By: Ryan M. Couture and John Auers
In December of 2015, just days before Christmas, U.S. producers got an early present with the lifting of the crude export ban. While it was a welcome change, it came too late for U.S. producers to really capitalize on it, at least immediately. With crude prices below $40 in December, the crude supply environment had changed, causing domestic production to decline, imports to increase and the domestic discount to disappear, along with the arbitrage to justify U.S. crude exports. This situation has persisted over the past few months, and although some cargoes have made their way into both the headlines and the hands of global refiners “testing the waters” despite the economics, the volumes have been small, with U.S. crude exports actually lower than they were pre-repeal. While U.S. producers have finally “caught the car,” making 2016 the first year in over four decades where exports can flow free, what will this really mean for both producers and refiners? Read on to find out some of our thoughts.
As U.S. crude production surged over the past few years and the prospects of a glut and impending “blowout” in the domestic crude price discount due to export restrictions became ever more likely, U.S. crude producers worked ever harder to get the export ban repealed. Politicians remained loathe to support the move, fearing that any move upward in gas prices would be blamed on the repeal, and ultimately on them. This was despite several studies that showed this to be quite the opposite (the “bathtub model”) and the fact that while crude exports may have been restricted, petroleum product exports were not, and thus were priced on the international market.
With the dramatic drop in prices, which disproportionately impacted the producers versus the refiners (we discussed some of the positive impacts low prices had on demand in previous blogs), coupled with the decades low fuel prices, politicians finally were able to come to an agreement. On December 18, 2015, the ban was officially lifted. But this came at a time when it was a day (or 18 months) late and a dollar (or five) short. Crude price deltas between Brent, LLS and WTI have narrowed considerably in the low price environment, and there is now little (and at times no) price differential between domestic and international crudes. When transportation costs are factored in, any advantage in most cases disappears. Even exports to Canada, the only “relief valve” for U.S. producers, began its decline when crude prices fell in late-2014, in part due to the falling price differentials making U.S. crude less attractive.
While economically there have been fewer opportunities for crude exports since the ban has been lifted, there have been some exports. Some of these economically-driven opportunities have been the shipments of crude to the Isla refinery in Curacao (operated by PDVSA). Venezuela has had increased demand for diluents to dilute their heavy crudes before export. Coupled with declining production of such crude, they have not had enough to both use as diluent and supply the Isla refinery. PDVSA has resorted to importing light crude to make up the difference. With the export ban lifted, U.S. light crude makes more economic sense than Russian Urals or African crudes which were the previous choice.
In September of 2015, Turner Mason published a whitepaper examining where crude exports would go should the export ban be lifted. At the time, we said that crude exports would stay primarily in the Atlantic Basin. Our conclusion was based on U.S. LTO exports “fitting” well into European and Latin American refineries, demand for diluents for Venezuelan and Colombian bitumen, and many “traditional” sources of light crude to the Atlantic Basin declining (North Sea production in long term decline, and African supplies unstable due to conflict and negative impacts due to low prices).
So far, that has largely been true. Over 2/3 of exports through March have stayed in the Atlantic Basin. Through March, exports to countries other than Canada averaged 134 MBPD. March saw a sharp uptick in exports, as prices helped to make them somewhat more attractive. March had 259 MBPD of exports, split between Asia/Pacific, Europe and Latin America.
The export volumes have been small, and are likely to remain so until U.S. production increases. In the lower price environment, refiners invested heavily to increase their throughput of domestic crude. The figure below shows a breakdown of investment by PADD. Nearly six billion dollars have been invested since 2012, with another billion of investment still planned. The sharp drop in oil prices has delayed some of these projects by several years, but we believe that many will ultimately be built when the market improves. This has created demand, and as production has fallen, helped to keep prices higher.
The low prices of the last year and a have had a sharp impact on U.S. crude production, and the ultimate future production numbers. With the “lower for longer” price forecast comes a “lower for longer” crude production forecast. When comparing our early-2014 production forecast to the latest EIA forecast in the figure below, what was once forecast to require upwards of 1.3 million BPD of crude exports will require no substantial exports over the baseline level of about 500 MBPD (including Canadian exports) which is what we are seeing now.
While we have discussed the volumes of crude currently being exported, we have not looked at what the actual economics are for these exports. When comparing the quality of WTI and Eagle Ford Condensate to the benchmark Brent crude for Europe, you see that Brent and WTI compare favorably, with Eagle Ford Condensate notably lighter and with a larger naphtha cut. Given these properties and using our refinery models for refineries in NW Europe and Italy, we looked at what the relative yield would be for each crude. Assuming shipping costs for Brent, WTI and Eagle Ford Condensate to NW Europe and Italy, we then calculated the differential between the two. Throughout 2015 and 2016 to date, U.S. crude remains “out of the money” in Europe, due in large part to the higher transportation costs ($1.75/bbl for Eagle Ford Condensate versus Brent and $4.25/bbl for WTI versus Brent). These higher transportation costs more than offset the slightly higher refining value for WTI. Eagle Ford Condensate which at times traded at a discount to WTI and Brent now trades at a premium.
Looking into the future(s) markets, we can see that in order for U.S. exports to flow to Europe, we need a discount large enough to cover the transportation differential. The futures markets for Brent – WTI from June 2016 show that the forecast differential does not reach these levels until 2021 and beyond. While the futures markets are hardly an accurate predictor of actual futures prices, it gives us a view that the financial markets do not see prices improving enough to support sustained European exports in the coming few years. The figure below shows some historic and projected futures prices for this differential.
Conclusion
While the lifting of the U.S. crude export ban appears a victory for the U.S. producers, its passage comes at a time where it has minimal impact on the industry as a whole. While prices slowly recover, until differentials increase enough to offset the increased transportation costs, we do not expect more than a base level of crude will be exported. In other words, until the car gets its wheels back (and we see higher crude prices), the dog’s prize doesn’t seem to hold as much value as it once did.
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. We will be releasing our latest Crude and Refined Products Outlook in mid-July which will cover in greater detail the factors, including the lifting of the crude export ban that will impact crude supply and prices. 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.