Since Washington lifted the decades-old restrictions on the export of U.S. crude oil more than two years ago, overseas trade in oil has boomed. The United States is now exporting about 2 million barrels a day of crude oil, making America a major supplier in international oil markets.
American crude oil, along with condensate and natural gas liquids have disrupted global trade patterns, seizing a bigger share of some of the most prized petroleum markets in the world, including the Asian consumption engines China and India.
One challenge facing U.S. exporters is that they often have to sell crude at a steep discount to other global benchmarks. The West Texas Intermediate (WTI) domestic benchmark at the start of January traded at a $7-per-barrel discount to Brent, a North Sea crude oil that is considered the global benchmark. WTI last year also regularly traded at a $2 discount to Dubai oil, a Mideast benchmark relied on heavily by rapidly growing, energy importing Asian economies.
The main reason for the discounts has been pipeline and infrastructure bottlenecks – a glaring lack of takeaway capacity that has caused difficulties transporting crude efficiently. While shale production has boomed, investment in pipelines and other infrastructure has failed to keep up. Producers have relied on inefficient logistics – moving crude by rail, truck, barge or using “ship-to-ship” transfers – as they deliver to buyers abroad. When logistics become too heavy a lift, surplus oil is stored in Cushing, Oklahoma – the pricing point for WTI. This depresses the WTI price and helps explain the steep discounts on U.S. crude relative to rival foreign supplies.
The fact is that refiners in America’s refining hub are processing as much light, sweet crude – the type of high-quality oil produced by the nation’s surging shale basins – as possible. That means any incremental barrels produced this year must be exported; no small task. The U.S. Energy Information Administration (EIA) estimates that total U.S. crude oil production will increase 1.3 million barrels a day this year to hit a record 10.7 million barrels a day. Output is expected to close out 2018 above 11 million barrels a day. Some independent analysts believe the EIA’s forecast is too conservative. In 2019, EIA expects production to average 11.2 million barrels a day, with the overwhelming bulk of the growth coming from the Permian Basin in West Texas.
The good news is that additional pipeline capacity and other long-overdue infrastructure investments have been coming online recently, relieving some bottlenecks and allowing domestic inventories to be drawn down; strengthening U.S. crude prices. WTI’s discount to Brent has dropped to the $3 neighborhood.
Will the shale miracle continue or will it be constrained by a lack of infrastructure? The answer depends on how industry and policymakers respond to the new market dynamics. Consultant RBN Energy estimates various “midstream” projects could add 1.8 million to 2 million barrels a day in pipeline takeaway capacity from the Permian, “likely more than enough” to accommodate growing Permian output for the next five years.
However, for this to materialize, producers must make firm – and costly – commitments to shipping their oil on these proposed pipelines. Many will be tempted to let rivals do this and hope to benefit from the stronger price differentials without the obligation.
Producers must be certain of low-cost growth plans as investors are increasingly demanding greater capital discipline and higher returns. The sector must demonstrate that it’s confident in the long-term sustainability of the shale resource. Even if benchmark differentials narrow, analysts believe there will still be an appetite abroad for U.S. For countries like China and India, U.S. crude is a strategic decision that enhances their energy securityby lessening dependence on supplies from the Middle East and Russia. A trade war between China and the United States could change Beijing’s calculation, however.
What the industry needs from federal and state policymakers is predictability in the permitting processes for essential infrastructure so that investments can be made with confidence. Since taking office in January 2017, the industry has an ally in President Trump, who has moved to reduce red tape and regulations after eight challenging years under the previous administration. But tariffs on imported steel could hit U.S. pipeline companies hard and threaten the infrastructure investment needed for the shale sector to reach its full potential.
While Gulf Coast pipelines and infrastructure plans generally do not run into the sort of political opposition that bogged down the Keystone XL and Dakota Access projects, natural gas pipelines are more vulnerable since many run through Northeast or Midwest states where environmental activists are stronger. The state of New York, for example, has denied clean water certificates for the Constitution Pipeline and slow rolled the process of issuing a certificate for the Millennium Pipeline project, putting it at odds with the Federal Energy Regulatory Commission.
The tariff proposal is at odds with Trump’s goal of “energy dominance” and the White House’s recent $1.5 trillion infrastructure plan could help accelerate environmental reviews and permitting of gas pipelines. It would also give Interior Secretary Ryan Zinke executive authority to approve lines that cross national parks. The proposal – which calls for significant government spending – is a longshot in a contentious midterm year. Make no mistake, though, production growth in U.S. oil and natural gas will continue to be determined by the pace of infrastructure development. America’s ability to get the most from its export of crude oil and LNG – a fuel that emits half as much carbon as coal – is also on the line. Exports are the name of the game now, and tariffs and other measures that could prompt a trade war with oil and gas importing nations around the world are wholly counterproductive.