Here's What's Really Happening With Crude Oil Exports

You'll have seen, perhaps out of the corner of your eye, the stories about whether the U.S. should allow crude oil exports for the first time in some four decades (as an example, this mulling over the point at the WSJ). The argument is being pitched, from both sides, as being about what will best benefit the American consumer: This is not so. The arguments are actually about which group of businesses, and their shareholders, are going to gain some of the profits of the current oil boom bonanza. Nothing to do with us poor consumers at all.

The backstory
The background here is that as "unconventional oil" (that's the various shales, tight oils, even fracked oils) comes flooding onto the market from places like the Bakken we're seeing that internal U.S. crude oil prices are diverging from world market prices. This isn't supposed to happen: Oil is usually considered to be "fungible." That is, one barrel is much like another and we can swap them around without any problems. This is true to an extent, but it's not perfectly true.

Oil comes in sweet (little sulphur), sour (lots of sulphur), light and heavy forms just to give you the basic four types. And refineries will be set up to run on one or other of the forms, or perhaps a mixture of them, but a consistent mixture over time. It's also true that our desire for the final products will have an influence on which crudes we want to have refined. A heavy oil will produce more bunker fuel (for ships) and less jet fuel for example, while a light one more jet and gasoline and less bitumen or asphalt. It is more complex than this, but that's a useful rough and ready guide.

Therefore we have the mix of crudes that we desire to process given the final products we want and we've also got our oil refineries set up to process this particular mix. This becomes a problem when the crudes that we have available change in their nature, and that's exactly what is happening now. The tight oils from places like the Bakken are light and sweet -- which is great, we like that. But we've not got enough domestic refining capacity to process all of that light and sweet oil coming through the pipelines and on the trains. Further, we don't actually have the demand for the finished products, that avgas and gasoline, that we're likely to gain from processing that light crude.

A simple solution?
A pretty simple solution presents itself: There's this thing called trade. We sell some of our light sweet crude to foreigners, use that money to buy the heavier crudes that our refineries are set up to process, and which produce those heavier products we want to consume, and we're set. Except we can't do that: U.S. law says that crude produced in the U.S. cannot be exported except to Canada (and they've got lots of new oil themselves in those tar sands). The refineries are going gangbusters, and they think that this situation is just great; because, while we don't allow crude exports, we do allow exports of refined products like gasoline. So, the refineries can buy these new crudes at artificially low prices (and the discounts are substantial, anything from $10 to $30 a barrel), refine them in their refineries that are running flat out, and then export the products for the full world price. They get to pocket, therefore, that extra profit there as a result of the ban on crude exports.

The drillers are of course a great deal less happy about this. They want to be able to export the crude and get that $10 to $30 a barrel for themselves. And that of course is what all the argument is about. Who gets to make the money?

Sure, it tends to get dressed up rather differently: Both sides do and will be claiming that only their proposal benefits the U.S. consumer. That keeping the crude in the U.S. provides U.S. jobs at refineries perhaps, but the drillers can equally well say that higher prices for crude domestically will encourage more drilling and that will provide jobs too. And no one at all is actually saying that either way will make a blind bit of difference to the price of gas. For it's going to be either the crude or the gasoline and other products that get exported, so in the end this is all about the who gains the cash, not whether the consumer benefits.

The bottom line
In terms of positioning yourself for the final outcome, that really depends upon who you think is going to win. The obvious strategy is that if crude exports are allowed then independent drilling operators will rise, independent refineries will fall, and vice versa if the ban is maintained. But who will actually win? That's going to depend upon who has the greatest lobbying power, and that's not something that we'll really know until the war is over. So I'm afraid this isn't a great deal of use in telling you a trading strategy unless you have prior knowledge of who is going to get the law changed (or not changed) their way.

This won't affect the big integrated majors like ExxonMobil (NYSE: XOM  ) as they do both tight oil and refining. Any change would only alter which division was making profits. But Kodiak Oil & Gas (NYSE: KOG  ) would benefit from a decision to allow crude exports again. And independent refiners like Holly Frontier (NYSE: HFC  ) would likely see their currently fat refining margins fall if those exports were allowed. If the ban on exports is definitively affirmed then obviously Holly Frontier would continue with the good profit margins and Kodiak would continue to receive a discount to the world price for its crude.

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  • Report this Comment On January 27, 2014, at 10:07 PM, Basilleaf wrote:

    Thanks for the detailed explanation.

  • Report this Comment On January 29, 2014, at 11:44 AM, perdidobay wrote:

    This article sounds quite positive for HFC. Their geographic location as well as their refining diversity is another strength. The company appears to be stockholder friendly when you take into account the extra dividend. I have it in a nontaxable account, so I can keep the entire dividend.

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