John Auers and Elizabeth Hilbourn
The year 1975 was a while ago, 42 years to be exact. In some ways, it was a tough year for OPEC as “Carlos the Jackal” led a deadly terrorist attack at their headquarters in Vienna and North Sea production began providing serious competition with the startup of the Forties pipeline; however, other developments in 1975 seemed to bode well for OPEC’s future. For one, production in the U.S., their biggest customer, was in the midst of steep decline, having fallen by over 1 million BPD since the beginning of the decade. 1975 was also the year that the U.S. enacted the Energy Policy and Conservation Act (EPCA), prohibiting the exports of crude oil (except in certain circumstances). At the time, it was certainly hard to imagine that U.S. produced crude oil would ever threaten OPEC dominance. Switching gears a bit, we would also like to point out that 1975 produced some major events in the world of entertainment. One of the most memorable was the release of perhaps the first true blockbuster film, “Jaws,” which ended up being the first movie to reach $100 million in U.S. box office sales. 1975 also saw the release of Bruce Springsteen’s third album, “Born To Run,” which is widely regarded as perhaps his best album and one of the greatest of all time. The title song from that album brings to mind the changes that have taken place in U.S. crude oil balances and trade dynamics since 1975. We will discuss these changes in today’s blog and explore how domestic crude might indeed be “Born to Run” and the destinations it might “Run” towards.
…We’ll run till we drop, Baby we’ll never go back
The Ups and Downs and Finally Ups of U.S. Crude Production
Since peaking at the end of 1970 at 10 million BPD, U.S. crude production entered a period of steady decline for almost four decades (excepting a temporary bump in the 80’s due to ANS start up). By 2008, it had fallen in half from the peak. But things were beginning to change, as high prices incentivized investment and technology breakthroughs allowed for wide scale production from previously uneconomic “tight” formations. This “Light Tight Oil” (LTO) revolution allowed U.S. production to jump by 90% over the next several years, with growth accelerating as upstream companies got better and better at extracting light hydrocarbons from various tight formations. By 2014, crude production growth was exceeding 100,000 BPD per month and forecasts were for even faster growth ahead; however, the success producers were having in producing LTO led to an oversupplied global market and a crash in oil prices beginning in mid-2014. Drilling activity fell dramatically and production declines soon followed, with U.S. crude output falling by over 1 million BPD from April 2015 through September 2016 (from over 9.6 million BPD to less than 8.6 million BPD). Despite a minimal recovery in oil prices, U.S. producers have continued to improve their ability to produce LTO and domestic production growth has returned to approach pre-crash levels, exceeding 9.3 million BPD in recent weeks. 
We, along with many other analysts, expect this growth to continue, even as oil prices remain well below previous highs. Even the Energy Information Administration (EIA) expects production to reach and exceed 10 million BPD in 2018. TM&C’s own current forecast has production reaching 12 million BPD over the next ten years, and we believe a sustainable era of domestic crude growth has arrived.
…Together we could break this trap
Crude Oil Exports – From Ban to Bonanza
The crude export “ban” was effectively irrelevant from the day it was enacted in 1975 through most of the next four decades, as the U.S. deficit in crude continued to grow. But the boom in LTO led to perhaps the most intensive lobbying effort the U.S. oil industry has ever been involved in as they attempted to remove it. They certainly had good reason to mount these efforts as U.S. refining industry was approaching its capacity limits for absorbing the light and very light barrels by 2013/14, resulting in large discounts for domestic crude. Thrown into the mix was the Jones Act, which essentially limited the flow of crude between U.S. ports, further constraining effective/accessible light refining capacity. The lobbying efforts paid off for the producers, first in a small way with the granting of licenses to export “processed condensate” in mid-2014 and ultimately with the “big win” as the entire crude export “ban” was overturned in December 2015.
While the lifting of export restrictions was a welcome relief to U.S. producers, it also came at a time when the initial impact was minimal. With U.S. production growth already slowing and about to enter a period of decline due to the price crash, the immediate need for the export outlet was minimal. In the first six months of 2016, total crude exports were only marginally above the pre-ban level in 2015 (480 MBPD vs. 465 MBPD) and even full year 2016 exports only exceeded the 2015 volume by 55 MBPD. Obviously, the vast majority of exports in 2015 were to Canada, the only major allowable exception to the “ban.” Canada continued to be by far the largest destination for exports post-ban in 2016, with total non-Canadian exports averaging only 219 MBPD.
Things have changed significantly in 2017 as resurgent U.S. crude production has led to a return of the domestic light crude surplus and a jump in exports. The first quarter of the year saw crude exports reach an average of 890 MBPD, with February setting a monthly record of over 1.1 million BPD. Exports to non-Canadian destinations averaged 618 MBPD, with the February total approaching 900 MBPD. Recently released April monthly figures and EIA weekly estimates show a continuing growth trend in U.S. crude exports. In April, total exports again exceeded 1 million BPD with movements to non-Canadian destinations averaging over 700 MBPD. Weekly data is certainly very volatile and highly dependent on the timing of outbound loadings, but May saw two more weeks with total crude exports exceeding 1 million BPD, including a record of over 1.3 million BPD in the week ended May 26. At these levels, the U.S. is exporting more crude than several OPEC members.
…`Cause tramps like us, baby we were born to run
The Market for U.S. Crude
As noted earlier, Canada was the only major exception to the crude export ban, so when U.S. light crude growth began to exceed accessible/economic domestic refining capacity, it became a very important “safety valve.” Eastern Canadian refineries are well suited to light crude (and unburdened by Jones Act rules) and volumes quickly increased rapidly from sub-50 MBPD levels prior to 2011 to an average of 427 MBPD in 2015. But the market in Eastern Canada is limited, and with the reversal of Enbridge’s Line 9 providing access to Western Canadian barrels, exports to Canada have declined to average just under 300 MPBD since the beginning of 2016. This is likely the sustainable market limit for the foreseeable future, subject to any major logistical, refining or regulatory changes.
In the early days of the post-ban period in 2016, most exports to non-Canadian destinations were “special situations” as declining U.S. crude production led to uneconomic arbitrage pricing. One of these situations was Venezuela’s shortage of light crude and need for diluent to blend with their heavy bitumen production. As a result, Curacao, where PDVSA operates a refinery, was the leading destination for non-Canadian exports during the first five months of 2015 (>50 MBPD). More recently Colombia has also imported some light U.S. crude to support their heavy crude production. A player that is notably absent from the Latin American countries that have received crude exports from the U.S. is Mexico, which, prior to the lifting of the ban, had obtained a waiver to import up to 100 MBPD of light crude.
Other special situations involved the “backhaul” of crude for various reasons (in at least one case, a tanker was headed to Asia for dry dock maintenance) and the purchase of “test cargoes” by refiners to see how different grades of U.S. crude “fit” into their refining systems. Most of these cargoes went to the large refining systems in Europe and Asia, with total U.S. crude exports to each continent averaging 85 MBPD and 105 MBPD from January 2016 through April 2017, respectively. The main destinations in these regions were The Netherlands and Italy in Europe and Singapore, Japan and South Korea in Asia.
As U.S. production has grown over the last several months, arbitrage economics have improved (a widening WTI discount vs. Brent) leading to the boom in crude exports, many of which are more directly driven by pure economics. A new player has also moved into the picture, China. In fact, China actually surpassed Canada as the leading destination for U.S. crude exports in both February and April, receiving over 300 MBPD in each of those months. Other new players have also entered the market as buyers for U.S. crude (notably the U.K, France, and the growing refining center of India), while the previously mentioned countries in Europe and Asia have increased their intake as well. A breakdown of U.S. crude export destinations during 2017 (through April) is shown in Figure 3 below:
So what happens next? How much U.S. crude will be exported and where will it go? It will certainly depend on a lot of factors (absolute price, OPEC actions, production costs, refined product demand, etc.), with the overall global supply, demand and price environment ultimately determining the answers. What we do know is that U.S. crude has become a key component in the global crude balance and unlike the situation in 1975; it will be an important competitor to OPEC and other crude producers for years to come.
Turner, Mason & Company follows and analyzes all the critical factors impacting global and regional oil markets. Changing patterns in crude flows is certainly one of the most dynamic developments that have taken place over the last few years, and we can expect continued changes over the next few years. Our analysis of these trade flows has become an important part of our overall consulting practice and our industry studies. We are currently in the process of preparing our next editions of the Crude and Refined Products Outlook (C&RPO) and the Worldwide Refinery Construction Outlook (WRCO), both of which are scheduled to be released in late July. An analysis and forecast of changing import/export patterns in the U.S. and globally will be an important part of these studies. More information on these publications and our other work involving oil industry developments and dynamics can be obtained by contacting either one of us, visiting our website at turnermason.com or calling Shanda Thomas at 214-754-0898.