The Pros and Cons of Exporting US Crude Oil

• Calls for an end to the effective ban on exporting most crude oil produced in the US are based on a growing imbalance in domestic crude quality.
• At least recently, the ban has likely benefited refiners more than consumers. Assessing the impact of its repeal on energy security requires further study. 

Senator Lisa Murkowski (R-AK), the ranking member of the Senate Energy & Natural Resources Committee, issued a white paper earlier this month calling for an end to the current ban on US crude oil exports. Her characterization of existing regulations in this area as "antiquated" is spot on; the policy is a legacy of the 1970s Arab Oil Embargo. However, not everyone sees it the same way, either in Congress or the energy industry.

This isn't just a matter of politics, or of self-interest on the part of those benefiting from the current rules. Questions of economics and energy security must also be considered. The main reason these restrictions are still in place is that for much of the last three decades US oil production was declining. The main challenges for the US oil industry were slowing that decline while ensuring that US refineries were equipped to receive and process the increasingly heavy and "sour" (high sulfur) crudes available in the global market. The shale revolution has sharply reversed these trends in just a few years.

No one would suggest that the US has more oil than it needs. Despite the recent revival of production, the US still imported around 48% of its net crude oil requirements last year. Even when production reaches its previous high of 9.6 million barrels per day (MBD) as the Energy Information Agency now projects to occur by 2017, the country is still expected to import a net 38% of refinery inputs, or 25% of total liquid fuel supply. The US is a long way from becoming a net oil exporter.

The driving force behind the current interest in exporting US crude oil is quality, not quantity, coupled with logistics. If the shale deposits of North Dakota and Texas yielded oil of similar quality to what most US refineries have been configured to process optimally, exports would be unnecessary; US refiners would be willing to pay as much for the new production as any non-US buyer might. Instead, the new production is mainly what Senator Murkowski's report refers to as "LTO"--light tight oil. It's too good for the hardware in many US refineries to handle in large quantities, and for most that can process it, its better yield of transportation fuels doesn't justify as large a price premium as for international refineries with less complex equipment.

As a result, and with exports to most non-US destinations other than Canada or a few special exceptions effectively barred, US producers of LTO must discount it to sell it to domestic refiners. Based on recent oil prices and market differentials, producers might be able to earn as much as $5-10 per barrel more by exporting it. Meanwhile the refiners currently processing this oil are enjoying something of a buyer's market and are able to expand their margins. The export issue thus pits shale oil producers and large, integrated companies (those with both production and refining) such as ExxonMobil against independent refiners like Valero.

Producers are justified in claiming that these regulations penalize them and threaten their growth as available domestic refining capacity for LTO becomes saturated. Additional production is forced to compete mainly with other LTO production, rather than with imports and OPEC.

I believe producers are also largely correct that claims that crude exports would raise US refined product prices are mistaken. The US markets for gasoline, diesel fuel, jet fuel and other refined petroleum products have long been linked to global markets, with prices especially near the coasts generally moving in sync with global product prices, plus or minus freight costs. I participated in that trade myself in the 1980s and '90s. What's at stake here isn't so much pump prices for consumers as US refinery margins and utilization rates.

Petroleum product exports have become a major factor in US refining profitability, and refiners are reportedly investing and reconfiguring to enhance their export capabilities. This provides a hedge against tepid domestic demand. Nationally, refined products have become the largest US export sector and contributed to shrinking the US trade deficit to its lowest level in four years.  If prices for light tight oil rose to world levels US refineries might be unable to sustain their current export pace. It's up to policymakers to assess whether that risk is merely of concern to the shareholders of refining companies or a potential threat to US GDP and employment.

The quest to capture the "value added"--the difference between the value of manufactured products and raw materials--from petroleum production is not new. It helped motivate the creation of the integrated US oil companies more than a century ago and impelled national oil companies such as Saudi Aramco, Kuwait Petroleum Company, and Venezuela's PdVSA to purchase or buy into refineries in Europe, North America and Asia in the 1980s and '90s.

On the whole, OPEC's producers probably would have been better off investing in T-bills or the stock market, because the return on capital employed in refining has frequently averaged at or below the cost of capital over the last several decades. It's no accident most of the major oil companies have reduced their exposure to this sector. When today's US refiners argue that it is in the national interest to preserve the advantage that discounted LTO gives them they are swimming against the tide of oil industry history.

The energy security case for crude exports looks harder to make. An excellent article from the Associated Press quoted Michael Levi of the Council on Foreign Relations as saying, "It runs against the conventional wisdom about what oil security means. Something seems upside-down when we say energy security means producing oil and sending it somewhere else."  The argument hinges on whether allowing US crude exports would simultaneously promote more production and increase the pressure on global oil prices. That makes sense to me as a former crude oil and refined products trader, but it will be a harder sell to Senators, Members of Congress, and their constituencies back home.

The politics of exports may be easing somewhat, though, as a Senate vacancy in Montana could lead to a new Chair at Energy & Natural Resources who would be a natural partner for Senator Murkowski on this issue. (That shift may incidentally be part of a strategy to help Democrats retain control of the Senate.) Will that be enough to overcome election-year inertia and the populist arguments arrayed against it?

As for logistics, the administration could ease the pressure on producers without opening the export floodgates by exempting the oil output from the Bakken, Eagle Ford and other shale deposits from the Jones Act requirement to use only US-flag tankers between US ports. That could open up new domestic markets for today's light tight oil, while allowing Congress the time necessary to debate the complex and thorny export question.

Senator Murkowski wasn't alone in calling for an end to the oil export ban. In his annual State of American Energy speech presented the day as the Senator's remarks, Jack Gerard, CEO of the American Petroleum Institute, noted, "We should consider and review quickly the role of crude exports along with LNG exports and finished products exports, because of the advantages it creates for this country and job creation and in our balance of payments." In a similar address on Wednesday, the head of the US Chamber of Commerce stated, "I want to lift the ban. It's not going to happen overnight, but it's going to happen."  I'd wager he at least has the timing right.

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

The Future Energy Station Arrives

I was very interested to read that Valero, the largest independent refiner in the US, is designing its new gas stations to offer a much wider variety of energy products, including natural gas, E85 ethanol, and potentially recharging facilities for electric vehicles. This is an announcement I've been expecting for more than ten years, and there are good reasons why other companies are likely to follow. At the same time, the economics of doing this now, when the market for non-petroleum fuels is still comparatively small, look challenging. Some will call this a vanity project, and they won't be entirely wrong, even if it also represents the template for the new retail energy facilities that will be built in the next several decades.

Valero's new station design, at least as described in the articles I've seen, embodies the result of trends that my former company, Texaco Inc., identified in the late 1990s in a scenario called Multiple Choice Energy. That view included a combination of new vehicle technologies such as hybrids, EVs and fuel cells, as well as a vision of the retail network that would meet their needs. As attractive as the idea was to many of the top executives to which our team presented, it was a tough sell, because retail fuel is such a difficult business. Margins are slim, competition high, and major redesigns of existing facilities--for rebranding or any other purpose--very hard to justify financially. Several companies have dabbled with elements of this vision, including my former employer, but I'm not aware of anyone deploying the full suite of options in one location.

I think this development, and the company pushing it, is significant for several reasons. First, Valero has already made a major commitment to non-petroleum fuels through its acquisition of ten ethanol plants, bought during a period when the US ethanol industry was being squeezed by poor margins and scarce credit. Those facilities contributed 18% of Valero's operating income in the first quarter of this year, even though they accounted for less than 4% of total output by volume. Adding E85, a blend of 85% ethanol and 15% gasoline, at the company's new stations merely completes a supply chain in which it is already well-established.

Incorporating these capabilities when a station is built, rather than adding them later, is also crucial. It saves a significant amount of money by avoiding the business disruption involved in retrofitting later. E85 faces other challenges, as I discussed recently, but this kind of planning overcomes one of the major impediments to its wider penetration in the US market, which already has millions of flexible fuel vehicles capable of running on it. And for this reason it's especially notable that this initiative is being taken by Valero, which has been expanding its retail network and investing in new sites. That's in contrast to the major oil companies, some of which have been exiting retail, either gradually or on an area-by-area basis, to free up capital for more profitable opportunities in exploration and production.

Adding natural gas and electricity to the array of fuels sold at retail sites is a natural evolution of this strategy but financially much riskier, given the small number of EVs and NGVs on the road so far. Although the company can take advantage of generous tax credits for installing some of these capabilities, the return is likely to be low for some time. EV recharging also requires a large footprint and extra caution, to ensure that it can be done safely in proximity to combustible fuels. Local agencies and fire marshals have definite ideas about this, as I learned when I was involved in plans for recharging facilities for GM's earlier EV-1 plug-in vehicle in the late '90s.

As with the market penetration of the alternative fuel vehicles they will serve, it will be some time before most retail stations offer quite as much choice as Valero's new multi-fuel facility. It takes time to roll out such changes, and the infrastructure can't get too far ahead of the demand for it without its owners going bankrupt in the process. Nor will every new fuel succeed. Methanol blends looked like the next big thing in the 1980s, but they never took off. Still, it wouldn't take many such facilities in each market to break the "chicken-and-egg" barrier that any non-petroleum transportation energy alternative faces. The success of this initiative depends on the demand for these fuels actually materializing. Launching when the average US gasoline price is just a couple of cents below $4.00 looks like good timing to me.