Why Oil Refiners Really Want to Keep This Regulation in Place

Businesses typically don't like regulation, but oil refiners really want this restriction to remain in place.

May 26, 2014 at 12:38PM

Rex Tillerson, the CEO of ExxonMobil (NYSE:XOM), once said that if oil traded solely based on supply and demand, oil prices would be $60 to $70 a barrel, not $100 a barrel. 

The reason for the discrepancy is speculation. Many financial institutions and hedge funds are long oil because they think it will go up in the future. Their net buying causes oil prices to trade substantially higher than what the underlying fundamentals justify.

Because of speculation's effect on oil prices, the U.S. government tacitly influences oil prices. Some regulations that promote speculation, for example, lead to higher oil prices while other regulations that dampen speculation lead to lower oil prices.

Divining the goals of government is difficult. While lower oil prices may be good for the economy in the short term, lower oil prices are bad for the economy in the long term. This is because lower oil prices leads to less investment and less investment leads to less oil produced in the future. Less oil produced in the future will inevitably lead to supply shocks and recessions.

Because the government is influential in the marketplace and its goals unclear, the regulations that government does promulgate are very important to oil prices.

To export WTI or not to export WTI
Among the many energy regulations, perhaps the most important is the current government restriction on exporting crude oil.  

The current export restriction was instituted in the 1970's during the Arab oil embargo when crude oil was in short supply. At the time, it made sense for United States to keep crude oil within its borders to promote energy independence and lower energy price volatility.

The crude oil export restriction makes less sense now. As a result of the shale revolution, the U.S. produced more oil last year than it has in any year since 1989. More importantly, many U.S. refineries cannot handle the lighter grade of oil produced domestically.

If the U.S. government does not repeal the export restriction, prices of the lighter grade crude oil, or WTI, are in danger of falling significantly due to oversupply. Indeed, hedge fund manger Zach Schreiber believes that WTI prices may be a replay of natural gas prices in 2012, a year that saw natural gas decline significantly. 

If the U.S. government allowed for exports of WTI, however, the chance of oversupply would be lower and the institutions long WTI contracts would be in a stronger position psychologically.

The bottom line
So far, the Energy Department has shown some signs that it wants the export restrictions to be repealed. The decision is not a final, however, and there will no doubt be intense lobbying on both sides. 

U.S. refiners such as Valero Energy Corp (NYSE:VLO) and Marathon Petroleum Corporation (NYSE:MPC) currently benefit enormously from cheap WTI. Valero Energy and Marathon Petroleum buy WTI as input, but price their products based on more expensive brent. The cheaper WTI becomes in relation to brent, the more profits the refiners make. 

If the U.S. government keeps its crude oil export restriction and WTI prices fall, the refiners may do even better than what they are doing now. Their share prices will likely rally significantly higher than current levels. If the U.S. government repeals the export restriction, however, refiners may not see as much upside. 

Whatever their belief that government regulation should be, the refiners no doubt want the crude oil export restriction to remain in place. 

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Jay Yao has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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