Posted June 14, 2018
With Wall Street Journal headlines such as “Trans-Atlantic Oil-Price Spread Soars as Supply Glut Disappears,” it might be hard to remember that the United States’ domestic oil production stood at a record 10.5 million barrels per day (mb/d) in April, and the nation’s petroleum trade balance is in its best position in 50 years. This has reinforced U.S. energy security, lowered the trade deficit and boosted economic growth.
That said, given our country’s much improved energy outlook, some may question why we’re still importing crude oil and refined products. And, while we’re still importing oil, why do we export domestic crude – especially when prices have risen at the pump? Why don’t we just keep American oil at home?
In fact, these kinds of questions recently became a partisan flashpoint on Capitol Hill, with a group of Senate Democrats advocating the re-imposition of a ban on crude oil exports. Answers are found in an understanding of basic market realities.
First, while we point out that oil is a global commodity, almost no one consumes oil directly. It must be refined into the fuels, feedstocks, materials and products that we purchase and use in our daily lives. This means that physical characteristics – such as where oil is produced versus where there is refining or manufacturing plants, or the location of the greatest consumer demand – affect its usefulness and therefore value.
At the same time, you need different kinds of oil to make different products and, despite the rapid increase in domestic oil output, significant portions of the oil that is being produced here may not be what is needed to make all of the products Americans use. This underscores the need for flexibility in trading oil internationally – marketing supplies that might not match local needs to global buyers – which is integral to unlocking the United States’ productive potential.
For these reasons and others it’s neither practical nor in our country’s best interest to keep American oil here at home and opt out of the global crude market.
Let’s discuss three factors – oil location, quality and quantity – to understand how U.S. petroleum trade and the policies that foster that trade have complemented the strength in domestic oil production, which in turn has helped to increase global supplies and keep oil prices relatively low and less volatile.
Oil production, refining and demand can differ geographically. A main reason why the U.S. continues to import crude oil and refined products is that much of the infrastructure to produce oil, as well as refine and transport fuels, is in the mid-continent and U.S. Gulf Coast regions.
At the same time, many states with high motor fuel demand lack such infrastructure and instead receive fuels via shipping, rail and trucking. Florida, Oregon and the New England states are prime examples of states that depend heavily on more expensive transportation modes and imports. The map below shows the concentration of U.S. refining and refined product pipelines along the Gulf Coast and in the middle of the country:
Crude oil is not a homogenous product. The U.S. continues to import and export crude oil because the viscosity of oil (measured by its API gravity) being light or heavy and its sulfur content being low (sweet) or high (sour) largely determine the processes needed to refine it into fuel and other products. In general, refineries match their processing capabilities with types of crude oils from around the world that enable them to:
- Make the most high-value motor fuels and other petroleum products in a cost-effective manner; and,
- Serve niche product markets for chemicals, petrochemical feedstocks, lubricants, waxes and materials for roads and roofs.
While transportation runs primarily on motor fuels, our society also depends on thousands of products that begin as crude oil.
Heavier crude oils contain more complex molecules, so they are better for producing many of these niche products. However, turning heavy oil into high-quality products also requires more advanced molecular processing than is possible with simple refining or distillation.
Consequently, using heavy oil requires substantial capital investments in additional refining processes, such as cracking or coking, or so-called conversion capacity. With the requisite additional investment and processing cost, heavy oil typically has been priced less than light oil. In May, for example, Bloomberg data show that Western Canadian Select (WCS) heavy oil averaged $54 per barrel, while West Texas Intermediate (WTI) light crude oil averaged just above $70 per barrel.
The ability to process the heaviest crude oils has vastly expanded the Western Hemisphere’s oil resource and supply potential, as these oils come mainly from Canada and Venezuela. Therefore, many U.S. refiners are configured generally to process heavy crude oil.
Shifting purely to light crude oil could underserve some product markets and idle (or even strand) the hundreds of billions of dollars invested in refinery conversion capacity. The supply, demand and prices for various crude oils and products have continually solved this equation for producers and refiners to determine the role that crude oils of different qualities should play in the market, in accordance with economic fundamentals.
Since the U.S. energy renaissance has accelerated, however, most of the 4.8 mb/d of new U.S. oil production the past six years has been light oil. With U.S. refining capacity geared toward a diverse crude oil slate, a key implication for U.S. petroleum trade is that it would be uneconomic to run refineries solely on domestic light crude oil. Consequently, the United States:
- Must import crude oil of different qualities to optimize production, given its mix of refining capacity; and,
- Has more light crude oil than it can handle domestically, while this same quality of oil is in high demand in Asia Pacific and other regions that mainly have simple refineries (without conversion capacity).
Therefore, differences among crude oils are important reasons why the U.S. continues to import oil in an era of domestic abundance and export light oil that can be problematic, operationally and financially, to handle with existing U.S. refinery capacity (but also is of great value to refineries globally). This leads our third consideration.
The domestic petroleum market has largely been saturated even as the U.S. has played a growing role in expanding global oil supplies. This is indicated by the fact that through the first four months of 2018, U.S. refineries were using 90.6 percent of their capacity – the highest capacity utilization rate for the same four months since 2005. Gross inputs to domestic refineries over the same period set a record of 16.8 mb/d. The point is that U.S. refineries ran about as hard as they could even as U.S. crude oil exports also hit record levels, growing to 1.9 mb/d in April.
Separately, consider the U.S. petroleum trade balance. In April, the U.S. was a net exporter of 2.9 mb/d of refined products. Consequently, domestic refined product markets have experienced a surplus and have needed export markets to make them viable. Below, the U.S. petroleum trade balance and refined product detail for April, from the API Monthly Statistical Report:
Taken together, it has been a win-win scenario. Refiners have produced as much refined products as possible, more than satisfying domestic needs. At the same time, the expansion we’ve seen in U.S. crude oil exports has largely generated its own new domestic oil production, augmenting the United States’ role as the top global producer.
This matters. Basic economic principles tell us that any restrictions on crude oil exports could force the U.S. market to rebalance to serve only domestic crude oil demand. While there might a period where an oversupply of domestic crude oil could lower prices, the domestic supply of oil has shown an ability to adjust quickly and could effectively stall new investment and downshift U.S. oil production as capital flows slowed, rigs were idled, crews disbanded and midstream infrastructure went into limbo. In any event, restricting crude exports would not break the linkage between domestic and international prices – ostensibly the political objective – since U.S. refined products still would be able to be exported, as they were long before crude oil exports were enabled.
Ultimately, banning exports is misguided energy policy because it could disrupt new sources of crude oil production that otherwise would not be needed domestically, and the supporting economic activity that has accompanied it could be squandered.
To be clear, the different locations, qualities and quantities of U.S. crude oil explain why the U.S. has continued to import and export crude oil even as it has become abundant domestically. These activities are integral to the 10.3 million U.S. jobs supported by the natural gas and oil industry and the broader U.S. economy. The right policies, though, are necessary to help sustain the energy renaissance and continue to foster domestic production.
This means increasing access to resources (onshore and offshore), expanding infrastructure and cogent policies that enhance trade, reduce tariffs and protect investments at home and abroad.
ABOUT THE AUTHOR
Dr. R. Dean Foreman is API’s chief economist, specializing in energy and global business. With a Ph.D. in economics from the University of Florida, he came to API from Saudi Aramco Strategy & Market Analysis in Dhahran, where he managed short-term market monitoring and the long-term oil demand outlook. Foreman has more than 20 years of industry experience in corporate strategic planning, forecasting, finance / risk management and regulatory policy at ExxonMobil, Talisman Energy and Sasol North America.