U.S. Refiners Bet on Export Quotas

Phillips 66 (NYSE: PHX  ) and Marathon Petroleum (NYSE: MPC  ) say they want the U.S. to lift its ban on crude oil exports. Valero (NYSE: VLO  ) and PBF Energy (NYSE: PBF  ) feel the exact opposite. 

Why the differing opinions? Well, Phillips 66 says lifting the ban will help everyone with free trade at both ends of the crack spread. Valero counters by saying consumers will get hurt at the pump and lose jobs.

Today, the U.S. can export crude oil only to Canada. Other shipments by pipeline and train end up in Cushing, Houston, New Jersey, and Los Angeles, among other destinations. World-priced Brent trades around $108 per barrel while contracts settled at Cushing, OK, trade around $96 per barrel.

Refiners ship cheaper West Texas Intermediate, or WTI, oil to Gulf Coast refineries to reap large margins. During the past three years, the largest U.S. export has been refined products. Domestic demand for refined products continues to weaken with increases in fuel efficiency, mandated standards, and renewables in the energy portfolio.

How we got here
Ever since oil was discovered in Pennsylvania in 1859, politics focused on limiting cheap imports from Mexico and Venezuela to protect small, independent U.S. producers. In 1973, as part of the price control program and the 55 mile per hour speed limit regulations, crude oil exports were completely banned.

The Export Control Administration Act of 1979, along with a patchwork of other statutes and regulations, ran the export quota program. The act expired in 1994, and its provisions are renewed each year by presidential executive order.

The terms of the orders and the act are to limit export of any good that is in short supply, in the interests of national security, or other emergency situations. Crude oil seems to no longer be in short supply.

Business as usual
Valero and PBF Energy would like to keep taking advantage of even lower WTI due to increased inventories in the short run. Valero is also right if it were to think that under a lifting of export quotas, it might have to import light, sweet crudes as feedstock for its refineries. Refiners have already modified their refineries to process the Bakken's high-vapor, light, tight oil. Now they would need to further modify their refinery kit.

Lift the export quotas?
Brent, priced in the middle of the North Sea, may exceed the WTI price in Cushing, OK, by over $7 per barrel. This is some evidence of accruing WTI inventories. But even recently, with increased inventories and more building each year against existing refinery capacity, the Brent-WTI spread has been narrowing.

Brent prices crude everywhere but the U.S. Brent value impounds the political instabilities that lead to significant supply disruptions. Even supposing that the WTI is a perfect refining substitute for Brent crude, WTI does not carry a premium for political supply disruptions. Bakken, Eagle Ford, and Utica shale currently deliver crude, gas, and condensate to the Gulf Coast in spite of significant pipeline under-capacity.

In a world with no export/import quotas and sufficient supplies to meet demand, WTI should price lower and be in more demand on average than Brent. This is because Brent price security induced supply disruptions. Brent would also price oil globally to meet demand spikes.

If we factor in shipping from the North Sea to the Houston Ship Channel then it is possible to see WTI higher than Brent. Again this would be unlikely since the export quota would have been lifted, and WTI would freely flow to the rest of the world.

U.S. refinery jobs would still be plentiful as refinery kits would be outfitted to accept light, sweet crude from foreign sources, refine them here, and then export the value-added product. Alaska would have more markets to ship cargoes to as well. 

The U.S. then becomes a net exporter of crude in addition to refined products and self-sufficient to handle any supply disruption. The Strategic Petroleum Reserve is packed full.

One last Foolish thought
Suppose the U.S. lifts the export quota tomorrow. Our liquefied natural gas, or LNG, shipping capacity is expanded. The Navy rebuilds the fleet to provide more sea-lane security. China, Korea, and Japan continue to be net, and very large, importers of LNG.

Very inexpensive natural gas on the beach in the U.S. is chilled and shipped to Asia at prices that undercut current spot prices of $15 per million British Thermal Units.

China pays with U.S. Treasury reserves against its manufacturing capacity. Japan and Korea pay with semiconductors, cars, mobile devices, and flat screen TVs. The dollar strengthens against the yuan and rouble. This bodes a very interesting future.

How should you play this energy market?
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