The U.S. oil industry has a very tricky needle to thread right now: It must convince the American public that exporting crude oil is in its best interest, when it is not.
The reason the industry wants to export crude oil is simple. U.S. refineries can't use all the crude coming from shale plays like the Bakken formation in North Dakota and the Eagle Ford in Texas. This boom in "tight oil" has created a bit of a glut for those specific grades of "light, sweet crude" because before the fracking revolution, most of the domestic refining complex was reconfigured to take in heavier sour crude grades of the sort we import from places like Saudi Arabia and Venezuela.
The oversupply has forced tight oil producers to sell their crude to refiners at a discount to the U.S. benchmark grade, West Texas Intermediate (WTI). For most of the past two years, for example, Bakken crude has sold for $5 to $15 per barrel (bbl) less than WTI.
Not only does the glut limit the profits of tight oil producers, it also threatens their ability to maintain their drilling rates, which are funded primarily with debt.
While tight oil producers and their boosters (most prominently, economist Ed Morse of Citigroup) talk about tight oil operations being profitable down to $70/bbl or less, they're often referring to the best "sweet spots" in the shale plays. In McKenzie, Williams, Mountrail and Dunn counties in the Bakken region, producers can break even at less than $40 a barrel, according to Lynn Helms, director of the North Dakota Mineral Resources Department. But Bakken producers generally need a price of $80 to $85/bbl to attract capital to maintain drilling, according to Reuters, and at $70/bbl or lower, spending would be jeopardized.
The $80/bbl threshold was reached more than once in recent years. In July 2012, some Bakken producers were forced to sell their oil for $65 to 70/bbl. Margins were generally acceptable in 2013, but prices fell to $71.42/bbl in November and $73.47/bbl in December, according to data released last week by the North Dakota Mineral Resources Department.
In short, the profit horizon for investors in debt-fueled drilling has been just a bit on the thin side, and it isn't getting any thicker. According to IHS Herold, more money has been invested in shale gas and tight oil exploration and production than the sale of those fuels has generated since 2008, leading to write-downs for many companies involved. (I detailed some of those losses in August.)
The problem for producers is that overseas exports of U.S. crude were banned after the Arab oil embargo of 1973. (Crude exports to Canada and Mexico are permitted, and exports of refined products like gasoline and diesel are unrestricted.) But U.S. refineries are pretty well maxed-out, and domestic demand for gasoline has been muted. The rest of the world runs on diesel, so diesel exports have been strong.
Business vs. business
The ban has had two consequences. The first is that domestic prices for gasoline have been lower in the United States than they would be without the crude export ban. The second is higher profits for refiners, because they can buy crude from tight oil plays at a discount, while fetching higher world prices for exports of refined products like diesel.
Producers need to find a way to get around the ban so they can export their oil to foreign refiners, where it would fetch at least $10/bbl more, and keep that investment cash flowing. If they can't do that, as I explained one year ago, the tight oil boom could go bust.
But they can't just come out and say that. Americans only want to hear about the promise of "energy independence;" they don't want to hear that independence will ultimately mean higher prices.
Instead, the oil companies deploy their business lobbyists, like Karen Harbert, president of the U.S. Chamber of Commerce's energy arm, the Institute for 21st Century Energy. "We have a mismatch between what we are producing and what our refining capacity is, and our refiners are not going to expend a tremendous amount of capital to meet this," Harbert told the National Journal. "We need to adjust to these market inefficiencies, which will benefit the American consumer over time." How, exactly, the American consumer will benefit, she didn't say.
Instead, they trot out their proxies in Congress, like Republican Senator Lisa Murkowski, ranking member of the Senate Energy and Natural Resources Committee, who has been stumping for lifting the crude export ban. "From a policy perspective, it's good policy, again, to allow for that level of trade. My interest is not to protect the refineries' bottom line," she said. And that's true. As a senator from Alaska, her interests are to protect the producers' bottom line.
Instead, we are treated to high-minded lectures by oil company economists about the virtues of open markets, as if our objective were to craft exemplary trade policy, instead of carefully stewarding our remaining resources and looking out for the best interests of U.S. consumers.
Instead, they get their pals at a Houston newspaper to pen a snarky political editorial about how "antiquated" the export ban is, invoking every moldy memory from President Jimmy Carter's so-called "malaise" speech of July 15, 1979 (in which he never uttered the word) to Nehru jackets and fondue sets. "When it comes to energy policy, the '70s aren't just 'so yesterday'; they're prehistoric," the editorial whined. C'mon, America, get hip! Don't you see how "now" and "today" crude exports are, some 44 years past the peak in U.S. oil production?
The other way to get higher prices for domestic crude would be for tight oil producers to cut back on their output to match the demand of refiners. But that would be silly. I mean, who ever heard of such a crazy notion? Like, you wouldn't expect a donut shop to only make as many donuts as people in town can eat, would you? Surely we all understand that we have to "drill, baby, drill" as fast as possible, and go get that money right now? Surely we know that the quest for "energy independence" can't wait?
Naturally, the refiners are against lifting the ban. Bill Day, a spokesman for Valero Energy, one of the largest American independent refiners, offered a bit of refreshing candor. “Since the sole reason to allow crude oil exports would be to give oil producers access to higher world prices, greater exports would lead to higher domestic oil prices,” he said.
And naturally, the unions oppose lifting it because it could hurt jobs, presumably in the refining, pipeline, and infrastructure sectors.
Everybody's interested in lining their pockets, and nobody cares about the long-term prosperity of the country, or the well-being of American consumers. Shocking, I know.
The last sip
As petroleum geologist Art Berman has quipped, the U.S. experience with fracking shale is "more of a retirement party than a revolution." We have burned through the big, accumulated reservoirs of oil, and now we're getting into the shale below them, or what geologists call the "source rocks" that created the oil. Once we get to the point where we can't produce oil and gas profitably from shale, we're done. Kaput. Toast.
That's why Berman calls it the "last gasp." Or, as I called it in 2012, the last sip.
As I explained then, there's only so much oil and gas we can reasonably expect to produce from these marginal, expensive shale resources. It's like a beer: We can drink it slowly or quickly, but it's not bottomless.
The real question for the United States is not about optimal trade policy or economic theory, but whether we want to extract the last drops of our oil endowment as quickly as possible by enabling the debt-fueled land rush that has brought us a gratifying, but temporary, bump in production, or whether we want to make it last as long as possible, knowing that two or three decades from now the world will be absolutely desperate for the stuff, with scarce exports and unimaginably high prices.
Good, transparent data analysis by Canadian geologist David Hughes of U.S. tight oil production suggests that it will peak around 2016. The latest projection from the U.S. Energy Information Administration (EIA) sees tight oil peaking by 2021. Either way, within a decade we'll be right back to competing with the rest of the world for the dregs. Even if the U.S. could ramp up production to the "energy independence" rate, it would simply cut the lifespan of our remaining oil in half.
In fact, U.S. "energy independence" is a chimera. The United States still imports about 40 percent of its petroleum. Credible analysts, including the EIA, do not foresee a day when U.S. crude oil imports will be eliminated. Ever. "Energy independence" is just a political slogan designed to manufacture consent for ever-more-disruptive drilling, and make the hearts of investors go pitter-pat.
More importantly to consumers, more fracking drives fuel prices up, not down.
Senator Ron Wyden, D-Oregon, has scheduled a hearing on the oil export question for Jan. 30. If you care about your future, I suggest you let your elected representatives know that saving some of our remaining oil for a rainy day is a better idea than lifting the crude export ban so we can suck the shale dry tomorrow. Out there in the not-too-distant future is not just rain, but a flood.
(Photo courtesy of Daniel Ramirez, Flickr Creative Commons)