With the U.S. experiencing a period of rapidly increasing production of light tight oil (LTO) and Gulf Coast refining configurations geared toward processing medium and heavy crude, a growing chorus is calling for the end of the ban on US crude exports. The concern is, due to the medium/heavy orientation of the US refining sector, LTO will continue to be sold at a discount to foreign light oil prices (Brent). This discount will grow as increased LTO production is faced with growing refining bottlenecks and, eventually, will restrict LTO production in the U.S. Moreover, the issue becomes even more relevant particularly as oil prices retreat, largely because the barrier to trade limits fungibility and, as a result, could further hinder investment capital into the domestic upstream in a lower price environment.
However, voices sympathetic towards the oil ban can also be heard, especially of those concerned with retaining the high profitability of refineries with greater light oil capacity. Because refined product prices (including gasoline) reflect global crude prices, U.S. refinery margins, particularly for those buying U.S. LTO, have significantly increased. To bolster its anti-oil export position, a small group of refiners who formed Consumers and Refiners United for Domestic Energy, or CRUDE, has recently commissioned a study, “An Analysis of U.S. Light Tight Oil Absorption Capacity” (B&OB Sep 24, 2014 & Exec Sum), by Baker & O’Brien (B&OB) to analyze the ability of the U.S. refining sector to process increasing amounts of LTO. The study concluded that “The U.S. refining system is expected to have capacity to process all the LTO that will be produced for the remainder of this decade,” assuming production estimates in the EIA 2014 Energy Outlook. Thus, the study implies, there is no need to end the ban on oil exports. B&OB estimates that U.S. refineries could absorb a mid-point increase in LTO production of 3.6 MMB/D via (1) displacement of 2.1 MMB/D of U.S. crude imports of primarily light and medium grades of oil, (2) 1.3 MMB/D of capacity expansion, and (3) 0.3 MMB/D greater utilization of existing refinery capacity.
Importantly, the B&OB study clearly states that its “…analysis is focused on technical feasibility. No attempt has been made to assess refinery economics.” This is a fatal flaw. Without an economic analysis, it is not possible to determine the commercial feasibility of the technical assessment. For example, it is technically feasible to produce oil that costs $200 per barrel. But, it is not done because it is not commercially feasible. In the case of refinery operations and investment, the B&OB study leaves lingering questions around whether such displacement of crudes and refinery investment make commercial sense, and at what crude price differential would each occur. In fact, this study could not rule out the same increased US LTO absorption by US refiners even with an end of a crude oil export ban since it will still be “technically feasible” for U.S. refineries to run more LTO. Economics, not technical feasibility alone, drive refineries’ processing investments and crude slate compositions. Once economic considerations are entered into the equation, it is clear that the study does not address the issue of an increasing discount on LTO under the oil export ban, which in practice amounts to a “regulatory price subsidy” to US refiners of LTO and “regulatory price tax” for US LTO production.
In order for such prognostications of technical feasibility to occur, there would need to be a significant WTI discount to Brent. Why? Let’s use the results of the B&OB study to highlight. First, consider the 2.1 MMB/D of displacement of light and medium imports by increased LTO throughput given refiners existing configurations. In B&OB’s Illustration #1, a refinery processing 100 MB/D of medium crude is limited by the volume of naphtha and lighter material that can be processed. It is assumed that a LTO/heavy crude blend backs out medium crude imports. But in that illustration, as LTO becomes a higher portion of LTO/heavy blend, less total crude oil can be processed by the refinery due to unchanged naphtha/lighter capacity constraints. At a maximum of 65% LTO in an LTO/heavy blend, only 81 MB/D of crude can be processed and only 81 MB/D of products produced versus 100 MB/D in the base case. The same 23 MB/D of naphtha/lighter material would be produced as the base case but distillate plus AGO/heavier products would decline by 19 MB/D. A refiner would not consider such an increase in LTO processing without a significant US LTO price discount compared to Brent to make up for the drop in overall refinery output. The other two illustrations in B&OB highlight different mixes of LTO and medium/heavy crudes but, similarly, both yield a significant decline in refinery runs and output as the share of LTO increases at a refinery.
Second, B&OB estimated that new “firm” and less certain refinery projects will increase LTO processing capacity of US refineries by 1.3 MMB/D. However, it is not assured that even the projects B&OB considers “firm” would be constructed without a significant discount on WTI to Brent. For example, B&OB consider Valero’s announced investment to increase LTO handling at its refinery in Corpus Christi and its refinery in Houston as “firm.” Yet, according to an article in the Oil and Gas Journal ( OGJ Oct 14, 2014 ), a Valero spokesman stated that its investment planned upgrades would likely have to be reexamined if the ban on crude exports was lifted. The implication is that a US LTO price discount is key for the refinery investment, but the B&OB sheds no light on how big a discount would be needed for the investment to go forward.
Additionally, many of the identified projects are investments in new condensate splitters. And, the B&OB study includes no analysis of whether these projects are driven by the long-standing ruling by the Department of Commerce (DOC) that with some minimal processing, the resulting condensate stream (as well as the other products from the processing) can be exported. Meanwhile, the DOC has seeded confusion by permitting several exports of lease condensate from a field condensate stabilizer – an even cheaper way to export condensate than via a condensate splitter. If this new interpretation concerning condensate by DOC holds, the economics for more expensive condensate splitters may evaporate for many of the proposed projects even with a ban on crude oil exports in place.
In conclusion, the B&OB study commissioned by CRUDE does not bolster the case for continuation of a crude oil export ban. The CRUDE argument in favor of a crude oil export ban raises the question of whether US energy policy should be one of providing what is a regulatory-driven LTO subsidy to certain US refiners at the cost of lower US LTO production. Numerous studies concluded that US refined product prices reflect world crude oil prices (e.g. EIA Oct 2014 ) and, as a result, this subsidy is not being passed onto US consumers. On the other hand, an end to the export ban would support US LTO production potentially even contributing to lower world crude oil prices. As a result, US oil product prices, including gasoline, could actually be lower than under an oil export ban.
Post by Michael Maher, Senior Program Advisor, Center for Energy Studies at Rice University’s Baker Institute for Public Policy
