27 February 2014

Ten Things You Should Know About Oil Exports

By Frank A. Verrastro, J. Robinson West, Molly A. Walton 
FEB 25, 2014 

On the heels of the shale gas and tight oil revolutions, as America shifts from import dependency to increasing self-sufficiency and exports, much will be written about how domestic gasoline prices and the nation’s national security will be impacted by increased domestic oil /liquids production. A number of analyses will be undertaken, models developed, and conclusions drawn about whether a surge in U.S. output will benefit consumers. Inevitably, most will be inaccurate as the market has a way of unraveling twenty year forecasts – often in a matter of months! And inevitably commentators and market watchers, single issue advocates and policy enthusiasts looking for certainty in an uncertain world will nitpick the various assumptions and models attempting to disprove or support a particular point of view. 

All that said, a couple of major points are worthy of being repeated: namely that despite both being hydrocarbons, the markets, uses, and handling of petroleum/oil and natural gas are distinctly different. Secondly, the regulations governing the export of domestic oil trace their origins to policies developed in the 1970s in the aftermath of the oil embargo - during a period of perceived domestic resource scarcity and rising demand – and one dramatically different from today.

Over the course of the next months and years, new policies will be advanced seeking to promote enhanced energy security and to align that with the nation’s economic, foreign policy and environmental goals. As we begin that discourse, we offer the following points to help frame and guide that debate: 

From a purely volumetric perspective, making additional barrels available to global oil markets anywhere in the world is good for consumers. It reduces competition and puts downward pressure on prices. Since crude oil (raw materials) costs account for the greatest proportion of gasoline prices, all things being equal, a reduction in crude costs should decrease NOT increase fuel prices. 

If incremental demand results from lower prices (environmental impacts aside for the moment), the added barrels can be used to supply consumers and is an indication of positive economic growth (also a good thing). If the overall supply still exceeds demand, warranting selective production cutbacks, the result will be an increase in global spare capacity. This spare capacity cushion can be used to mitigate price spikes caused by scheduled or unscheduled supply disruptions, which will almost certainly continue to occur. 

The U.S. has long been a nation that espouses free trade. In times when we needed extra widgets we looked to global suppliers to meet demand we could not satisfy from domestic sources. We have vociferously opposed the notion of global producers holding back supplies, restricting trade or using strategic resources/energy for foreign policy purposes. That policy has served us well for more than two centuries and ought not be reversed by virtue of being blessed with additional resources. 

Oil is a globally traded commodity but all oils are not alike in terms of quality, characteristics or value to refiners. U.S. Gulf of Mexico refineries are among the most sophisticated in the world and can convert lower quality (and typically lower priced) oils into high value middle distillate products. As U.S. demand for gasoline continues to decline, forcing refiners to utilize more domestic light oil will require costly infrastructure investments, but not improve the economics of the product slate refiners provide to meet consumer demand. Higher utilization rates will allow domestic refiners to churn out more refined product – including for export – there is both an economic and a technical limit to that approach. Forcing producers to shut in wells by denying export outlets will not improve the nation’s economics or security. On the other hand, permitting domestically produced light oil that is surplus to domestic demand to be exported will improve trade balances even though it may continue to require us to import complementary heavier oils that are more compatible with our demand and refining capability. 

As U.S. production continues to increase, infrastructurewill be increasingly challenged to provide safe and affordable delivery. Timing and sequencing are important as midstream investments typically take longer to put in place than new upstream production. Downstream (refining) infrastructure modifications take even longer. The net effect is that a transition will occur, but it will take time for markets and delivery systems to adjust to the change. In the interim, there will undoubtedly be seasonal issues, market distortions and price movements that at times may seem counterintuitive. And along the way, a serious re-evaluation of legacy policies governing things like Jones Act requirements and the size, disposition and management of the strategic petroleum reserve will need to occur. 

The importance of the Forward Curve: given the enormous advances in drill rig efficiency and technical improvements related to fracking and recovery, indicators like the rig count are no longer accurate proxies for projecting future production and development profiles. The success of shale gas development (in the absence of infrastructure and demand growth) inevitably led to price declines and similar conditions could undercut the economics of unconventional oil development. Current production is likely to continue but new investments could be at risk. Allowing export outlets will increase the marketability of those oils beyond domestic limits. 

As the technology spreads and the economics improve for producing unconventional oil and gas, more countries are likely to pursue indigenous energy forms, including fossil fuels. This development needs to bemanaged with responsible climate, safety and operational practices and regulations to mitigate local and global impacts. And while there is concern that the development of these unconventional resources will ultimately extend our fossil fuel future, in practice it will provide the breathing space necessary to develop and deploy next generation technologies for cleaner fuels that are at once scalable, reliable and affordable – even as we develop the resilient infrastructure and engineering needed to withstand the most damaging impacts of a climate already in transition. 

As energy and investment patterns shift, thegeopolitical landscape is also likely to change, altering trade relationships and creating challenges and opportunities for (both existing and new) regional and global partnerships. 

The development of unconventional resources will supplement not displace conventional oil and gas sources, and market forces will still hold center ground. The U.S. will soon exceed Saudi Arabia and Russia as the number one global liquids producer, but as a practical matter the world will need continued output from all three as collectively they represent over a third of global supply. In addition, even as the U.S. moves up to occupy a top producer slot, we are likely to remain an enormous consumer and importer as we currently produce around 11 million barrels per day (mmb/d) in liquids but demand exceeds 18.5mmb/d. 

As circumstances change, it will be necessary to develop better information, diagnostics/analyses and guideposts to identify emerging trends and patterns and develop strategies to address new challenges - and implement them in a timely and effective manner. Since nothing is a certainty or forever, policies and perspective need to be flexible, adaptive and collaborative to cope with changing circumstances – which are sure to manifest themselves in multiple ways. And we always need to be mindful of unintended consequences. 

Frank A. Verrastro is senior vice president and James R. Schlesinger Chair for Energy & Geopolitics at the Center for Strategic and International Studies in Washington, D.C. J. Robinson West is a senior adviser with the Energy and National Security Program at CSIS. Molly A. Walton is a research associate with the Energy and National Security Program at CSIS.

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