December 1, 2015
On October 9th 2015, the US House of Representatives passed, thanks to the Republicans’ votes, a bill lifting the oil export ban, which will have to be approved by the Senate, where the Republicans are the dominant force, in order to become law. The President’s signature will also be needed, but he is unwilling to back the bill, sharing the Democrats’ concerns that axing the export ban would increase fuel prices and make the American economy less competitive. He favours a gradual approach, which has been implemented for over a year now, issuing individual permits for export of condensate – minimally processed super-light crude oil (the ban applies to export of unprocessed crude), and the swapping of super-light tight oil for heavier Mexican crude. The debate on whether the ban should be maintained or lifted has been getting more and more heated over the recent year, and it seems that the camp in favour of axing the ban has gained new supporters, both in the US and outside it. The sentiment is also shared by the European Union, an importer of light crudes, which proposes that the move be part of the chapter on energy in the free trade agreement (otherwise known as the Transatlantic Trade and Investment Partnership or TTIP) currently being negotiated between the US and the European Union. The markets are expecting a decision to be made only after the US presidential election, due in early October 2016.
It should be remembered that despite an impressive upsurge in oil production in the US and reduced imports, crude consumption in the American economy still surpasses domestic supply by more than 30%. If the US is an importer of crude oil, and is set to remain one for a long time, who wants the export ban gone and why?
The ban was introduced in the mid-1970s with a view to curbing inflation which could follow in the wake of a sudden increase in the price of oil from OPEC countries, associated with an embargo on exports to the US and some Western European countries. Concerns were raised that American oil producers would start to sell their crude abroad, where prices were significantly higher, which would ultimately drive up the price of oil and, as a consequence, of fuels on the internal US market. Initially, the export ban also extended to fuels, which carried the same risk, but it was lifted in 1981, when crude oil became an exchange-traded commodity. As the only exception, in 1996 Alaska was allowed to export its oil output in view of the high cost of transporting it to the refineries in the Midwest and the Gulf of Mexico. It was simply less expensive to supply those refineries with oil imported from Mexico, Venezuela and Canada. However, since these were heavy, low-grade crudes, they could be bought at a considerable discount to WTI (the American benchmark crude), which is a light, high-quality oil. It should not come as a surprise then that many refineries made significant investments to be able to process these cheaper heavier varieties in place of light crudes, whose domestic production was dwindling.
The situation was changed by the shale revolution, which brought increasing volumes of domestic super-light crude to the American market. However, the growing production soon came up against limited demand for this type of crude from American refineries. Since oil could not be sold abroad, upstream companies were forced to sell their light crudes at a significant discount to increase domestic sales. The growing pressure on light crude prices in the United States is best illustrated by the changing spread (differential) between the prices of WTI and Brent (which is the European benchmark crude). Until 2008, WTI, which is a light, high-quality crude, cost one or two US dollars more than Brent. In 2008–2010, the situation reversed, with Brent often being more expensive than WTI. In 2011, when the production of light shale oil skyrocketed, the price of WTI declined by over 25 US dollars in relation to Brent. Since 2011, there have been 28 months when WTI was cheaper by more than 10 US dollars per barrel than Brent, including seven months when the difference exceeded 20 US dollars.
A consequence of the export ban, the decline in WTI prices in relation to Brent is not caused by the disproportion between the US market’s excessive oil supply and refining capacities, since refineries purchase additional oil abroad. What is problematic is the oversupply of light crudes compared with the available capacities to process them. In early 2014, the surplus was markedly reduced, sending WTI prices closer to Brent. The narrowing of the spread was due to an anticipated, and then actual, reduction in the shale oil production in America. The price pressure was also eased on account of permits, issued gradually over a year, for exporting minimally processed super-light crude oil known as condensate, and for swapping light American crudes for heavier Mexican varieties. For several months, the WTI/Brent spread has oscillated in the region of four US dollars per barrel, which experts believe to correspond to the cost of transporting shale oil to Europe.
If the ban on oil exports was lifted as of 2017, its effects would become manifest during the growth phase of the new mega-cycle in the oil sector, which according to the most likely scenarios should begin in late 2016 or early 2017. When crude oil prices begin to go up is extremely important, as their increase will translate into the growth of oil production in the United States. An increase in tight oil production will bring the prices back down and deepen the WTI/Brent differential, unless the additional supply is exported. In this context, it seems a sensible course of action to lift the oil export ban, which shifts the upstream industry’s profits to refineries by underpricing crude oil. Lifting the ban would benefit the upstream sector, which needs money to fund investment projects. What is more, American refineries would suffer no negative consequences either, as they have made significant investments to adapt to processing heavy crudes. Switching back to heavier imported varieties, chosen to optimally match every refinery’s configuration, would reduce processing costs. Only the refineries which are still best equipped to process highly efficient light crudes would lose their extraordinary margins. However, they would still benefit from a more predictable WTI/Brent spread.adamczyzewski