Crude Oil: The 'New' Kid On The Block

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Includes: BNO, CRUD, DBO, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Cornell Business Review

By Jessica Krause

For the first time in 40 years, the United States exported unrefined crude oil this summer. Two ships were granted refuge from the U.S. law, which illegalizes exporting crude oil. This exemption has sparked the controversial debate on officially overturning this ban. Policy makers enabled this exemption because they were carrying condensate, a lighter version of crude oil, rather than pure crude oil. But now, oil refiners, producers, economists, policy-makers and even the Wall Street Journal are all demanding to know: did this exception mark the beginning of a new era in the U.S. oil industry?

A Brief History:

In 1973, the Arab Embargo caused the western world to rethink its energy policy. In reaction to the crisis, the Energy Policy and Conservation Act of 1975 was signed into law by President Ford to block exports of U.S. crude oil and natural gas. The stated goal of this act was to increase domestic energy supply and production.

Since then, the U.S. has experienced a surge in domestic production of oil, which has resulted in a plea from oil producers to enable exporting. Domestic oil production has increased 70 percent over the last six years to about 8 million barrels a day, which marks the peak production since 1988. This growth can mainly be attributed to new drilling technology, such as fracking. Horizontal drilling has unlocked a high supply of condensate, a light crude oil that is typically mixed with heavier oil. It was this extraneous condensate that was recently exported, sparking the oil debate. This new supply is starting to resemble the oversaturation of natural gas in the U.S. market, leaving producers and politicians alike questioning the relevance of the 1975 policy.

The Battle on the Hill Today:

The newly elected and re-elected Congress members need to reach a decision on the relevancy of this law. They can secure the current ban, enable exporting, or delay the decision. A key player in the decision to keep or overturn this ban is the Chair of the Senate Energy & Natural Resource Committee. Pre-elections, this was Mary Landrieu (D-LS). However, neither Landreiu nor her opponent, Bill Cassidy, made the required 50 percent of Louisiana’s vote, meaning a re-vote will take place in December. By not winning the majority, she lost her title as Chair of the Senate Energy & Natural Resources Committee. U.S. Sen. Lisa Murkowski (R-AZ) is expected to take over that position as she watched her party take over the Senate. Murkowski recently said in an interview that she would approve the Keystone XL oil pipeline (which would run from Canada to the Gulf of Mexico) as well as push for exports of liquefied natural gas. Currently, the domestic natural gas supply remains larger than that of crude oil. Nonetheless, the enabling of gas and oil flow would certainly indicate Senator Murkowski is willing and able to overturn this ban.

Why Keep This Ban?

Oil refiners are the major proponents for keeping the ban, but many economists and politicians alike argue that the everyday consumer of gas and oil in the U.S., will be worse-off by the overturn from a hike in gas prices. Additionally, supports of the ban argue it would reduce refined oil exports, and that the time isn’t right.

First, by selling more crude oil, supply will decrease for oil producers within the U.S, artificially creating a shortage, and thereby raising prices. Since 52% of oil consumed in the U.S. is produced domestically, a supply drop could increase consumer prices. The U.S. is actually experiencing a price low in oil, and some argue they’ve been selling approximately $13/barrel less than the international standard for the previous three years. This makes the price more vulnerable for an increase.

While crude oil has been dropping in price, refiners have watched their revenues double over the past few years. Valero Energy is the U.S.’s largest refiner and its net income has doubled since 2010. These are the companies that would experience cannibalized revenue, which could stunt the U.S. oil industry as a whole.

Finally, Capitol Hill may be justified in voting to decide on this issue later. The U.S. still imports 7 million barrels of crude oil each day (almost half) so the case can easily be made to simply decrease imports before increasing exports. Additionally, since the U.S. is so new to experiencing this surge in crude oil, there is no infrastructure in place to physically transport the oil. This could take up to five years, which may be too late to capitalize on the boom. Former Director of Energy Policy in the Treasury, Philip Vergler said, “The real threat to the U.S. oil boom isn’t a lack of exports, it’s the lack of efficient ways to move crude around the country.” In other words, by the time the infrastructure is ready, the U.S. may have already missed the optimal time, resulting in large fixed cost losses by all parties.

Why Overturn This Ban?

Supporters of overturning the law argue that the U.S. overall position in the world economy would be enhanced through increased job creation, a reduced trade deficit, and oil industry contribution to GDP.

Given the infrastructure needed and labor-intensive process of extraction, domestic job creation is a major plus for overturning this ban. However, since it is unknown exactly how many producers would get in on the oil business, job creation figures are almost impossible to accurately predict, leaving for a wide range of interpretation. The American Petroleum Institute estimates 300,000 jobs created by 2020 but an energy research firm, IHS, optimistically projects that 1 million jobs will be added to the U.S. economy. This research firm also forecasts a $22 billion cut in the trade deficit by 2020.

Rather than look at job creation or trade deficit, Goldman Sachs analyzed the position from the standpoint of overall GDP. Oil extractors (or producers), would see a slight increase in revenue from exportation. At the same time, oil refiners would experience a major decrease in revenue. The result would be a marginal increase of about $5 billion to crude oil’s total contribution to U.S. GDP, which is currently about $800 billion.

Now or Never… or Maybe Just Later?

If an economic case can be made to overturn the ban, the question becomes: when? Goldman Sachs found that refiners are producing at about 91% capacity currently, so they recommended waiting full saturation in the market. Policymakers will be able to tell when this happens as U.S. crude prices will trade at a significant discount when compared to international prices. This seems simple enough, but how much is a significant discount? Oil extractors are arguing that time is now. The estimated breakeven price for oil is about $85/barrel, and when this study was done this summer oil was trading around $100/barrel, but now in fall prices have dropped down to break-even range. Goldman announced in the summer that because of this margin, a price drop won’t be devastating to the refiners, but now policymakers, economists, and consumers will need to decide: does this recommendation still stand?

The Deputy Director of the Energy Institute at the University of Texas, Michael Webber, finished his thoughts off crisply, “This debate is a major slugfest between industrial consumers and producers of oil.” Whichever way the vote goes, changing U.S. energy policy sends a clear message to the rest of the world and will definitely have snowballing effects throughout the globe.

Disclosure: None