Many times we think the most important information to glean from quarterly conference calls relates to very specific details about a company's operations. However, in the topsy-turvy world of energy, conference calls are increasingly providing details on business models and macroeconomic trends that make these group chats a can't-miss quarterly tradition.
The most recent call at Plains All American Pipeline (NYSE:PAA) is a perfect example, and today we'll look at what CEO Greg Armstrong had to say about disconnect in U.S. oil markets. It's an issue affecting almost every aspect of the American oil and gas game right now, including production, midstream, and refining.
As domestic oil production has boomed across North America, our pipeline network has been overwhelmed, to say the least. The result of a lack of adequate infrastructure has resulted in the formation of gluts at oil hubs across the U.S. and Canada. The result of that is that there are actually many price disparities within the West Texas Intermediate benchmark, which itself trades at a discount to Brent, the world benchmark.
For example, crude at Cushing, Okla., fetches a lower price than crude sold at St. James, La. Oil in Midland, Texas, goes for even less, and oil coming from Canada trades for even less than that.
This situation explains why producers are so willing to pay a few extra dollars to ship their crude via rail to markets outside traditional hubs such as Cushing. It explains why companies such as PBF Energy (NYSE:PBF) built out rail terminals in Delaware, why companies such as Enbridge (NYSE:ENB) are building rail lines across Pennsylvania, and why companies such as Plains All American are securing rail terminals in Bakersfield, Calif.
Getting the highest price makes good business sense for producers, but more importantly, given the high cost of production, it's also absolutely necessary to keep the rigs drilling and the oil flowing.
On the Plains fourth-quarter call, an analyst asked CEO Armstrong what effect he thought the burgeoning production in Texas would have on discounting Louisiana Light Sweet Crude. Here's what Armstrong said in reply:
I think, for example, what we see in the next 12 months may differ from what we see 12 months beyond that point, or 24 months into the future. And so I think logistics is going to be a critical part of that. Rail, I think, is going to be the pressure relief valve in the short term. Longer term, there [are] issues with respect to Jones Act relief and potentially either exporting crude or exporting slightly refined crude products.
We know about rail, but Armstrong's mention of the Jones Act and potentially exporting crude deserves a closer look.
Two acts to know
Armstrong makes specific mention of the Jones Act and alludes to the Export Administration Act of 1979. The former stipulates that shipments from one American port to another American port must be made by American ships sporting American crews, while the latter allows the president to prohibit the export of commodities.
The Jones Act has been on the books since 1920 and was originally intended to protect American interests during times of national emergency. However, as editors at Bloomberg noted earlier this year, the Jones Act had to be temporarily suspended during our most recent emergencies, including Hurricane Sandy. It is also economically debilitating to the economies of Puerto Rico, Hawaii, and Alaska. Why? Essentially, the ban on foreign competition inflates American shipping rates. Allowing foreign shippers to move crude from port to port would, at least in theory, lower shipping rates and reduce oil gluts in certain regions by relieving bottlenecks. And in fact, suspending the act during Hurricane Sandy did indeed drive down the price of gasoline.
As far as the Export Administration Act goes, the thinking is that U.S. refiners only have capacity to process so much crude. Once our supply moves past that point, the stored oil becomes a huge liability. Oil drops in value as it sits, and low oil prices will make production in certain regions prohibitively expensive. Exporting crude would keep prices high and allow production to continue.
Consider the source
No one understands how the movement of oil affects prices like the people in charge of moving that oil. The midstream industry's entire livelihood depends on knowing where the oil is and where producers want to move it, even before the producers may know themselves. In short, Armstrong is an expert, and his words carry a certain weight as a result.
In fact, Valero (NYSE:VLO) has already received special permission from the Department of Commerce to export crude to one of its facilities in Canada. The company is using the light sweet crude from the Eagle Ford shale to displace imports from West Africa.
Armstrong, again, is on record with the idea that what we think right now may change wildly in 12 months, and again 24 months beyond that. The industry is in such a state of flux that there are no guarantees. Still, it is important to think about the effects that any potential rollback or adjustment to the Jones Act and the Export Administration Act might have on our investments.
It can be hard to catch every conference call -- or any conference call, for that matter -- but the transcripts are almost always available online 24 hours later, and investors should make a point of checking them out. The Q&A at the end is especially valuable for gaining insight on the larger trends that can dramatically affect our investments.