By: Ryan M. Couture and John Auers
In our blog two weeks ago (Nov. 17th – House of Cards), we discussed the changing political landscape that surrounds the crude export debate. While recent developments in Washington make it very unlikely that there will be any changes to the current policy banning crude oil exports (with a few specified exceptions) during the current legislative session, this debate will not go away. The fact remains that the Light Tight Oil (LTO) boom has drastically changed the market dynamics which led to the current policy in the first place, which does require a reexamination of that policy. Although the recent sharp drop in crude prices and decline in domestic production has decreased the imminent need to find foreign markets for U.S. LTO exports, that has not changed longer term supply/demand forecasts, which still expect that those outlets might be necessary, depending on an the level of future production growth and other key factors. In today’s blog we won’t get into the prospects for policy change or even the implications or economic impacts associated with the policy. Rather, we will attempt to answer the question of where U.S. crude imports would go if, indeed, all restrictions were removed.
There have been a number of studies released over the last couple of years which discuss the impacts of a change in crude export policy. These studies, which have been sponsored by both proponents and opponents of export liberalization, have assessed the impacts on crude production, both crude and gasoline prices, overall economic growth, jobs and a variety of other economic factors and indicators. What these studies have not addressed in any quantifiable manner has been where crude exports would go if restrictions were removed. This has not stopped advocates or politicians of one side or another of making speculative claims on this subject, generally to support their positions. Opponents of policy change have often claimed that U.S. crude would end up going to China, a geopolitical and economic rival, supporting their claims by China’s supposedly unquenchable thirst for crude oil. Instead of speculating, and to fill the void that previous studies have left on this subject, Turner, Mason & Company has recently performed a detailed quantitative evaluation to answer the question of on what destinations U.S. crude exports would likely end up if allowed, and published the results in a “White Paper.”
Slow Boat to…
Because of the quality of LTO and the appetite of U.S. refineries for heavier grades of crude, our analysis focused on exports of light crude, which would be the type of crude most likely to be in surplus in a production growth scenario. The rise in light crude production in the continental U.S. in recent years had brought total U.S. production above 9.5 MMBPD by mid-2015, an increase of over 90% from the low in 2008. While low prices have taken their toll and domestic crude production has begun to decline over the last few months, it remains above 9.0 MMBPD. As production grew, it created a mismatch, which at times severely depressed domestic crude prices relative to international benchmarks. The ability to export some light crude and in turn import additional heavy barrels, taking advantage of the higher values that light crudes yield on the market, is the impetus for the relaxation of crude export restrictions.
Based on the analysis of our report, we conclude that a majority of crude exported from the continental U.S. into an open market environment would stay in the Atlantic Basin. The crude would flow to refineries in Europe and Latin America. The primary factors driving U.S. exports into these markets revolve around compatibility with existing refinery configurations and replacement or alternative cost economics.
For the analyzed Atlantic Basin destinations, U.S. light crudes “fit” existing refinery configurations and are both cheaper and more efficient to transport to those markets than to markets farther away (primarily Asia). U.S. crudes make a good replacement for declining or stagnating production of similar types of regionally produced crudes in the North Sea, Africa and Latin America. Noneconomic factors, including geopolitical concerns, were also considered in our analysis and provide further support to our conclusions. The reality is, all the crude isn’t going to take “a slow boat to China.”
Across the Pond
U.S. LTO is the primary source of U.S. incremental crude production. U.S. refineries, after decades of investment, are better equipped to process heavier crudes than other worldwide refining centers. Because of this, any crude exports would be predominantly LTO. Refining centers in both Europe and Latin America are generally simpler facilities, designed to process lighter grades of crude. U.S. LTO “fits” well into those facilities. The limited U.S. exports today, to Canada (and most recently, Mexico), highlights this. Exports of U.S. LTO to these destinations is efficiently and economically displacing other less economic supply options.
While a region’s ability to process the crude is a critical factor, transportation costs also play an important role in determining the destinations. Due to the location of the largest LTO basins and existing pipeline infrastructure in place, U.S. LTO exports will almost exclusively come out of U.S. Gulf Coast ports. From the USGC, transportation costs to European and Latin American destinations vary from $1-3+/bbl. This is much lower than the $5-7/bbl to access the key Asian refining centers.
In addition to the cost, time also plays a role in determining where crude may end up. Crude in transit represents inventory that cannot be accessed, and longer delays can mean less flexibility for refiners. Transit time is much shorter, with most deliveries in under 20 days (and for areas in the Caribbean, only a few days), versus 30+ days to Asia. The “swing” producers in the Middle East have similar transportation advantages when selling to Asia as U.S. refiners do when selling to the Atlantic Basin, making it logical that Asia will continue to import crude from the Middle East.
Production Factors
Production from existing suppliers of light crude to the Atlantic Basin has been in decline in recent years. For Europe, North Sea production has been a key source of light, sweet crude supply for European and other Atlantic Basin refiners. Unfortunately, production has declined by more than 50% since 2000, at less than 3 MMBPD today. African production, another key source for European imports, has seen a decline of nearly 2 MMBPD since 2008. Major disruptions in Libya, coupled with declines in Algeria, Angola, Nigeria and Sudan/South Sudan have all contributed to the decline.
The decline in global crude prices can be expected to continue impacting supply. Costly deepwater African production will likely see deferrals or possible cancellation until the market improves. In Latin America, the decline in crude prices has also impacted projects. While overall production in Latin America has continued to rise in recent years, the production of light crude has generally declined, while their refining infrastructure remains dependent on volumes of light crude to maximize efficient operation.
What, Where and How
Comparing the quality and sources of crudes from various locations into Europe and Latin America by country and refining region, our analysis showed that as much as 1.7 MMBPD of U.S. crude exports would most profitably go to Europe and Latin America. Northeast Europe, the largest of the European refining regions, could absorb an estimated 1+ MMBPD of crude. Latin America has room for about 400 MBPD, while Mediterranean and Eastern European regions could process an additional 200+ MBPD. While the analysis does not mean all exports would go to these markets, the analysis shows these markets are economically advantaged versus alternate destinations.
When comparing those volumes to U.S. production forecasts, we do not see exports climbing to the 1.7 MMBPD level. Based on aggressive production forecasts we had in mid-2014 (before the price collapse), we forecast maximum U.S. production at 11.7 MMBPD in 2020. The result was <1 MMBPD of U.S. Lower 48 exports (ex. Canada) in 2020. Given the current price scenario, current forecasts are well below this.
Other Factors
In addition to crude matches and logistical drivers, there are a variety of other factors that further support U.S. crude movements into the Atlantic Basin. Geopolitical factors are important, especially the evolving and continuing tensions between NATO and Russia, which is the largest current supplier to NATO and other European countries. U.S. crude exports can serve as a critical alternate supply source, helping to offset some Russian barrels, thereby limiting their ability to pressure our allies. Currently, total Russian crude imports to Europe are over 3 MMBPD, nearly 1/3 of total crude imports to the region. A majority of these Russian barrels are light and could be replaced by U.S. LTO.
Potential U.S. crude exports are also a more secure source of supply to Europe than many other major suppliers. With conflict in Africa and the Middle East, disruptions to crude flow are common. Libya, Iraq, Nigeria and other producers have experienced sudden and prolonged outages due to local and regional conflicts. The U.S., on the other hand, is stable, with transparent markets and reliable supplies.
Israel could also benefit from U.S. access to crude. Since many Middle Eastern producers refuse to provide crude to Israel (with the exception of semi-autonomous Iraqi Kurdistan), U.S. LTO could play a part in supplying Israel’s 250 MBPD of crude imports.
Conclusion
The fear of U.S. crude sailing to Asia in the event of crude export liberalization is largely unfounded. While it is possible (and probable) that some cargoes will make their way there, a vast majority would work to supply Atlantic Basin refiners. China has become the world’s largest crude importer, but is also a major economic competitor to the U.S. The likelihood of China wanting to become even more dependent on the U.S. is unlikely. U.S. exports would only serve to strengthen the U.S. presence in the Atlantic Basin, providing stability to our allies while allowing U.S. oil markets to reach a new equilibrium. For a more detailed assessment, read our report U.S. Light Crude Oil Exports: Likely Destinations which can be found on our website.
Turner, Mason & Company is continually monitoring the global refining industry, to see how upstream developments may impact current and future trends and flows. We utilize this knowledge to assist both individual clients on specific projects as well as publish reports and studies which we provide on a multi-client basis. Our Outlook products take a look at crude and refined products developments over the next decade, while conducting an analysis of individual relevant industry topics. In addition, we recently developed a comprehensive assessment and forecast of what can be expected in global crude markets and what those trends will mean for production levels, demand, prices, differentials and other key parameters. The Evolving New World Order: Rebalancing Oil Supply in the Next Decade 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.