average specific gravity of crudes refined in the US have ranged consistently between 30.5-31.2 API since 2010. The surge in high gravity light sweet crude has not altered that.

This indicates there has not been a big move by refiners to switch to refining more light sweet crudes from North Dakota or Texas than previously. US refiners, with the exception of the US Northeast refiners, for years invested heavily in cokers, which require them to run medium and heavy crudes to benefit from the economics of those units. That doesn’t suddenly change just because the slate of crudes produced in the US has gotten lighter.

It is doubtful that US refiners in the short-term would shut their cokers and run light sweet crudes. Refining sources point out that most US refiners, even if they wanted to, particularly those with complex refining systems, do not have facilities to capture the Liquid Petroleum Gases (LPG) that are released while refining light sweet crudes. Currently, refiners without the means to refine light sweet crude tend to blend it with very heavy sour crudes from Canada or Latin America. But even blending has its limits.

So with those hindrances, what remains to encourage the continuous growth of US domestic crude oil production is for these crudes to be shipped beyond North America, that is, to permit exports.

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There are indications that refiners are starting to map out a possible resistance to easing the legislation that now bans crude exports to most markets. (Exceptions include shipments to Canada, which have been rising in recent months.)

But the restriction to export crude oil does not necessarily mean lower oil prices for local industries. While there are restrictions on the export of US crudes, there is no restriction on the export of refined products. (The irony of course is that refiners who may resist changing the crude export ban are benefiting from the free market in product exports.)

Refined product prices are a reflection of both domestic and international market fundamentals. US pump prices need to remain competitive with international markets, or refiners will export a growing amount of their output rather than suffer poor refining margins in the US domestic market.

So the belief of keeping US domestic crude within the country to lower domestic product prices is simply incorrect. Refined products like gasoline, diesel and jet fuel do not have export restrictions and thus will be attracted to where the best netback occurs. The crude that could not be exported could easily turn into products that can.

The notion is that US refiners will suffer as domestic crude prices rise. US refiners are market-oriented and do not depend solely on cost-advantaged domestic crudes to maintain their refining margins. US refiners benefit more from lower operating cost offered by lower natural gas prices and lower cost of producing hydrogen — necessary in numerous refinery applications — from natural gas streams than merely from cost-advantaged crudes. It must be borne in mind that the US still imports almost half of its crude oil needs. So the restrictions on crude oil exports act as a subsidy to US refiners.

Exports of US light sweet crudes will bring equilibrium to the oil markets and stabilize global markets. Whenever the Brent-WTI spread widens, US crudes will be arbitraged to markets based on the North Sea marker to capture Brent’s premium. In doing so, it would put downward pressure on the global crude oil benchmark.

Yes, the counter-argument would be that oil is a strategic commodity and has political and economic ramifications beyond oil itself. Natural gas produced in the US has a much greater impact on the operating cost of industries than does oil, but that hasn’t stopped the US from granting a growing number licenses to export limited quantities of natural gas in the form of LNG. (Though that hasn’t been without controversy either.)

What would change the debate would be if US crude oil production needs to rise to a level where domestic crude oil prices in the US start experiencing steep discounts in certain markets that discourage producers from hiking production and even shutting in existing production. Can the opponents of exports assume that production is going to be unaffected by an export ban in the face of sharp drops in differentials to world markets?

If the breakeven point of Bakken, WTI Midland and Eagle Ford Shale crudes are $60/b to $70/b, then with WTI at $94.50/b, there is a margin of $34.50-24.50/b. So if tight oil production continues to rise with no fresh outlets and discounts reaching the $24.50/b mark, we could see the first shut-in and shelving of future production. As the accompanying chart shows, markets have surpassed that differential at times.

Crude oil produced in the US —  a free market economy – should be free to attain market value and not be restricted in its quest to obtain the highest value it can.

platts