Will Oil Prices in America Hit a Wall?

There's no doubt about it, the US energy market is pretty unique. Not only do we have a one of a kind natural gas market that gives us a competitive advantage for chemical manufacturing and LNG exports, but we also have a robust pipeline infrastructure that is getting better every day. Both of these elements have contributed to the boom in American oil and gas production, but there also one unique element of the US oil market that could slow it down: our inability to export crude oil. We are still a long ways off from being completely oil independent, so how could a ban on exports constrict the market? Let's take a look at why a 30 year old rule could hold back our boom in oil.

The Other Blend Wall
At first glance, it would seem a bit odd that we would need to start exporting crude oil. Even though we have turned around production in the US thanks to shale oil and increased activity in the Gulf, the US still imports about 9 million barrels per day. What is important to note, though, is the type of oil we produce and the type of oil we import.

Source: US Energy Information Administration

Much of the oil that we are finding today in shale plays is considered very light, sweet oil and we're growing our production of this particular type of oil very fast. Continental Resources (NYSE: CLR  ) recently announced that it is shooting for a production rate of 200,000 barrels per day by the end of 2014, which is 47% higher than the company's current production. They aren't the only ones, either. EOG Resources  (NYSE: EOG  ) expects a 35% increase in production from shale oil this year alone, and has plans to drill 500 wells in the Eagle Ford and Bakken formations next year. According to a recent report from Deutsche Bank, the US is expected to increase production of light, sweet oil by about 700,000 barrels per day within the next 12 months.

Source: EOG Resources Investor Presentation

This is in some senses good for the US, because these types of oil generally command the highest price point, and producing domestically does give a small discount based on today's prices. But, for refineries to run at optimum capacity, they need heavier, more sour oils as well.

This is where the situation gets sticky.

At this rate, we would produce more light, sweet oil than US refiners can handle. Also, since the US cannot legally export crude oil with some minor exceptions regarding crude originating from Alaska and oil destined for Canada, then any production that is greater than refinery capacity would essentially have no place to go. Based on the report from Deutsche Bank, this effect could result in the the spread between domestic and foreign prices growing and US crude prices dropping to $75-$80 a barrel.

Oil Prices....Not Gas Prices
This should be good news, right? The basic laws of supply and demand mean that gas prices will drop because supply is in abundance. There are two reasons why this isn't the case: 1) Our supply of gasoline is still limited by how much can be refined, and 2) There are no rules against exporting petroleum products. This means that excess supply of gasoline can be deflected to foreign markets, where refiners can command a higher price point. This past quarter, both Valero (NYSE: VLO  ) and Phillips 66 (NYSE: PSX  ) combined to export 420,000 barrels per day of gasoline and diesel. Furthermore, the two companies have plans to increase export capacity to about 500,000 for each company. With such a large release valve for domestic gasoline supplies, refiners like Valero and Phillips 66 will have a much stronger control of domestic gasoline prices. 

The Ripple Effect
Provided there is no action from Congress to repeal the oil export laws, then this emerging trend could have a deep impact across several sectors of the oil industry. As you can imagine, refiners would be elated to be given the keys to the gateway of American oil, because it could potentially lead to those magnificent crack spreads they enjoyed back in 2012. At the same time, domestic oil producers could find themselves in a situation very similar to what we saw in 2012 when the price of natural gas slumped because supply was outpacing demand. If Deutsche Bank's prediction were to come true, then domestic producers could see realized oil prices drop by 20-30%. This could put the brakes on US shale drilling very fast. 

What a Fool Believes
America's oil industry has fundamentally changed over the past few years, and the way that we think, regulate, and invest in it needs to change as well. It may seem counter intuitive to allow crude oil exports from the US, but in doing so we can maximize the value of our domestic resources. Since we have the ability to export gasoline but not crude, we're not going to see a major price change at the pump if we keep the ban in place. As investors, we should keep a sharp eye on domestic production and what Washington decides to do with the oil export ban because it will have a profound impact on the prospects for companies across the energy value chain.

Keep Up to Date
Rapid, unforeseen developments in the energy space like this one is why picking the right investments in this particular industry is so challenging right now. For this reason, we have put together a comprehensive look at the US energy landscape and identified three energy companies set to soar during this transformation in the energy industry. Let us help you unwind the complexities in the energy space and discover these three companies that are spreading their wings by check out our special report, "3 Stocks for the American Energy Bonanza." Simply click here and we'll give you free access to this valuable report. 


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  • Report this Comment On September 17, 2013, at 10:43 AM, Schneidku40 wrote:

    You know, it's interesting how differently the US regards oil compared to middle eastern countries, and even many others in OPEC (plus Mexico). Beginning in the 60s and 70s, many middle eastern countries evolved an attitude towards their crude oil as a national treasure, one which should be conserved for future generations. Several countries nationalized the oil production not just for the revenue, but also because they wanted their own countrymen to work with it. The US, on the other hand, mainly only talks about conservation of production in terms of national security (making sure we have enough for war times). I think our policymakers are very aware of this situation and would rather import as much crude as possible in order to conserve our own. OPEC countries obtained a huge amount of power in the 1970s once they realized how dependent western countries were on their oil. With that power has come a lot of problems for the US. Honestly, from a strictly strategic point of view, western countries would rather see the middle east pumped dry before becoming independent of imports. It's a classic war of atrition, and it's a game that has been played by governments on a worldwide scale for 100 years.

    Of course I understand the economic side of the coin as well, though. Oil field jobs have been booming at a time that the overall US economy is lackluster, and that can't be discounted. Without that increased energy production and investment in the US, our economy would have been in a very sore position for the last 3-4 years. The increased oil revenue from exports could help our country's financial situation. But as long as the country is muddling along in at least >0% GDP growth, I don't see it happening.

    This is why I don't see crude oil exports going up for the US anytime in the foreseeable future.

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