The age of US energy exports is upon us.
In 2013 international shipments of refined products and liquefied petroleum gases (propane and butane) reached record levels, fueled by new capacity and wide differentials between domestic prices and the value of these commodities in international markets.
This trend should pick up stream over the next several years.
By our count, midstream operators have approved projects that will add at least 18.9 million barrels per month of propane and butane export capacity through the end of 2015.
Meanwhile, major independent refiners Phillips 66 (NYSE: PSX), Marathon Petroleum Corp (NYSE: MPC) and Valero Energy Corp (NYSE: VLO) have all highlighted the importance of building additional capacity to export finished petroleum products, especially diesel.
Although US pipeline exports of natural gas to Mexico have increased significantly over the past two years, international shipments of liquefied natural gas (LNG) to international end-markets represent the next major release valve for the oversupplied North American market.
Cheniere Energy Partners LP's (NYSE: CQP) Sabine Pass project, which is slated to produce its first volumes of LNG in 2015, will have the capacity to export up to 2.2 billion cubic feet of natural gas per day.
In addition, the Dept of Energy has granted permits to four other terminals authorizing them to export LNG to countries with which the US doesn't have a free-trade agreement. As of Dec. 6, 2013, the queue of projects that had applied for this critical permit stood at 23.
All of these export projects support additional drilling activity and the ongoing construction of new capacity to transport and process this incremental production growth.
But what about US exports of crude oil?
The government has prohibited international shipments of domestically produced crude oil since 1973, when the Nixon administration placed the hydrocarbon on the Commerce Control List as an item in short supply.
This ban made sense at a time when the OPEC embargo and soaring gasoline prices made Americans acutely aware of their dependence on foreign oil.
The Case for US Crude-Oil Exports
Policymakers and regular Americans have long coveted the prospect of energy independence. However, few actually contemplated the ramifications of replacing our addiction to foreign oil with a newfound domestic supply.
Robust drilling activity in the nation's prolific shale oil and gas plays has brought these questions to the fore.
In 2009 US crude-oil production increased for the first time in decades. Output climbed by 15 percent last year and is on course to grow by a similar magnitude in 2013-an impressive feat when you consider that offshore oil production has declined since the Macondo spill in summer 2010.
(click to enlarge)
Source: Energy Information Administration, Energy & Income Advisor
The Energy Information Administration's most recent Short-Term Energy Outlook calls for US crude-oil output to increase by 15.5 percent in 2014 and 13.8 percent in 2015.
This upsurge in domestic production-much of which is light-sweet crude oil-has dramatically reduced US imports of oil exhibiting an American Petroleum Institute gravity that's greater than 35.1 degrees.
US imports of light crude oil declined by almost 32 percent between 2010 and 2012 and tumbled another 33 percent in the first nine months of 2013.
Independent refiner Valero Energy Corp estimates that imports of light-sweet crude oil to the Gulf Coast will shrink to almost zero by the end of 2013. In a presentation at the UBS Global Oil & Gas Conference, Valero Energy's CEO noted that these volumes had already declined to about 100,000 barrels per day in a normal month.
Recent trends in regional crude-oil prices provided an early glimpse of some of the ramifications of growing domestic output of light-sweet crude oil and a refinery complex that's equipped to process heavy crude oils.
In October 2013, the price weakness that has afflicted West Texas Intermediate crude oil extended to Light Louisiana Sweet (LLS) crude oil for the first time. This coastal benchmark traditionally has tracked the price of Brent crude oil because it competes with seaborne imports from international markets.
The recent weakness in the price of LLS suggests that the influx of crude oil to the Gulf Coast from new pipeline capacity, rail deliveries and surging production from the Eagle Ford Shale in south Texas pushed this regional market closer to an oversupply.
These trends give credence to Plains All American Pipeline LP's (NYSE: PAA) forecast that the US eventually could face an overhang of light-sweet crude oil. (See Blue-Chip MLP's Outlook for North American Energy Markets.)
Maria van der Hoeven, executive director of the International Energy Agency (IEA), kicked off the debate with US Must Avoid Shale Boom Turning to Bust, an editorial that appeared in the Feb. 6 Financial Times.
In this oft-quoted article, van der Hoeven makes two key points:
- The prohibition on US crude-oil exports means that refiners, not US consumers, reap the rewards of lower energy prices; downstream operators purchase domestic crude oils at a discount and sell the refined products at international prices.
- If growing production of domestic crude oil overwhelms refiners' capacity to process light-sweet crude oil, upstream operators could slow their drilling activity.
The IEA director warns that the asymmetry between regulatory policy and economic realities eventually will create a situation where "either US crude is shipped abroad or it stays in the ground."
Her conclusion: "Washington will need to address this misalignment, lest the great American oil boom goes bust."
The deterioration in LLS prices and growing inventory of crude oil on the Gulf Coast coincided with a number of articles and editorials in prominent publications highlighting the need for policymakers to end or relax the restrictions on US crude-oil exports:
- US Export Ban Has Oil Producers over Barrel (Oct. 14, Financial Times);
- Time to End the US Oil Embargo (Oct. 15, Financial Times);
- Exporting American Oil (Dec. 16, Wall Street Journal); and
- Obama Could Lift US Oil Ban without Congress (Dec. 18, Reuters).
After the Platts Global Energy Outlook Forum in December, US Energy Secretary Dr. Ernest Moniz reportedly acknowledged to the media that it may be time for the nation to review its ban on exports of crude oil.
Investors can expect to read and hear more about the push to export domestically produced crude in the new year, especially with independent producers reportedly ramping up their lobbying efforts.
The media will likely frame this contentious debate as an all-or-nothing battle between upstream and downstream operators, an approach that simplifies the conversation and amplifies the controversy.
As we've seen in the past, investors who take a measured view of the situation and keep a level head will be best-positioned to profit.
Limited exports of light-sweet crude oil shouldn't imperil the refinery industry's profitability; before the shale gale started blowing full force, many downstream operators invested heavily in upgrades to prepare their facilities to run heavy crude oils from western Canada.
With a number of rail terminals slated to come onstream in Alberta toward the end of 2014 and in early 2015, discounted output from Canada's oil sands will make its way to US refineries regardless of whether the Obama administration approves the controversial, cross-border leg of TransCanada Corp's (NYSE: TRP) Keystone XL pipeline.
Given the politically sensitive nature of exporting crude oil and the government's gradualist approach to LNG exports, we wouldn't expect any movement on exporting light-sweet crude oil until price action makes such a move more palatable.
Recall that the push for LNG exports gained momentum when the price of this commodity dropped to less than $2.00 per million British thermal units because of the no-show 2011-12 winter.
Two catalysts would make authorizing limited exports of light-sweet crude oil less galling to a skeptical public:
· Increasing global exports of US gasoline into an international market that favors diesel could pressure the price of this fuel; in turn, lower gasoline prices would make consumers more amenable to crude-oil exports.
· A building inventory of light-sweet crude oil on the Gulf Coast depresses prices to levels that prompt producers that lack access to favorable coastal markets to curtail production, underscoring the value of limited light crude-oil exports to balance the market.
Rather than open the floodgates to unfettered exports, the government likely will pursue a gradualist approach that involves approving export permits in the order in which they were received, with several months in between approvals.
And unlike capital-intensive LNG export projects, dock capacity to export light-sweet crude oil from the Gulf Coast should be relatively easy to come by.
Of course, any prognostication involving the federal government and North America's rapidly evolving energy markets is prone to uncertainty, especially when it comes to timing.
We see three opportunities for investors in the scenario that we laid out:
- Formerly high-flying shares of exploration and production companies could retreat to prices that make them more appealing from a valuation perspective. As always, investors should focus on high-quality names.
- Midstream operators such as Plains All American Pipeline LP that primarily handle crude oil should benefit from the uptick in crude-oil production that accompanies the eventual approval of exports.
- Outfits such as Oiltanking Partners LP (NYSE: OILT) that own significant liquids storage and export capacity on the Gulf Coast.
You can learn more about our favorite picks in Profiting from the US Energy and Manufacturing Renaissance.