By Andy Hill and John Auers
(Spoiler alert!) Frank Underwood (D-SC) has held high political ambitions for many years. Using a ruthless political strategy, he ascended into the world’s most powerful office. Collecting political enemies (both red and blue alike) along the way, he has always been arguably successful in passing his agenda. To top it off, he did it all with the public only seeing his southern charm. Real life proponents of removing the restrictions on U.S. crude exports have not been nearly as successful in their quest; however, it’s not a fair comparison. The fictitious Underwood uses highly manipulative, arguably psychopathic behavior to advance his cause. The proponents of the export ban removal (most of whom are Republicans) are simply trying to pass a bill which President Obama won’t veto, and are handicapped by a rather disorganized caucus. Frank may have stated it best for the current crude export climate: “Proximity to power deludes some into thinking they wield it.” Republicans may have control of both the House and the Senate, and have even gotten buy-in from some oil state Democrats, but they have found that passing landmark legislation on crude export policy still remains out of reach. In today’s blog we examine some of the recent developments in the policy debate, and also look at the changes that have taken place in the crude supply/demand environment which are impacting the very dynamics behind the desire for policy change.
Evolving Congressional Efforts
The collective effort to pass a bill allowing oil exports has gained plenty of steam over the last year or two as the industry became increasingly worried that crude production gains might be constrained by the four-decade-old policy restricting exports. With the price crash which began in the second half of 2014, the perceived impact of the existing crude export policy lessened as producers cut budgets and crude production has begun to decline.
Despite this, proponents of policy change have continued to move forward, and even accelerated their efforts to remove the crude export restrictions. In fact the lower price environment has made it less politically risky for legislators to come out in favor of this controversial position. But this has not changed the strong opposition that President Obama and most Congressional Democrats have voiced in opposing the changes, supported in most cases by consumer, labor, environmental and certain refining entities.
Sen. Lisa Murkowski (R-AK) was one of the first strong proponents of changing crude export policy; at one point, publishing a white paper on the subject back in mid-2014. Since then, there has been much discussion and debate, within industry and U.S. politics. Even foreign countries have gotten involved, as consuming countries in both the EU and Asia have petitioned the U.S. for export policy liberalization, while producing countries express fear increased competition from U.S. exports. Intensity has stepped up a notch in the last couple months, and the House of Representatives passed a bill in early October to overturn the ban by a vote of 261-159. Although impressive, this margin still fell 29 votes shy of the 2/3ds majority necessary to override a promised veto by the President, and it does not appear that there is enough support for the 2/3rds majority in the Senate either.
With the House bill having little-to-no chance of becoming law, a last ditch effort was made in early November to attach it to the must-pass Federal Highway Spending Bill. While some analysts viewed it as a quality opportunity as the bill included provisions favorable to Democrats, the ban repeal amendment was killed on November 5th, and that probably was the last gasp for this session. While it appears unlikely that anything will happen during the next session due to election year politics, proponents still hold out hope that some “horse-trading” can be done, as opponents use it for bargaining purposes to force concessions on other policies (i.e., climate change, alternative fuels, etc.).
Other Pathways for Exports
While Obama’s threat of a veto has been enough to block the reality of a major legislative change, the Administration has allowed for some alternate and less comprehensive pathways for exports within the last 24 months.
First, batches of processed condensate were allowed to be exported by the Bureau of Industry and Security (BIS) in mid-2014. Since then, these exports have increased up to 120 MBPD, with Enterprise, Plains, BHP, Shell and BP all involved. The rationale given was that lightly processing the condensate changes its designation to an allowable “product” from a restricted “crude.” Although the volumes were relatively small, the industry gladly welcomed this news as it was seen as the first “crack in the wall” and could lead to more substantive changes.
Although this hasn’t happened yet as detailed earlier, a second pathway has recently been opened in the form of crude swaps with Mexico. Roughly 12 months after the condensate rulings, it was announced that some U.S. crude oil and condensate could be exchanged for heavy Mexican crude, which is routinely imported in significant volumes to the U.S. A swap of this type is provided for in current export policy as long as it meets certain criteria and is approved by the BIS through a specified application process. This is a strategic benefit for Mexico, as its refineries are better configured to run the lighter crude, and the country wants to boost gasoline production to meet growing demand, which is facilitated by a lighter crude slate. The initial approved volume of crude swaps are 75 MBPD, beginning in October, 2015, and continuing for 12 months, at which point the application will have to be revisited.
In addition to these relatively new pathways, export policy has provided for certain preapproved outlets for years. The most significant of these was exports to Canada, but also included limited volumes of California production, ANS crude using U.S. flagged vessels and some other minor avenues. Until the last couple of years, these were employed in only very limited situations, primarily some small volumes of cross-border crude going to Canada. As domestic production boomed, the Canadian outlet became a critical safety valve and has reached levels as high as 500 MBPD over the two years, as shown in Table 1 below:
The Changing Supply/Demand Environment
So what caused the crude export policy debate to become so hot? In two words, it was the LTO boom (okay, I cheated by using an acronym). It started just a few short years ago, and caused domestic production to climb ever faster from its trough in 2008. Initially, with significant volumes of light crude imports, it was simple enough for the growing volumes of LTO to just displace those barrels in refiners’ crude slates, and domestic crude prices retained their traditional premium to international prices, based on import parity. Eventually, as light crude imports disappeared, accelerating production of LTO began to outstrip refiners’ abilities to readily process those volumes, particularly the lightest barrels. With no export “relief valve,” and running out of options, producers were forced to discount the crude to incentivize refiners to displace cheaper, lower quality international grades, resulted in an ever widening “domestic discount.” Although refiners invested in some facilities to process additional volumes of the discounted domestic light crude, it was anticipated that if production continued to grow, the domestic discount would blow out to double digits when all ready homes in domestic or allowable export markets became exhausted. Thus producers sought export policy changes in anticipation of such an event, which they expected would cause them to have to significantly back down on production.
However, with the drop in crude prices over the past year, the environment has radically changed, as domestic production has fallen and the urgency for crude exports ban relief has gone away. The world crude market remains oversupplied and prices are anticipated to stay low for some time. The domestic discount has substantially gone away, and in fact LLS has traded above Brent for a significant amount of the time this year. Waterborne imports have actually increased, and in the near term, even if the ban on crude exports was lifted, we would not anticipate any significant increase in exports or shift in prices. Figure 2 below shows the roller coaster ride that U.S. crude production has taken, with the last year highlighted in the close-up.
Conclusion
While this issue may not be at the top of any of the political debates over the next 12 months, the removal of the crude export ban will continue to remain an important policy goal for producers. At the same time opponents will remain adamant in opposing any changes. At this point it does not appear that major changes will take place during the last part of Obama’s tenure, however, the political landscape after next November’s election could significantly change the dynamic. If we see a new party in the Oval Office, change could take place in short order, perhaps even before it happens through Congress due to the Executive Branch prerogative allowed within the current law. In our next blog, we will consider the implications of such a change, by providing a brief summary of our Crude Export Destinations study published in September, which looks at where U.S. light crude would go should export restrictions be relaxed.
Turner, Mason & Company is continually monitoring developments in the global petroleum markets and assessing how they will impact the industry. We utilize this analysis to assist both individual clients and also to develop reports and studies, which we provide on a multi-client basis. In our most recent study, we developed a comprehensive assessment and forecast of what can be expected in global markets and what those trends will mean for production levels, demand, prices, differentials and other key parameters. Earlier in this blog, we referenced the Western Canadian production forecasts from this study, The Evolving New World Order: Rebalancing Oil Supply in the Next Decade. The study contains significant detail and analysis of crude production and flows for all regions of the world. For more information about this publication or studies and other consulting services TM&C can provide, please visit our website or give us a call.