17th April 2014
Guinness Asset Management’s Tim Guinness makes the case for lifting the US ban on exporting crude oil.
A forty year old decree bans US producers from exporting crude oil, and it needs to be repealed. It represents misguided protectionism and is a hangover from the days before the US embraced free trade. We believe that exporting crude oil would not cause gasoline prices to rise, and would be a net economic benefit to the US as it incentivises the full development of the US shale resource.
This paper below outlines the key economic and political issues behind this hot topic in the energy world.
A forty year old decree (that was ineffectual at the time) may become damaging in the new US energy environment. The 1973 Oil Embargo by several Arab Nations reduced oil imports into major consuming countries and caused oil prices to more than triple between 1972 and 1974. The US was importing around 2m barrels/day of oil at the time, and Congress put in place a number of measures to reduce US exposure to global crude markets.
The measures were primarily focused on conservation, but also included a ban on crude oil exports, which came in to effect in 1975. Despite the new measures, US oil imports rose in the subsequent years to over 6m b/day before falling back to around 3m b/day in the mid 1980s. The low oil price in the second half of the 1980s tempted US consumers to increase their consumption, and twenty years later the US was importing over 10m b/day of crude oil: the largest oil importer in the world by a long way!
Here we are in 2014, almost forty years after the oil export ban was enacted, and the energy landscape of the US has changed again dramatically. US domestic oil production peaked in the early 1970s at over 9m b/day, then fell steadily, reaching 5m b/day in 2008. In the last few years, US domestic oil production has increased to over 8m b/day, and is likely to exceed 11m b/day by the end of the decade as a result of the development of shale oil.
Oil imports have fallen sharply as a result of greater production of light sweet crude oil from the new shale plays and weaker US demand. This rapid turnaround has caused the price of US domestic light sweet crude oils (such as West Texas Intermediate) to trade at a discount to international crude oils (such as Brent), and has raised the question of whether the US should repeal the export ban and start exporting crude oil, in order to defend domestic light sweet crude oil prices.
Despite importing nearly 8m b/day of oil, there is still a strong case for exporting some of the rapidly growing light sweet crude oil supplies, and continuing to import the medium crudes best suited for its refineries.
There are many different types of crude oil. Broadly speaking, crude oil is often referred to as being ‘light’ or ‘heavy’ (depending on its density), as well as being ‘sweet’ or ‘sour’ (reflecting the level of sulphur it contains). The new crude oil being produced from the shale developments is entirely ‘light’ and ‘sweet’; it is basically the same high quality as Brent crude oil (a light sweet blend of crude oil traded in the North Sea), West Texas Intermediate (the light sweet oil traded at Cushing, Oklahoma) or Louisiana Light Sweet (the light sweet crude oil traded at the US Gulf Coast in Louisiana).
As the US produces more light sweet crude oil, so it needs to import less of that blend. We expect domestic production of light sweet crude oil to exceed refinery demand at some point during 2014, so we could have a situation where the US is importing nearly 8m b/day of various crude oil blends (as required by the configuration of its refining capacity), yet the country is oversupplied with light sweet crude oil and needs to start exporting.
The pure volumetric issues are exacerbated by various logistical issues which would be overcome if the US exported crude oil. These issues could make a substantial difference to the future of the US energy market.
If oil is not exported, WTI prices could remain weaker than global crude oil benchmarks; the US oil industry will not generate sufficient cash flow to reinvest back into the shale plays for their full development. If the oil industry is starved of cash flow to reinvest (and its ‘shale bounty’ is not fully developed), total US oil production (and therefore GDP) would not reach its full potential. Oil industry jobs would likely be lost in this scenario.
We believe that this is an issue that the US ought to address now. We note that the WTI forward oil price in 2020 is only $77/bl, ostensibly because of fears of light sweet crude oil saturation in the country. At $77/bl, we believe that many of the non-core US oil shale plays are marginal in economic terms, and that existing producers will not generate enough cash flow (at those oil prices) to reinvest enough to fully develop their acreage.
The US refining system is just not set up to refine this volume of light sweet crude oil. The US has the biggest refining capacity in the world, and the refineries on the Gulf Coast represent the largest individual refining system.
Like crude oils, every refinery is slightly different and has been constructed to maximise the value of its products relative to the cost of its input blend of crude oils. The US refining system has been upgraded significantly over the last decade to improve its ability to consume heavy and sour crude oil that was expected to come from Canada, Mexico and Venezuela. Many of these refiners are now making small adjustments to their equipment to maximise their intake of the new cheap and easily available light, sweet WTI oil. To be fair, refiners do these kinds of adjustments on a daily basis to maximise refinery efficiencies anyway, but many years and many billions of dollars will be required to make the wholesale changes required to consume the volume of light sweet oil that the US could produce. So, while the US refining system is running at full capacity (and is exporting record levels of oil products to international markets), it is neither configured nor located correctly to reap the maximum benefits of the shale boom.
If it is not refined or exported, US light sweet oil must either be consumed or stockpiled.
Quite simply, the excess light sweet crude will go into storage if it is not exported, refined or consumed. We expect some of the excess light oil volumes to be consumed as a result of refinery configuration changes (as much as 1m b/d over the next three years or so) or potentially exported in small quantities with one-off export licences, but these will be small in the context of 2-3m b/day more light sweet oil production from the US over the next few years. Ultimately, inventories of light sweet crude oil could start to build from 2015, although if US oil product demand growth continues at the current run rate of 5%pa, the inventory build could be less than initially feared.
The logical economic outcome is that the export ban should be lifted. As we will explain, economic logic dictates that the ban should be lifted. However, we note that the decision to lift the ban will be impacted by political considerations as much as logical arguments. In our opinion, the key (and we believe unappreciated) point in this debate is that US domestic gasoline prices are more closely correlated to Brent oil prices than they are to WTI oil prices.
Exporting US light sweet crude oil into a global oil market (that can easily consume it) will have little net impact on gasoline prices. We are aware that this view contrasts directly with US public opinion that oil exports will cause higher gasoline prices, and that there has been some recent weakness in the gasoline price. We believe that the recent gasoline price weakness has been caused by temporary refining product slate issues, and that, on the basis that refined products continue to be exported, international gasoline prices will still be the principal medium-term price setter.
There are a number of very good reasons for lifting the crude oil export ban: Against this, there are some of the arguments as to why the ban should not be lifted. We list them below.
• Free trade
The ban is an impediment to free trade and to a wider free market. Exporting energy is good for the US economy and it would show the USA’s commitment to free and fair trade, strengthening its negotiating position on other trade issues.
• Limited effect on gasoline prices
Exporting light sweet oil into the international market will have little effect on international oil prices and international product prices (i.e. gasoline and diesel). US gasoline and diesel prices are unlikely to rise as a result
• Oil industry jobs are at risk
Not exporting could cause lower WTI prices and weaker E&P profitability, thus putting oil industry jobs at risk
• Capitalising on the shale legacy
Exporting would allow higher WTI oil prices with higher reinvestment levels into the shale plays bringing stronger oil production growth and positive US economic effects
• Why differentiate in oil?
The US is already exporting oil products and is planning to export large quantities of LNG, so why should the export of crude oil be any different?
• Higher gasoline price
The broadly held view of the US public (incorrect in our opinion) is that gasoline prices will rise if the US exports its crude oil
• Insufficient political will
There are more oil-consuming states than there are oil-producing states so there is unlikely to be a political majority towards action that might in due course raise domestic oil prices, especially during a mid-term election year
• Political sensitivity
US consumers (i.e. US voters) are very sensitive about the price of gasoline and any negative change to the status quo could be politically very damaging
• No public support
If job losses are feared due to higher oil prices then there may be political opposition.
• Pro ‘Big Oil’
A lifting of the ban would be seen as advantaging ‘Big Oil’ and would therefore be politically unpopular
The logical and obvious outcome is to lift the ban, as it benefits everyone. Logically, it makes sense to us that the US exports crude oil, as it is unlikely to cause higher gasoline prices and it will enable the full economic development of their shale resource. Logic also tells us that the export ban should be repealed soon, but we fear that political issues might delay its ultimate lifting.
Whether it is lifted or not, we expect to see a steady adjustment by the US oil industry (including both producers and refiners) and US lawmakers to relieve pressure in the system, prior to a time when it is politically palatable to lift the ban. Small scale one-off export approvals have started to happen in recent months, and we would expect to see more of these.
We note that the issue is gaining momentum in Congress, and also that the export ban can be repealed by the President on his own (i.e. without having to be discussed in Congress) as long as he deems it to be ‘in the national interest’.
The repeal of the export ban will be a hot topic in energy in 2014, and we have high confidence that the correct action will be taken to ensure that the US fully develops its windfall of shale oil, and that the US economy will benefit accordingly in terms of employment and balance of trade. When the market becomes satisfied that the issue has been resolved, we would expect WTI and LLS crude oil prices to reconnect with international crude oil prices, and for the energy sector to benefit accordingly as the issue is resolved and uncertainty is overcome.