Are Liberalized US Crude Oil Exports Finally on the Horizon?

As I mentioned a few weeks ago, a large segment of the energy policy world has suddenly realized that America's archaic crude oil export restrictions are really, really bad policy.  But things have just been kicked into an even higher gear with two new developments:

• In a much-publicized speech today, Sen. Lisa Murkowski (R-AK), ranking member of the Senate Energy Committee, advocated modernizing US policies for energy exports, particularly natural gas and crude oil.  Accompanying her speech was a new white paper on the same topic, which (among other things) highlights the serious economic problems caused by the current crude oil export licensing system (which is effectively a ban on exports to all countries except Canada), confirms the growing economic consensus that exports won't cause higher gas prices, and recommends that the President, the Commerce Department or (if the first two continue to do nothing) Congress relax the ban.  Just as importantly, Murkowski's views were recently echoed by Sen. Mary Landrieu, (D-LA) who stands to take over the Senate Energy Committee this year. That means that we could have bi-partisan support for easing the US crude oil ban on the Senate committee arguably most integral to any such reforms.
• Also today, the American Petroleum Institute's President and CEO Jack Gerard reiterated his organization's support for lifting the crude oil export ban:

  API's Jack Gerard on US crude exports: "action should be taken" to free oil trade. "It's time for a change of mentality" #SOAE2014
  — Ed Crooks (@Ed_Crooks) January 7, 2014

  Gerards's formal announcement echoes a few previous statements from folks at API (which is the largest US energy trade association and a big player on Capitol Hill) and is a good sign that they're going to push harder on this issue in the future. (API's related blog post, which calls the crude export ban "obsolete," certainly indicates as much.)

So, given these two big developments, does this mean that the US crude oil export ban will finally die the fiery death that it deserves in 2014?  I'm a bit pessimistic for two reasons.  First, Murkowski is not calling for a complete overhaul of the crude oil export licensing system (or its natural gas cousin): her white paper merely recommends that the Commerce Department or the President exercise their discretion within the current system and thereby approve crude exports to countries other than Canada (which, as noted above, enjoys a presumption of approval). And, according to the Financial Times, Murkowski stated today that any legislation from her on this issue would be “small, targeted bills” to “move the ball forward” - clearly not the overhaul (or total elimination of the system) that free traders, supporters of US energy production and our trading partners would ideally want.  Indeed, the maintenance of an ad hoc, discretionary export licensing system would do little to provide energy markets with the consistency and predictability that they need to operate most effectively, and probably wouldn't quell concerns that the export restrictions violate WTO rules.

Second, while API's support is obviously a big deal, there will undoubtedly be intense opposition to any reform efforts.  As the National Journal reported yesterday, some uninformed politicians and certain domestic refiners - who benefit greatly from the ban - have already come out against reform. Combine that opposition with the inevitable push-back from fossil fuel-averse environmentalists who, in John Podesta, now have a sympathetic ear in the White House, and you have a recipe for a big political battle in Washington and diminished hopes for quick resolution to this problem.  (Indeed, that Podesta's former digs, the Center for American Progress, immediately "blasted" Sen. Murkowski's remarks may be a good indication of what he's thinking.)

In short, crude oil exports could end up being like KeystoneXL or natural gas exports all over again - a frustrating and cripplingly slow process that's subject not to rational market forces but the mercurial whims of our political class.

And, make no mistake, the crude oil situation really is a problem.  As I've repeatedly noted over the last year, the current export restrictions raise a host of legal, economic and policy concerns:

• Original Cato paper on America's crude oil and natural gas licensing systems (and their economic, legal and policy concerns).
• Cato podcast on the need for free trade in energy.
• Reuters oped on the specific trade and economic problems caused by the US crude oil ban.

And, unfortunately, the serious oil supply disruptions contemplated in my Reuters piece - already experienced for natural gas - could be happening a lot sooner that anyone thought:

Oil is a global commodity; therefore, the global supply-demand balance is the primary driver of its price. However, transportation and refining capacity affect local pricing, which is what we as producers care about. The first red flag was pipeline capacity from the Permian to the Gulf Coast. While Permian oil production has risen from 850,000 barrels per day (bpd) in 2007 to an estimated 1.3 million bpd currently, the five inland refineries buying our crude have a capacity of approximately 410,000 bpd. That means almost 900,000 bpd needs to find its way to the Gulf Coast refining complex that stretches from Corpus Christi to New Orleans, or to Cushing, most of which ends up in the Gulf Coast. There is 450,000 bpd of pipeline capacity from Midland to Cushing, and once the four pipeline projects are all completed in 2015, almost 1.5 million bpd of capacity from the Permian to the Gulf Coast will be in service. Problem solved.

Well, not so fast. The problem is that refiners, including Shell/Pemex, Lyondell/CITCO, Exxon Mobil, and Valero, spent billions of dollars each primarily in the 1990s, as domestic sweet production declined, to modify their refineries to process heavy, sour crude from sources including Mexico (Maya), Venezuela (Orinoco), and Saudi heavy-sour. It is not coincidental that Pemex, CITCO (Venezuela), and Aramco (Saudi Arabia) formed joint ventures with refiners in the Gulf Coast in the 1990s to secure outlets for their poorer quality crude. It will cost hundreds of millions to convert each refinery back to sweet service, and the EPA is unlikely to approve a permit for a new refinery in the United States. It remains to be seen whether refiners will invest money to switch back to sweet service, but rest assured they will want a price that is competitive with the heavy sour grades from our Latin neighbors and the Middle East.

E&P companies have long dealt with gas-on-gas competition. Our industry drilled and developed natural gas so efficiently that we drove the price of gas down to a point where drilling for gas was marginal except in the most prolific plays in the best locations relative to consumer markets (e.g., the Marcellus). In addition, the Permian Basin and Eagle Ford have long suffered a glut of NGLs, especially ethane, the lightest and lowest valued component of the NGL stream. In 3+ years, the construction of ethane crackers and olefins complexes in the Gulf Coast for the export of products ranging from ethylene and propylene to plastics and fabrics will help alleviate the NGL glut. Between now and then, “Houston, we have a problem,”–a glut of NGLs.

The same phenomena will occur with the light, sweet crude oil and condensate that is produced from the Eagle Ford, Wolfcamp, and Leonard-aged formations that include the Bone Spring, Spraberry, and Avalon. The price at the wellhead in the Permian will likely be $10-30 per barrel below that of Brent crude, the new global benchmark for oil prices. The price of Brent or WTI Cushing will be irrelevant to Permian or Eagle Ford producers, as it will take discounting to induce an oversupplied sweet refinery to take one producer’s crude over another’s.

There are at least three market-based solutions to this quandary. One, the federal government should lift its ban on exports of crude oil. There are simple, “tea kettle” refineries in Mexico and other Central and Latin American countries that would buy our sweet crude if permitted to do so. We, in turn, import heavy, sour Latin crude to be processed in our complex Gulf Coast refineries. This amounts to a crude swap with our Latin neighbors. Two, refiners invest billions in the aggregate to convert their refineries back to sweet service. The impediment to this strategy is the fact that most of the incremental oil to be developed outside the U.S. is heavy sour, whose producers are willing to discount and enter long-term contracts to sell it. Three, prices fall into the $70s or worse at the wellhead and the investment and the rig count drops, reducing oil production, alleviating the problem. You see, E&P companies primarily reinvest their cash flow into leasehold, drilling, and completions. Few of the most active drillers in the United States pay a dividend.

Lower oil and gas prices mean lower cash flow and reduced rates of return on investment, thus reduced reinvestment, and slower production growth. It is a brutal self-correction mechanism that would have worked for natural gas if not for the large amounts of rich associated gas produced with the oil in our unconventional plays. None of us hopes to resort to the third option.

If the US government were smart, it would pursue the first option - completely lifting the ban on crude oil exports - as soon as possible.  Doing so would restore a little sanity to US energy policy (although more definitely needs to be done), and provide ample benefits for the economy.  However, if the aforementioned concerns and the government's track record with KeystoneXL and natural gas exports are any indication, US energy producers, consumers and market more broadly may endure a lot more pain before any serious, long-term solution is implemented.

If it ever is.