In the U.S., a Turning Point in the Flow of Oil

Source: By CLIFFORD KRAUSS, New York Times • Posted: Thursday, October 9, 2014

The tanker BW Zambesi before sailing to South Korea from Galveston, Tex., in July. The crude aboard was the first unrestricted export of American oil to a country outside of North America in nearly four decades. CreditEnterprise Products
HOUSTON — The Singapore-flagged tanker BW Zambesi set sail with little fanfare from the port of Galveston, Tex., on July 30, loaded with crude oil destined for South Korea. But though it left inauspiciously, the ship’s launch was another critical turning point in what has been a half-decade of tectonic change for the American oil industry.

The 400,000 barrels the tanker carried represented the first unrestricted export of American oil to a country outside of North America in nearly four decades. The Obama administration insisted there was no change in energy trade policy, perhaps concerned about the reaction from environmentalists and liberal members of Congress with midterm elections coming. But many energy experts viewed the launch as the curtain raiser for the United States’ inevitable emergence as a major world oil exporter, an improbable return to a status that helped make the country a great power in the first half of the 20th century.

Like just about everything else in the oil and gas business, petroleum exports are contentious. The oil bounty is thanks to modern production techniques including hydraulic fracturing, or fracking, which involves injecting water and chemicals into the ground to crack oil-saturated shale. Exports would mean more of that. Many environmentalists say fracking operations endanger water supplies or create other hazards, including air pollution. Ramping up exports of fossil fuels, critics will surely note, is inconsistent with the Obama administration’s push for a global climate deal.

The Valero refinery, in South Texas, is above the Eagle Ford shale field.CreditMichael Stravato for The New York Times

Independent refiners argue that exports could mean more expensive domestic oil for them, which they say could mean higher prices for American consumers.

Oil companies, and many independent economists, say just the opposite is true, because American exports would add to global supplies and lower international oil benchmark prices that ultimately determine the rise and fall of American gasoline prices. And with Russia causing mischief in Europe and the Middle East in turmoil, many analysts say allies would be happy to have a dependable supplier of oil. The oil companies appear to be grinding out a road to victory just as they have gained momentum in promoting natural gas exports against the opposition of some chemical companies and environmental groups that want to curb drilling and fracking. The Energy Department has begun a major study on the merits of exports, and how they would affect American consumers and United States energy security. Their previous study on gas exports backed the industry position.

Whatever the merits, the prospect of the United States becoming a major oil exporter was unthinkable as recently as 2008, when the conventional wisdom had it that the country was “addicted” — a word that even President George W. Bush famously used — to imported oil from unstable or unfriendly countries. Domestic production had been in free fall for decades as repeated presidential promises of “energy independence” echoed hollowly. But then came the frenzy of drilling in shale oil and gas fields across the country.

Domestic oil production has rocketed by roughly 70 percent over the last six years to 8.7 million barrels a day, and imports from members of the Organization of the Petroleum Exporting Countries have already been cut roughly by half. With domestic oil production growing month after month, many oil experts predict that the country’s output will rise to as much as 12 million barrels a day over the next decade, which would mean the country will be swimming in oil the way it is currently dealing with a surplus of natural gas.

Analysts at Turner, Mason & Company, a Dallas engineering consulting firm, say the country could hit a saturation point when production hits 10 million to 10.5 million barrels a day, at which point large exports will become necessary or drilling and production may have to slow.

“A flood is upon us,” John Auers, a Turner, Mason senior vice president, recently told energy executives at a Houston oil conference. “We are getting close.”

The country will continue to import some grades of oil for years to come, but energy experts says oil exports should rise significantly over the next few years because of a mismatch in the type of oil the country now increasingly produces and the mix of oil its refineries were designed to process. Shale oil is predominately light, sweet oil, meaning it is low in sulfur content and flows freely at room temperature. American refineries can refine only so much of it because they were structured to process abundant amounts of much heavier crudes imported from Mexico, Venezuela and Canada. That is leading to a crude-oil glut in parts of the country’s midsection already — which has pushed oil companies to lobby for expanded exports and directly led to that recent shipment from Galveston.

The United States has strictly limited exports since the Arab oil embargo, when President Jimmy Carter wore a cardigan sweater to encourage lower thermostats.CreditAssociated Press Photo

The Galveston sailing was historic because the United States has strictly limited exports since the era of the Arab oil embargo, when President Jimmy Carter wore a cardigan sweater to encourage lower thermostats and other measures to limit the country’s dependence on foreign oil. In sweeping legislation, Congress in 1975 directed the president to prohibit the export of oil as “consistent with the national interest,” although broad exemptions were allowed. Various administrations since then have permitted limited exports, including shipments from Alaska’s Cook Inlet and to Canada, but the issue rarely came up because the country was seemingly running out of oil.

But the buildup in light crude has continued to outpace the capacity of refiners to process and export it, and that has spurred new thinking in Washington. In what appeared to be a trial balloon, Energy Secretary Ernest Moniz last December suggested to reporters at a New York energy conference that it may be time for the administration to reconsider the export ban. “There are lots of issues in the energy space that deserve some new analysis and examination in the context of what is now an energy world that is no longer like the 1970s,” Mr. Moniz said at the time.

Energy Secretary Ernest Moniz has discussed reconsidering the export ban.CreditLeonhard Foeger/Reuters

The first baby step toward a new policy came in June when the Commerce Department approved applications from two Texas energy companies, Pioneer Natural Resources and Enterprise Products Partners, to export light liquid hydrocarbons known as condensates that are normally characterized as crude oil even though they share attributes of both oil and natural gas and normally are found in gas form in the ground. The government ruled that since the companies had minimally processed the condensates through a simple oil processing unit that separates the gas and makes it safe for transport, the result was now considered a refined product.

Since refined products like gasoline and diesel are legal to export, the Obama administration said that the decision did not signal a reversal of the crude oil trade limits. Nevertheless, oil company executives and many Wall Street analysts who follow the oil industry interpreted the move as being a fundamental shift in direction. The country can now potentially export 300,000 barrels a day of condensates, most of which come out of the Eagle Ford shale oil field of South Texas, easing some of the glut of a product refiners cannot absorb and thus improving the profitability of drilling in the zone.

But the wording of the Commerce Department ruling means oil producers can potentially export much more than just condensates, since the department said it covered all crude oil that is processed through a distillation unit. Basic distillation can occur at the wellhead at minimal cost, and the new interpretation is likely to unleash investment in basic processing of oil in the field to meet the export requirements.

“It was another crack in a process that is historic,” said Eric G. Lee, a commodities strategist at Citigroup.

Oil exports (including condensates) remain small, but they have already surged from 67,000 barrels a day in 2012 to 120,000 barrels a day in 2013 to more than double that currently. Citi Research estimates that under the new condensates ruling, exports could hit a million barrels a day by next year.

Another way the country is easing some of the glut is by exporting more refined products like gasoline and diesel. Exports of refined petroleum products have already soared to 3.4 million barrels a day from 2.3 million barrels a day in 2010. But most oil experts say that growth in such exports will be limited by United States refinery capacity and available export markets, especially if refineries planned in Latin America — a major market for American products — are completed.

That will leave exports of crude to soak up the excess production, but there are still political hurdles. United States exports of oil could reach three million to four million barrels a day in a few years, more than most OPEC producers currently provide world markets.

“The politics are hard,” said David L. Goldwyn, the State Department’s coordinator for international energy affairs in the first Obama administration. But he added, “When the economics become overwhelming, the politics will shift.”

For Mr. Goldwyn, American oil exports would increase Washington’s credibility in global trade talks, where the nation typically argues that countries with excess supplies should export them. They would allow China and India to diversify their supplies from the Middle East, and Europe to diversify from Russia, the Middle East and North Africa. Adding United States oil to world supplies would bring down the global Brent oil price benchmark, which would bolster the world economy, they argue.

The refiners disagree that American consumers would benefit, especially those who live in the Northeast and along the West Coast, who get their fuels from local refineries. Those coastal refineries depend on low domestic prices to offset high transport costs since they are so far from the Texas and North Dakota shale oil fields. With insufficient pipelines, coastal refineries are obliged under current maritime laws to transport domestic oil in a most expensive fashion — by barges that must be American-built and flagged; majority American-owned and manned by crews that are predominately American.

The refiners are joined in an unlikely alliance by congressional liberals like Senator Edward Markey, Democrat of Massachusetts, who argue that an extra couple of million barrels a day of American production will not bring down global oil prices as long as OPEC remains in a dominant position to manipulate prices by increasing or decreasing output at will. Senator Markey noted that the United States still imports a third of the oil it uses, about the same proportion as when Congress limited exports 39 years ago.

Many oil experts say that the debate will be settled when American oil production rises to such a high level that there are no longer adequate domestic markets for the sweet crude oil produced in the shale fields. That could happen as soon as 2017, some oil executives say. The telltale sign of a glut will be a collapse in the West Texas Intermediate price, the principal American oil benchmark price, which is currently about $3 below the world Brent price. That differential has been as high as $28 in recent years, but has been relieved by additional pipelines bringing American production to domestic markets and refineries for export of finished products.

If the spread cracks open, the economic arguments for free export of domestic crude will probably win the day, many energy experts say, while a narrower spread would keep the debate going. Many oil experts say it is only a matter of time before a much steeper spread emerges — leading to trouble for an industry that has done much to keep the national economy afloat in recent years. Gluts of domestic oil are already mounting in West Texas.

“You would see a significant reduction in drilling, resulting in a significant reduction in production, a significant reduction in employment in the industry,” predicted Scott Sheffield, chief executive of Pioneer Natural Resources, one of the two companies that won the initial condensate export approvals.

The White House and Congress would not let that happen, oil executives say.

Not surprisingly, Senator Markey took a different view: “They claim that exporting American oil to China will be good for oil companies and there will be no impact on American consumers and industries and our national security. If something sounds too good to be true, it probably is.”