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Summary

  • Wall Street Journal reports that U.S. Department of Commerce will allow Pioneer Natural Resources (PXD) to export crude oil. White House denies any change to ban on crude oil.
  • Exemption to oil export ban would allow PXD to capitalize on the significant spread between price of domestic and foreign crude oil.
  • Department of Commerce's action is a short-term windfall for PXD.
  • Long-term implications to PXD of lifting the ban on exporting oil depends on whether investors and refiners still view expanding refineries' capacity as attractive.

According to the Wall Street Journal (WSJ), the U.S. Department of Commerce recently issued a ruling that paves the way for Pioneer Natural Resources (NYSE:PXD) to begin exporting crude oil. Since the ruling was private, it's unclear what stipulations, such as volume limits, the Department of Commerce imposed, but WSJ suggested PXD could begin shipping oil as soon as August. The matter is complicated by a statement by White House spokesman, Josh Earnest, that there has been no change to US policy on exporting crude, but minimally refined petroleum product has always been exportable. The US instituted a ban on crude oil exports in 1973 in response to certain members of the Organization of Petroleum Exporting Countries' (OPEC) embargo against the U.S. in 1973. OPEC's action stemmed from the U.S.' decision to re-supply the Israeli military.

The market's short-term reaction to the WSJ report was clearly positive. PXD soared over 5% in the first trading day after the WSJ's story. Exporting oil will enable PXD to sell prices closer to the Brent crude oil benchmark (Brent). Enterprise Products Partners LP (NYSE:EPD), a pipeline company, also received permission from the Department of Commerce to export crude oil in a separate ruling from PXD's case. The shift in the government's position on exporting could be a material benefit for other domestic producers, such as Devon Energy Corp. (NYSE:DVN), Marathon Oil Co. (NYSE:MRO), ConocoPhillips (NYSE:COP), and Murphy Oil Co. (NYSE:MUR). Lifting the ban on exporting oil would be a significant negative for major refiners, such as Valero Energy (NYSE:VLO), PBF Energy (NYSE:PBF), and Phillips 66 (NYSE:PSX).

Today, the export ban confines PXD to the market where price is approximated by the West Texas Intermediate benchmark (WTI). The chart below demonstrates the spread between Brent and WTI widened dramatically in 2011 and has remained in Brent's favor. If the WSJ report is accurate and today's spread persists, PXD should realize $5 more per barrel less any incremental costs of trading outside the U.S., such as transportation.

Source: U.S. Energy Information Administration

The unusually large spread between Brent and WTI is likely a consequence of the combination of an unusually strong growth in U.S. oil production and stagnant growth in U.S. refining capacity. The chart below shows that domestic oil production has increased 39% since 2009 when it ended a streak of 16 years of consecutive declines in production. Conversely, U.S. refining capacity is essentially the same as it was in 2009.

Source: U.S. Energy Information Administration

The dramatic widening of the spread between Brent and WTI seems obvious in retrospect. The demand for refining capacity increased significantly because U.S. oil companies ramped up production and the export ban forced them to use domestic refineries. However, the supply of domestic refining capacity did not increase to satisfy the surge in domestic demand. Even a C student in Microeconomics 101 knows that increasing the demand for a product while holding its supply constant will cause the product's price to increase.

Understanding the domestic refiners' strategy is one of the keys to determining whether lifting the export ban is a significant positive to PXD in the long-term. There are several reasons why refining capacity did not grow in tandem with domestic production.

  1. Adding refining capacity is an expensive and time-consuming project. Refiners and investors would want to be sure that the expansion into domestic production is permanent especially since it is largely driven by fracking which is controversial.
  2. Domestic refiners still import the majority of their crude oil even after the recent boom in domestic production. Consequently, domestic refiners' will focus on global oil consumption, not domestic production. Global oil consumption has been stagnant in recent years due to a combination of the recession and an emphasis on conserving energy.
  3. The U.S. export ban created an imbalance in supply and demand that was advantageous to the domestic refiners. Building additional refining capacity would diminish that advantage.

An increase in domestic refining capacity could have been a better outcome for PXD than lifting the export ban. The WSJ article notes that 20 refining projects with capacity totaling 900,000 barrels per day have been proposed, and lifting the export ban could jeopardize those projects. The price of oil reflects global oil consumption and global oil production. The Brent-WTI spread reflects imbalances in regional supply and demand. An increase in domestic refining capacity would have eliminated the Brent and WTI spread because domestic refiners would have reduced their offering price for Brent crude oil to ensure an adequate utilization rate for their additional capacity. Eliminating the Brent-WTI spread would save PXD the transportation, taxes and other costs involved with exporting oil.

Increasing domestic refining capacity and lifting the export ban are not mutually exclusive. Investors and refiners could view the Department of Commerce's decision as an indication that the government is comfortable with fracking; therefore, the increase in domestic production is more likely to be sustainable. Furthermore, the White House's response to the WSJ article suggests that the rulings for PXD and EPD are not a landmark shift in the government's position on exporting crude. Consequently, investing additional capital in refiners could still be very attractive.

There is still one more piece to the puzzle. Domestic refiners' utilization is below peak levels. If the wide Brent-WTI spread results from an imbalance between domestic production and domestic refining capacity, domestic refiners' should be operating at maximum capacity. Utilization has been hovering between 88% and 89% the past couple years. That level is below the peaks in the mid to late 1990s. The reason for the under utilization is unclear.

Source: U.S. Energy Information Administration

Conclusion

In the short-term, lifting the export ban has improved PXD's within a Nash equilibrium. A Nash equilibrium is a non-cooperative game where each player knows the others' equilibrium strategies and none of the players has anything to gain by changing only their own strategy. PXD will soon have the option to export some of its crude oil production, and it will likely exercise that option if the Brent-WTI spread remains material.

The long-term implications of the lifting the export ban are more complicated. The critical question is whether lifting the export ban will decrease capital investment in domestic refineries. If that occurs, PXD may have been in a better position with the export ban in place.

Source: Exporting Crude Oil: A Short-Tem Windfall And A Long-Term Question Mark For Pioneer Natural Resources